Maquiladoras, also referred to as "in bond" or "twin" plants, are manufacturing facilities located in Mexico that process imported materials or commodities for reexport to the U.S. Businesses transport goods for repair or components for assembly to Mexico duty free. Once the goods are repaired or assembled, they are exported to the U.S. with a duty or tariff on the value added.

Maquiladoras were first established by Mexico's Border Industrialization Program of 1966. Initially, under this program, raw materials were sent to Mexican border towns and placed in bond so as not to enter the Mexican economy. These materials were processed in Mexico and exported to the U.S. and duty was collected by U.S. Customs.

To enhance competitiveness, reduce costs, and maintain quality, many U.S. companies place labor-intensive operations in less developed Mexico, in order to benefit from lower wage rates there. For many U.S. companies, manufacturing in Mexico has become necessary to battle overseas competition. With many manufacturers moving to "just-in-time" inventory systems, the quick delivery possible from Mexico's border towns offer a substantial advantage over Asian alternatives.

Removal of restrictions on non-Mexican ownership of maquiladora plants in 1972 was important to the growth of the maquiladora program, and recent growth has been phenomenal. Many companies are now pushing to allow maquiladora-produced goods to enter the Mexican market: this would require a yearly permit and be limited to 20% of production or 50% of "additional production" (current year production over previous year production).

The maquiladora program, now numbering approximately 1,800 U.S.-owned plants and employing half a million workers, is not without controversy. As the program has grown, critics have claimed the loss of U.S. jobs, while others point to the creation of over 100,000 U.S. jobs as a direct result of the maquiladoras. The general expert consensus, though, is that the program increases the cost-effectiveness of U.S. production by providing low-wage labor and helping businesses remain competitive worldwide. Any U.S. jobs that may have been lost to Mexican workers would otherwise have been lost to workers in Asia or elsewhere.

Preferred border town locations for plants have been in U.S.-style industrial parks in Ciudad Juarez, Nuevo Laredo, Matamoros, Mexicali, and Tijuana. The program worked so well that the Mexican government expanded the program in 1972 to include maquiladoras for the interior of Mexico in addition to the border towns. In establishing these manufacturing plants, U.S. companies are seeking low-wage workers, low operating costs, and fewer labor union restrictions.

The maquiladora industry provides security for the U.S. textile industry and is especially suitable for the apparel industry and others with high value-to-weight ratios and routine assembly operations. However, second-generation maquiladoras, like the Ford Motor Company plant in Hermosillo, rely more on skilled design and manufacturing than on basic assembly.

ADVANTAGES OFFERED BY

MAQUILADORAS

The chief advantages of the maquiladoras to U.S. firms are low wage rates, special tariff treatment, and easy access to U.S. transportation and communication facilities as well as technical, managerial, and support services. Mexico offers an abundance of low cost labor. The Mexican wage rate is very low by standards of major manufacturing countries and is actually lower than that of Korea, which is considered another low cost labor market.

The special customs treatment given maquiladora products is attractive to U.S. manufacturers. Under prevailing customs provisions, only the value added in Mexico is liable for tariff or duty. The value added is equal to the material, labor, and overhead costs incurred in Mexico. In addition, some products qualify for reduced tariffs or are exempt completely. The impact of tariffs and duties may be further reduced by use of Foreign Trade Zones. The most common use of Foreign Trade Zones. The most common use of Foreign Trade Zones by maquiladora operators is for the deferral of customs and duties, but they can also be used to change the duty status of imported products.

The vast majority of maquiladora plants are located in border cities that have adjoining U.S. sisters or twins. For example, a large number of maquiladoras are located in the Ciudad Juarez-El Paso and the Tijuana-San Diego areas. All U.S. cities that are major players in the maquiladora program are linked to the U.S. interstate highway system. Non-Mexican managers, technicians, engineers, and others involved in maquiladora programs often choose to live on the U.S. side of the border to eliminate many problems typically associated with an international transfer. Support services of all kinds and readily available in, or near, these twin city areas.

BUSINESS FORM

The Mexican government has been very supportive of the maquiladora program, requiring mainly that maquiladoras operate within the framework of Mexican laws. Recognizing the benefits that maquiladoras bring to Mexico, especially in alleviating unemployment, the Mexican government places few restrictions on them.

Under the Maquiladora Decree a foreign investor may only qualify for maquiladora status if it has a corporate presence in Mexico. The general rule in Mexico is that foreign investors may own no more than 49% of the stock of any Mexican company. As an important exception to the general rule, if the corporation operates under maquiladora status, it automatically qualifies to operate under 100% foreign ownership. For that reason, the great majority of maquiladoras are wholly-owned subsidiaries of foreign corporations.

