Neville Peterson LLP: Customs and International Trade Law

December 2000
M E M O R A N D U M
TO:	Clients and Friends of the Firm
FROM:	Julia S. Padierna-Peralta and George W. Thompson
RE:	Maquiladoras and Mexico's Sectoral Programs in 2001

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Introduction

The maquiladora industry is both a key component of the Mexican economy and one of the most successful production-sharing schemes in the world. It accounts for almost half of Mexico's manufacturing exports, and employs about 1.3 million workers in more than 3,600 plants located both along the Mexico-U.S. border and in interior states. Both the United States and Mexico have benefited from the program: approximately 40.5% of maquiladora operations are owned by U.S. firms that manufacture products such as electronics, electricity goods, iron and steel, textiles, autos, transportation equipment, chemicals, photographic goods, furniture, food and toys.

     The hallmark of the maquiladora program is the in-bond, duty free importation of materials, parts and components for manufacturing of finished products for export. This feature grew hand-in-hand with U.S. customs policies that provide favorable duty treatment to articles undergoing "repair and alteration" abroad, as well as to "American goods returned" after undergoing certain processing abroad. After the goods undergo processing and return to the U.S., they are assessed duty only on the value of the operations performed in Mexico. Thus, there are complementary benefits provided by the Mexican and U.S. governments.

     Clearly, since its inception in 1965 the maquiladora program has been a creature of government regulation. The regulatory regime served the program well, and has been liberalized over the years to permit, for example, sales of some maquiladora products in Mexico while maintaining the program's fundamental duty deferral underpinning.

     However, this special customs regime is about to undergo major changes beginning in 2001. This article highlights some of them. Companies currently operating maquiladora facilities in Mexico, and those considering commencement of such operations, should pay close attention to these impending changes.

Elimination of NAFTA Duty Drawback

     The waiver or deferral of import duties, commonly known as "duty drawback," has been a prime feature of Mexico's maquiladora regime. Beginning January 1, 2001, however, maquiladoras will no longer enjoy duty drawback treatment on non-NAFTA originating inputs used to manufacture products for export to the U.S. or Canada. In short, the duty deferral regime that characterized maquiladoras for the past 35 years is coming to an end, at least with respect to certain inputs incorporated into finished products destined to NAFTA markets.

     Elimination of duty drawback is mandated by Article 303 of the North American Free Trade Agreement (NAFTA). Drawback on U.S.-Canada trade was eliminated in 1996 and Mexico will eliminate it with respect to trade with the U.S. and Canada in 2001.

     NAFTA duty drawback elimination means that maquiladoras using non-NAFTA originating inputs - whether materials, parts, components or packaging - to produce goods for export to the U.S. or Canada would start facing Mexico's general external tariffs (i.e., most favored nation (MFN) rates) as of January 1, 2001. Mexico's MFN import duty rates can be as high as 35%. This could disadvantage maquiladora plants that are heavily dependent on non-regional inputs since they would have to pay duties on such inputs, while inputs from the U.S. and Canada would still be allowed to enter Mexico duty free. Note that duty drawback will still be permitted on NAFTA-originating inputs and non-NAFTA inputs exported outside the NAFTA region. Other exemptions to the elimination of NAFTA duty drawback will apply to textiles and apparel imported pursuant to specific NAFTA provisions; temporary imports from the U.S. or Canada for "repair or alteration"; and re-exportation of NAFTA-originating goods "in the same condition".

Mexico's Sectoral Programs

     Mexico has not remained idle in the face of the crucial changes arriving in 2001. To ease the transition towards a new era in manufacturing and to bolster the competitiveness of key industries in Mexico, the Mexican government has established Sectoral Development Programs (known in Spanish as Programas de Promocion Sectorial - PROSECs or PPSs).

     These Programs, administered by Mexico's Economy Secretariat (formerly SECOFI), will allow participating companies to import eligible non-NAFTA inputs and "capital equipment" - machinery and equipment - at reduced fixed duty rates to be used in certain industries. By regulation, the Programs went into effect for maquiladora and pitex plants on November 20, 2000, and by law will do so for all other manufacturing companies on January 1, 2001.

