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Significant Tax, Social Security Reforms to Impact Employment in Mexico
 

By Maria Rosario Lombera-Gonzalez  4/2/2014
 

Major legal reforms have recently been approved while others are still under discussion that will significantly impact employers in Mexico and in some specific cases, will considerably increase the cost of formal employment.

Provisions in the Income Tax Law have been modified and amendments are expected in the Social Security Law as well. In particular, the modification to the “base quotation salary” for the payment of social security contributions and an increase on the quotas for the illness and maternity branch of insurance. In addition, new legislation is under discussion at the Congress, establishing for the first time in Mexico the creation of unemployment insurance and a universal pension, tending to grant minimum financial benefits to individuals over 65 years old, who do not have a pension or social security system benefit.

Income Tax Law Reform

On October 31, 2013, the Mexican Congress approved a major Income Tax Law reform, entering into force on January 1, 2014. Three specific provisions of this reform will affect employers:

  • The first establishes that exempt payments for workers and employees such as fringe benefits (food coupons, savings funds, overtime, Christmas bonuses and others) will only be deductible up to 47 percent. The amended Income Tax Law provides however that if the fringe benefits paid in a given year are not reduced from the payments made in the immediately previous tax year, they will be tax deductible at 53 percent. It also establishes that the nondeductible portion of such payments shall be further deductible for the purposes of determining the base of the mandatory profit sharing payouts.
  • With respect to the contributions made by employers to create or increase the reserves for supplementary pension funds to those established under the Social Security Law, and seniority bonuses, such contributions will be deductible up to 47 percent. However, if the benefit paid in a given year does not decrease from the one paid in the previous fiscal year, such deductions up to 53 percent will be allowed.
  • In addition, the deductible amount for investments in automobiles was reduced from MXN 175,000 to MXN 130,000 pesos per unit. It also establishes a new limit of MXN 200 pesos per day for car leasing. Cars are usually granted as working tools in Mexico by employers to managerial and director-level positions to facilitate the execution of work-related activities. This particular provision will impact the type of automobiles granted to employees or increase the cost of this working tool.

Social Security Reform

In the framework of the tax reform, the Federal Executive Power submitted to the Congress an Initiative of the Decree to issue the Universal Pension Law and the Unemployment Insurance Law, in order to establish universal social security mechanisms.

In general terms, this reform proposes the following, regarding social security matters:

The Universal Pension Law. The purpose is to create a universal pension to cover those individuals who cannot obtain a tax-related pension, in order to grant basic well-being, protecting senior citizens from circumstantial events that may increase transient poverty or deepen poverty levels, providing economic support to these citizens through a monthly amount of MXN 1,092 pesos.

The requirements set for having access to such a pension are:

  • To reach the age of 65 years as of 2014 and not being a retiree.
  • Residence in national territory.
  • Be registered by the National Population Registry.
  • Have a monthly income equal to or less than fifteen minimum daily wages ($971.40).

In order to receive this pension, the Mexican Social Security Institute (IMSS) will verify that the universal pension applicant meets the requirements indicated above and will issue the corresponding resolution. If the resolution is favorable, then it shall notify the Ministry of Finance and Public Credit, which will be in charge of processing the corresponding payment. These pensions will be paid through the public budget.

Unemployment Insurance. The legislation proposes the creation of a new branch for a mandatory social security regime for unemployment. This insurance will cover employees who are registered by the IMSS in the mandatory regime of the Social Security Law.

In order to gain access to unemployment benefits, the following requirements must be met:

  • Having paid social security contributions for at least 24 months within a period no longer than 36 months, following affiliation to IMSS, as of the date when the last monthly payment for such benefit was made.
  • Having been unemployed for at least 45 calendar days.
  • Not receiving any other monetary income for retirement, pension, unemployment support, or any other similar reasons.
  • Proof of meeting some requirements set in the promotion, placement and training programs under the care of the Ministry of Labor and Social Welfare, basically tending to facilitate the re-employment.

This benefit and its corresponding administrative expenses will be funded through resources obtained from the employer’s mandatory contributions to the National Workers’ Housing Fund Institute (INFONAVIT), with a two to five percent increase in the amount of the dues paid to the institute.