Once a company has been incorporated in Mexico, in order to qualify to operate under maquiladora status if must receive approval for a Maquiladora Program from the Ministry of Commerce and Industrial Development. The company must submit information including: 1) the products to be assembled or manufactured and their intended use; 2) a brief description of the manufacturing process; 3) a breakdown of investment in fixed assets and projections on operating expense for a two-year term; 4) projections on the number of jobs to be created during the first two years of operation; 5) a list of all machinery, equipment, tools, and auxiliary items to be imported into Mexico for the manufacturing process and the fair market value of each item; and 6) a list of all components, raw materials, and auxiliary supplies to be processed, manufactured, or assembled in Mexico as well as the unitary weight and value of each item. Once the Maquiladora Program is approved, permits are issued for the importation of all listed items in (5) and (6) above. The Maquiladora Program approval is valid for an indefinite period and not subject to any renewal requirements.

CUSTOMS

Mexican Customs Law provides for two different manners of importation of merchandise into the country; permanent and temporary. Permanent importation involves the full payment of duties on imported items. Temporary importation allows an item to be imported without payment of a duty, provided it is eventually exported. Temporary importation is only allowed under special circumstances, one of those being for maquila-type operations. A company that has qualified to operate under the Maquiladora Program automatically qualifies to import the items discussed earlier, as well as trailers and containers for shipping.

On certain temporary importations a surety bond issued by a bonding company duly authorized to do business in Mexico is required to be posted by the importer of record with the Mexican Customs Department to guarantee that the imported items will be timely exported. The bond will be called upon if the importer of record cannot produce evidence that the goods have been exported as required.

To conform with U.S. Customs rules for export and import, the company exporting from the U.S. is required to have a General Export License for equipment, a General Temporary Export License for materials, a Commodity Control List License (a complicated form itemizing specifically the materials or articles to be exported) and a Shippers Export License to qualify for re-entry of the goods into the U.S.

U.S. Customs require that goods leaving the U.S. and expected to return must be registered at point of export to be eligible for reentry without paying duty. Included in this requirement are all materials to be processed in Mexico and also any equipment to be shipped to the maquiladora to be used in training or setting up the operation and intended to be returned.

Even while merchandise is in Mexico, goods must be warehoused separately from any products that may have been permanently imported or which are destined for the domestic market. Permanent inventory records of incoming and outgoing merchandise must be maintained, and records must be kept on outgoing merchandise setting forth the product and process for which they were used and the invoice with which they were shipped.

Temporary importation entails detailed record-keeping obligations for all items entering Mexico and returning to the U.S. Failure to maintain detailed records can result in substantial penalties and duties.

MEXICAN TAXES

There are no express exceptions made as to the manner in which the Mexican Income Tax Laws are applied to companies that operate under the Maquiladora Program. However, it is widely accepted that such companies may, to a certain extent, operate as cost centers rather than as profit centers. Most maquiladoras are structured so as not to be selling a product but rather as rendering a service. Maquiladoras typically receive a materials from their parent on consignment for processing and are paid the full amount of their operating expenses plus a certain percentage of profit. Mexican income taxes are payable only on such profit. To avoid challenges by the Ministry of Finance and Public Credit, transfer prices should be established which will result in Mexican taxable income equal to about 1% or 2% of sales. Losses should definitely be avoided because they provide no tax benefit in the U.S. The maximum corporate income tax rate is 35%.

As an alternative minimum income tax, Mexico enacted the Company Asset Tax. The rate is 2% on all tangible and intangible assets carried on the books of the company during the year. The amounts paid for this tax are then credited against the company's income tax.

Mexico imposes a Value Added Tax on all purchases of goods and services in the country. The general rate is 15% of the value of the product, but only 6% for many goods purchased in border areas. The Value Added Tax normally requires each party in the chain of production to collect the tax from customers and to pay the tax authority the difference between the tax collected from its customers and the tax paid to its suppliers. Maquiladoras, which export all their production, may receive a refund for any Value Added Tax paid in Mexico.

U.S. Taxes and Transfer Prices

A maquiladora is a subsidiary of a U.S. company and is therefore classed under the U.S. tax code as a controlled foreign corporation. For U.S. income tax purposes, when a U.S. taxpayer imports goods from a related party, there is generally an incentive to maximize the price at which the goods are purchased, in effect increasing the U.S. company's cost of goods sold, resulting in lower U.S. income taxes. If the imported goods are subject to import duties, there is also an incentive to minimize the value reported to the U.S. customs authorities, thereby reducing customs duties. IRC Sec. 1059A requires that importers must now reconcile their transfer prices for income tax purposes to those reported for customs valuation purposes.

The IRS has increased examinations of U.S. companies with maquiladora operations. Careful study of the transfer price, inter-company charge and customs valuation policy for any U.S. company incurring expenses in the U.S. that are related to the maquiladora operation is necessary to avoid problems arising from the interaction of income tax laws and customs rules.