     The industries covered by Programs adopted thus far include:

Mexico's Sectoral Programs¹

I. Electricity	XII. Rubber and Plastics
II. Electronics	XIII. Iron and Steel
III. Furniture	XIV. Pharmochemicals, Drugs and Medical Equipment
IV. Toys and Games	XV. Transportation
V. Footwear	XVI. Paper and Cardboard
VI. Minerals and Metals	XVII. Wood
VII. Capital Goods	XVIII. Leather and Skins
VIII. Photographic Goods	XIX. Auto and Autoparts
IX. Agricultural Machinery	XX. Textiles and Apparel
X. Miscellaneous	XX. Chocolate, Candy and Similar ("Like" Products)
XI. Chemicals	XX. Coffee

Mexico's Sectoral Programs At Work

     The Sectoral Programs will work as follows. Participating manufacturers will be able to import non-NAFTA originating inputs, machinery and equipment that are classified in one of the listed qualifying Mexican Tariff Schedule (HTS) numbers, at an ad valorem tariff indicated in the specific Sectoral Program. Each Program lists certain end-products and inputs (as well as capital equipment) by HTS number. If both the end-product and the non-NAFTA inputs (and/or capital equipment) used to manufacture such end-product are listed, the non-NAFTA inputs or capital equipment may be imported at the import duty rate specified in the particular Program. The import duty rates on most qualifying inputs and capital equipment are either 0% or 5%. Although, a number of products have duty rates of 3%, 7% or 25%. On the other hand, inputs, capital equipment and finished items whose tariff classifications are not listed in a Sectoral Program are ineligible for these benefits.

     Note that the ability to use the lower Sectoral Program duties is not contingent on subsequent exportation of the finished articles, which may be sold in Mexico or exported as the producer sees fit. However, the maquiladora or pitex operator would remain subject to certain minimum export requirements under the programs. Therefore, a manufacturer that becomes eligible to operate under a Sectoral Program may, nevertheless, face an export requirement - not because of the Sectoral Programs themselves, but because of the maquiladora and pitex rules.

      The potential benefits provided by the Sectoral Programs will work in tandem with the limited duty drawback options still available under NAFTA. These permit deferral of duties on imported inputs used in subsequently-exported goods until after the date of exportation, and a limited ability to waive or refund on exported goods some or all of the Mexican duties that would otherwise have applied to the imported materials. To comply with NAFTA Article 303, the Mexican government may only waive import duties on the non-NAFTA inputs equal to the lower of two amounts:

(1) the sum of import duties paid or owed on the non-NAFTA inputs imported into Mexico and used in producing the exported end-product, adjusted for inflation from the month of importation; or

(2) the amount of import duties paid or owed on the end-product subsequently exported to the U.S. or Canada.

     Under the new rules, Mexican import duties on the non-NAFTA inputs will be payable within 60 days of exportation of the end-product to one of the other NAFTA countries, and may be waived in whole or in part. Duties on machinery and equipment imported by maquiladora or pitex plants will have to be paid at the time of importation, under either a preferential Sectoral Program or MFN rate.

     While the referenced formula may appear confusing at first sight, the principle it represents is actually quite simple. Mexico will reduce the amount of duties owed to it on the imported non-NAFTA inputs by an amount equivalent to the lower amount collected by either Mexico or the other NAFTA party. If duties in the country of exportation are higher than those in Mexico, no duties will be owed to Mexico on the non-NAFTA inputs. However, if the duties on the inputs in Mexico are higher, Mexico may or may not exempt any duties of its own, depending on the amount of duties collected by the other NAFTA country on the end-product. This principle has a dual objective: (1) to limit the NAFTA tariff preferential treatment to NAFTA goods; and (2) to avoid double taxation on the same product within the NAFTA region.