An unemployed individual will be entitled to receive the benefit in up to six monthly payments, using first the resources accrued in the Mixed Sub-Account of his Individual Retirement Account and in accordance with the following percentages of the base salary for purposes of computing social security dues and benefits for the latest 24 monthly payments:

  • First Payment 60 percent.
  • Second Payment 50 percent.
  • Third to Sixth Payments 40 percent.

In case the balance in the Individual Sub-Account proves insufficient to cover the amount of the payments, then the benefit will be paid out of resources from a Federal Government Fund, in order to cover the difference, for an amount of up to a sum equal to a minimum wage per each remaining month until covering the full benefit. Should this fund prove insufficient, then the

Federal Government will cover the payment of any remaining difference through a sum equal to one month of minimum wages per each remaining month until the benefit is covered.

The payment of the benefit will be completed upon the unemployed individual’s receipt of all six monthly payments, entering an employment relationship, receipt of monetary income due to retirement, pension, or unemployment support of a similar or another kind, or upon the unemployed individual’s failure to perform the obligations set forth in the promotion, placement, and training programs under the care of the Ministry of Labor and Social Welfare.

Social Security’s Base Quotation Salary Modified

On April 25, 2013, the Chamber of Representatives approved a bill amending the Social Security Law which is currently under discussion in the Senate.

According to the Social Security Law in effect, the salary for the payment of social security contributions is integrated with all in-cash and in-kind benefits paid by the employer to the employee as a compensation for his or her work. Some concepts, because of their specific nature are excluded, such as working tools, savings funds, additional contributions granted by employers to the retirement insurance for employees, Christmas bonuses, Housing Agency contributions and profit sharing, food and housing, food coupons, assistance and punctuality bonuses, contributions performed by employers to pension funds, and overtime. All of the above will be subject to specific limits and conditions.

The reforms cancel or exclude some items (i.e., punctuality and assistance bonuses) and/or reduce the amounts not to be part of the integrated salary (i.e., savings funds, overtime, Christmas bonuses, profit sharing) and restrict the exclusion of others such as working tools, food and housing, to very specific conditions.

The financial impact of this reform, if approved, will raise the cost of social security contributions depending on the specific compensation package granted by each company and therefore, the cost of the impact cannot be calculated.

Conclusions

The new provisions of the Income Tax Law that came into effect on January 1, 2014, will increase the tax on the fringe benefits employers grant to their employees, and companies are currently analyzing their financial impact and evaluating different alternatives. Among those, is the possibility to monetize nonmandatory benefits (i.e., food coupons, savings fund, etc.), consideration for absorbing the full cost of the reform, a modification of the compensation package, and a combination of these options.

Employers, employees and unions are also evaluating whether to file a Constitutional Claim considering the reform does violate constitutional principles and human rights embodied in the International Agreements ratified by Mexico.

It is advisable for each employer to calculate the impact of the reform and carefully analyze the options that can be implemented.

The universal pension and unemployment insurance are positive because they will provide a minimum level of protection to individuals affected by being unable to earn income, in the event that the universal pension is implemented on a permanent basis, and on unemployment insurance on a temporary basis.

If the reform to the Social Security Law modifying the social security dues and the base quotation salary were to pass, it will also trigger a substantial financial impact for employers, and it is highly advisable to analyze its cost on a case-by-case basis. In addition to the financial impact, companies will need to significantly restructure payroll systems and anticipate the need to review actions that may be implemented for the specific case.

The Income Tax Law and the proposed modifications to the Social Security Law will increase the cost of formal employment in Mexico.

As in other countries, Mexico is struggling with a very active underground economy (where taxes are underpaid or not paid at all, and where individuals are not protected by the Mexican Federal Labor Law nor the Social Security System) and the reform should address in a very specific manner the particular issue of increasing the costs for those employers who are in compliance with their labor and social security obligations.

A significant amount of litigation is anticipated since the legal community is considering that some of the specific provisions may be in violation of Constitutional principles and human rights. Major difficulties are also foreseen with respect to collective bargaining agreements.

Maria del Rosario Lombera-Gonzalez is a partner at Baker & McKenzie, based in Mexico City.

Copyright 2014 © Baker & McKenzie. All rights reserved.

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