Accounting for Maquiladoras

Mexican audit and accounting practices and reporting requirements are contained in the Mexican Commercial Code, the Mexican Corporate Law, and the Mexican Income Tax Law and its Rulings. Mexican companies are required to maintain accounting records and corporate books in Spanish and post them in Mexican pesos.

Mexican GAAP are issued by the Mexican Institute of Certified Public Accountants (Instituto Mexicano de Contadores Publicos). The Accounting Principles Commission of the Mexican Institute has issued a number of formal statements on GAAP and practices. They are, in essence, similar to those followed in the U.S. The most significant difference relates to inflation accounting. Mexican companies are required to recognize the effects of inflation in the accounting books and present the effects in basic financial statements.

Inflation adjusted data is not always useful to maquiladoras because their financial statements are usually expressed in the parent's foreign currency, to be consolidated or incorporated into the parent company's financial statements. In most cases, adjustments for inflation are not considered by maquiladoras.

The Mexican Corporate Law requires the appointment of one or more Statutory Examiners (Comisarios). The examiner has the obligation to carry out an examination of the operations, documentation, accounting records, and any other matters deemed and reporting requirements as the company's overseer. The examiner reports on the authenticity, sufficiency, and reasonableness of the financial information rendered by the administrators to the stockholders. Because of the personal legal responsibility imposed upon the Statutory Examiner, maquiladora companies generally follow the common practice of having the Mexican external auditors appointed as the Statutory Examiner when incorporating the company. When the Mexican external auditors are so appointed, they will normally request that an audit be performed by them to support their report.

OPPORTUNITY ... AT OUR

BACK DOOR?

Mexico's Maquiladora Program provides opportunities for U.S. companies to minimize labor costs in manufacturing, especially where the products manufactured are highly labor intensive. This may provide many companies the opportunity to compete profitably in international markets.

This article briefly discusses the Maquiladora Program and aspects of maquiladoras of particular interest to CPAs. Readers who wish to learn more about maquiladoras should refer to the bibliography, and research further before advising clients in this area. A thorough understanding of all costs - direct and hidden - of operating a maquiladora is needed to fully benefit from this type of operation. Another consideration that should be watched closely is the developing free trade talks with Mexico - what effects this will have on how successful maquiladoras will be for U.S. businesses is yet to be seen.

BIBLIOGRAPHY

Boyd, William R. and Ortiz, Bobby, "Offshore Sourcing - Mexico: Still South of the Border," Bobbin (June 1988), pp. 94-98.

Decree for the Promotion and Operation of the Export Maquiladora Industry (the "Maquiladora Decree"), Diario Oficial de la Federacion (December 22, 1989).

De Leon, T., "Maquiladoras: Accounting, Auditing and Special Tax Implications," a paper presented at the annual meeting of the Texas Society of CPAs, El Paso (1990).

Department of the Treasury, U.S. Customs Service Trade Agreement Act of 1979, (the "Customs Law").

Diario Oficial de la Federacion. December 30, 1981.

Groff, James E. and McCray, John P., "Maquiladoras," Management Accountant (January 1991), pp. 43-46.

Jacobson, Gary, "The Boom on Mexico's Border," Management Review (July 1988), pp. 20-24.

Iaberreche, Dr. S., "Vital Signs on the Border," Border Trax (June 1990).

Jacobson, Gary, "The Boom on Mexico's Border," Management Review (July 1988), pp. 20-24.

Ljundahl, William C., "Maquiladoras: Financing," a paper presented at the annual meeting of the Texas Society of CPAs, El Paso (1990).

McCray, John P. & Gonzalez, Juan J., "Increasing Global Competitiveness with U.S.-Mexican Maquiladora Operations," Advanced Management Journal (Summer 1989), pp. 4-7, 23, 38, 48.

Ochoa-Bunsow, Andreas, "Maquiladoras: Legal and Customs," a paper presented at the annual meeting of the Texas Society of CPAs, El Paso (1990).

O'Reilly, Brian, "Business Makes a Run for the Border," Fortune (August 18, 1986), pp. 70-76.

Project Link, a study prepared by the University of Texas at El Paso (December 1986).

Putnam, Karl B., Schroeder, Richard G., and Soto, Alfonso, "Functional Currency Elections for Maquiladoras," International Tax Journal (Fall 1989), pp. 287-320.

Regulations of the Law to Promote Mexican Investment and Regulate Foreign Investment. Diario Oficial de la Federacion (May 16, 1989).