     To illustrate: assume a piece of cloth from Taiwan has a duty of $6.00 in Mexico, and the finished product is a handbag made with it that has a $7.00 duty in Canada. The Mexican government can waive $6.00 in duty on the material. On the other hand, if the handbag has a $5.00 duty in Canada, Mexico is allowed to waive $5.00. So, only $1.00 would be owed to Mexico, following the exportation of the handbag. Finally, if the handbag qualifies as NAFTA originating, and enters Canada without duty, no waiver of the Mexican duty is permitted.

Examples of Duty Payment on Non-NAFTA Inputs Under NAFTA Duty Drawback Elimination in 2001

Import Duties payable to Mexico on "X" inputs from Taiwan	Duties payable to the U.S. or Can. on "Y" end-product	Duties exempted by Mexico: the lesser of two quantities	Final duties payable to Mexico (within 60 days)	Total Amount of Duties paid by Exporter
$6	$7	$6	$0	$7
$6	$5	$5	$1	$6
$6	$0	$0	$6	$6

Interestingly, the elimination of NAFTA duty drawback and the establishment of Mexico's Sectoral Programs coincide with Mexico's total opening of its domestic market to maquiladora sales, beginning in 2001. Maquiladoras will also continue to be exempt from the payment of Mexico's value-added tax (VAT) on inputs, capital equipment and machinery to be used for the manufacturing of products for export.

Any company with manufacturing operations in Mexico, whether foreign-owned or not, may apply to participate in the Programs, and seek the addition of products to the Programs' coverage.² Consequently, the fact that a particular item is not currently eligible for favorable treatment under a Sectoral Program does not preclude it from receiving benefits in the future. Authorization to operate under the Programs will be valid for a year, and automatically renewed upon compliance with certain reporting requirements.

     We have several words of caution for companies seeking to take advantage of a Sectoral Program: verify the tariff classification of your imported materials as well as of your finished, exported products. Eligibility for both is premised on their tariff classification, not on their commercial description. In the past, due to the maquiladora program's duty deferral feature there was little concern about the tariff classification of materials or finished goods. The Sectoral Programs, by contrast, make tariff classification central to their coverage. Although the Economy Secretariat attempted to classify numerous commercial goods correctly for purposes of including them in a Sectoral Program, there is no guarantee that the Mexican customs authorities will adopt the Economy Secretariat's classification decision for any given item. Therefore, companies that anticipate using the Sectoral Programs to their advantage should make certain the tariff classification of their materials and their finished products.

     Mexico-based manufacturing companies seeking to remain competitive in light of the elimination of NAFTA duty drawback, should become familiar with Mexico's Sectoral Programs and the new legal framework under which maquiladoras will operate. These developments will undoubtedly impact business decisions with respect to sourcing, manufacturing and selling in Mexico.

     George W. Thompson (gthompso@npwdc.com) is a partner, and Julia S. Padierna-Peralta (jpadierna@npwdc.com) is an associate, in the D.C. office of the law firm of Neville Peterson LLP.

1.     The first ten Programs were established in a Decreto por el que se establecen diversos Programas de Promocion Sectorial [Decree establishing various Sectoral Promotional Programs], D.O., May 9, 2000. Ten additional Programs were published in a subsequent Sectoral Programs Decree, D.O., Oct. 30, 2000. Furthermore, on Dec. 31, 2000, Mexico's Economy Secretariat (formerly SECOFI) published a new Decree that established two additional Programs -- for the Chocolate, Candy and Similar ("Like" Products) Industry, and the Coffee Industry). This latter Decree also listed the qualifying inputs and end-products of previously established Programs and superseded both the May 9, 2000 and Oct. 30, 2000 Decrees. The new Decree made substantive changes to the previously established Programs by adding, modifying and eliminating a number of previously eligible tariff items.

2.     The rules and regulations to participate in the Programs were published in an Acuerdo por el que se dan a conocer diversas disposiciones en materia de los programas de promocion sectorial y el formato de solicitud de autorizacion y ampliacion de programas de promocion sectorial [Agreement regarding the regulations on sectoral programs and the format to request authorization and expansion of participation in the programs], D.O., Oct 13, 2000.

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