Scanlon, J.J., et al, "Importation of Merchandise into the United States - Appraisement; Use of Tariff Sections 9801.00.10, 9801.00.40, 9802.00.50, 9801.00.60 and 9802.00.80; Generalized System of Preferences," a pamphlet of Kemp, Smith, Duncan & Hammond, Attorneys at Law (June 17, 1990).

Schwartz, Scott M., "The Border Industrialization Program of Mexico," Southwest Journal of Business & Economics (Summer 1987), pp. 1- 51.

Welles, L., ed., "Maquila Myths and Realities," Border Trax (June 1990), pp. 8-9.

THE IMPACT OF A NORTH AMERICAN FREE TRADE AGREEMENT

ON THE MAQUILADORA INDUSTRY

Free Trade and the Maquiladora

Maquiladoras are flourishing because they allow U.S. manufacturers to take advantage of "cheap" labor costs south of the border, while keeping duties and related costs of international trade at a minimum. Will a North American Free Trade Agreement eliminate the need for the maquiladora? What is the outlook after free trade for both the U.S. and Mexico? Some analysts contend that the maquiladora industry would become stronger, while others argue that a free trade agreement would erode some of the most important competitive advantages of the existing maquiladora program. Free trade between the U.S.-Canada-Mexico would establish the largest integrated market area in the world - with more than 360 million consumers and a joint GNP exceeding 6 trillion U.S. dollars. At this time, Mexico is the U.S.'s third largest trading partner after Canada and Japan. U.S.-Mexico trade has more than doubled in the last five years - with manufacturing accounting for 70% of that trade.

The dynamics of the maquiladora industry have benefitted not only Mexico but also the U.S. The maquiladora program has been in operation for 25 years, and in the current year, maquiladoras have had greater access to the domestic market in Mexico, due to changes in their regulation by the Mexican government.

The anticipation of a North American Free Trade Agreement has increased expectations in border cities of the U.S. as well as urban centers throughout Texas, including San Antonio, Dallas, and Houston.

Mutually Beneficial?

Many view a free trade agreement as an overall plus because it is a rationalizing process. All Mexican companies, maquiladoras and non- maquiladoras, must become more efficient producers because there will be a great deal more competition. The Mexican rationalization process began with trade liberalization policies developed during the 1980s. The state-of-the-art manufacturers operating in Mexico are examples of Mexico's modernization efforts - General Motors, Zenith, General Electric, Honeywell, Texas Instruments, Chrysler, and many other prominent U.S. companies. Other examples of assembly facilities in Mexico include sophisticated production units performing such tasks as molding plastic components, wiring computer keyboards, inserting chips onto printed circuit boards, etc. A free trade agreement would only intensify these rationalization processes and the presence in Mexico of U.S. firms.

Liberalization of an economy generally leads to more export activity, and increasing specialization and lean ness for existing companies. It also enables new companies to flourish and satisfy developing market niches.

On the Other Hand...

Elimination of barriers would reduce the protection from U.S. manufacturers enjoyed by Mexican producers because subsidies and import preferential programs will be eliminated. The impact of competition by U.S. manufacturers on the non-maquiladora industry will depend on the nature of goods being exported to Mexico. If U.S. manufacturers export complement goods of those produced domestically, a rise in U.S. exports to Mexico stimulated by trade liberalization will have a positive impact on the Mexican non-maquiladora industry. If goods are substitutes, the impact will be negative. Two possible resulting scenarios include: 1) Inefficient producers both in the U.S. and Mexico are wiped out; and/or 2) Mexican producers already operating in Mexico establish joint ventures with U.S. manufacturers to streamline operations.

What About Our Existing Free Trade with Canada?

The experiences of the free trade we now enjoy with Canada can be very helpful in anticipating changes in the nature of competition between Mexican and American manufacturers. The early efforts toward a free trade agreement with Canada in the 1970s and 1980s produced fear that Canadian industries would be all but wiped out by more efficient U.S. producers and that U.S. jobs would be lost. Quite the opposite actually occurred. Trade liberalization resulted in significant rationalization - fewer, larger, more efficient plants. The result was a larger, more efficient market created by free trade that allowed Canadian firms to exploit the benefits of economies of scale and scope at production and research facilities. Free trade also encouraged the growth of many U.S. firms through joint ventures with Canadian firms, and encouraged U.S. firms to establish a presence in Canada.

If our experience with free trade with Canada tells us anything, it is that free trade with Mexico can result in an anticipated growth in U.S.- Canada-Mexico joint ventures. This may result in a strong domestic manufacturing sector that is export-oriented and capable of serving the internal market with a strong Mexican presence mixed with foreign capital and technical expertise.

For information on maquiladoras or other investment opportunity in Mexico for U.S. firms, contact: Mexican Investment Board, Paseo de la Reforma 915, Lomas de Chapultepec, 11 000 Mexico D.F., Mexico.