In recent years, direct investment from Chinese companies into Mexico has experienced significant growth. This surge is evident in the figures, rising from $38 million in 2011 to $386 million in 2021 and $282 million in 2022.  Notably, Chinese companies now represent the fastest-growing source of foreign investment in Mexico. Their investment predominantly targets the manufacturing sector, encompassing diverse projects ranging from computer equipment (e.g., Lenovo’s “mega site” investment in Mexico on computer, server and computer rack assembly), construction equipment (e.g., Lingong Heavy Machinery), electric-vehicles (e.g., BYD and Chery), and furniture (e.g., Man Wah).

Throughout 2021 and 2022, a substantial portion of China’s direct investment flowed into the northern state of Chihuahua, followed by $216 million in Mexico City, $78 million in Nuevo León. Furthermore, January to September 2023, the states in Mexico that received the highest foreign direct investment from China were Nuevo León ($36 million), Jalisco ($11.7 million) and Sonora.

Attractions of Mexico

Chinese companies’ growing interest in Mexico is mainly attributed to the following factors:

Proximity to the United States.  Chinese investment primarily targets industries and geographic locations that export to the United States, one of the world’s largest consumer market. This focus is particularly significant given the substantial increase in tariffs on Chinese imports into the United States.  As a member of the United States-Mexico-Canada Agreement (USMCA), Mexico offers companies on its soil access to the United States and Canadian markets without tariffs.  Additionally, Mexico boasts the largest number of trade agreements of any country, which provides benefits for companies operating within its borders.

Established Sectoral Capabilities.  The most well-known and developed industries in Mexico include automotive, electronics and oil. With a growing trend of nearshoring investment by U.S. companies, Mexico has expanded its capabilities into aerospace, new materials and medical devices.  For instance, Mexico is the leading exporter of medical equipment to the United States and ranks 8^th largest global manufacturer of medical devices. It is home to over 2,500 medical device manufacturing companies.  Mexico boasts a highly educated workforce and has experienced a rapid growth in its information technology and business process outsourcing (BPO) sectors.

Skilled and Cost-Efficient Labor Force.  Mexico boasts a large and skilled labor force with a strong technical education background suited for high-value manufacturing, particularly in sectors such as the automotive, aerospace, electronics and medical devices.  In terms of labor costs, wages in Mexico are significantly lower than those in the United States. While they may be higher than in some Asian countries, the combination of lower transportation costs and preferential tax treatment may still result in substantial savings compared with those countries.  When compared with China, a Bloomberg Law report pointed out that factory wages are generally lower in Mexico, averaging US$2.75 to US$4.82 per hour, depending on the location. In contrast, factory wages in China average around US$6.50 per hour.

Supply Chain Resilience.  Major Chinese companies are investing aggressively in Mexico, leveraging not only the benefits of the USMCA, but also aiming to relocate production closer to customers to mitigate vulnerability to geopolitical tensions.  For Chinese companies with significant North American markets, Mexico provides an alternative to the manufacturing plants in China or in other Asian countries, significantly reducing risks associated with pandemic outbreaks, trade barriers, or geopolitical instability.  Additionally, reduced transportation costs and shorter transportation distances further enhance the competitiveness of products manufactured in Mexico and exported to the United States and Canada.

Key Considerations

For Chinese companies contemplating diversifying manufacturing operations to Mexico, thorough due diligence is essential. This includes gathering information on various aspects such as applicable laws and regulations, workforce availability and quality control, cost considerations, manufacturing base and supply chain, logistics and customs clearance, investment procedures, disputes resolution mechanisms, and intellectual property protection.

From the legal perspective, there are several factors to consider when evaluating nearshoring opportunities:

Company and Operational Structure.  The majority of Chinese companies we’ve assisted in establishing their manufacturing operations in Mexico express a preference for employing an offshore structure. This structure serves to further distance the Mexican subsidiary from the Chinese parent company, aiming to mitigate risks associated with geopolitical instability, comply with local partners requirements of certain companies, and fully capitalize on tax benefits offered by the Mexican government, such as those available under the IMMEX Program.  Multiple entities are typically established to facilitate the achievement of the ultimate commercial strategies and business objectives.

It is imperative to consider all the major factors pertaining to future operations and expansion when designing a company and operational structure. This structure should not only be robust enough to maximize benefits but also sufficiently flexible to allow future adjustments based on  changing economic conditions.

International Tax.  Nearshoring to Mexico will typically entails tax considerations for China, the United States and Mexico at a minimum. Depending on the business objectives and commercial strategies, additional tax considerations for multiple jurisdictions may become relevant. Therefore, it is crucial to understand and deploy an efficient tax structure for cross-border operations. This may involve, among other strategies, utilizing offshore holding companies, establishing trading companies tailored for different countries or territories, deploying investment vehicles, and structuring financing arrangements accordingly.

Regulatory Compliance.  Thorough regulatory analyses are essential for Chinese companies intending to conduct business in Mexico, as they prepare them for unforeseen risks associated with operating in a foreign country.  For instance, Mexican labor can entail potentially hidden costs, depending on the structural/operational approach adopted, such as social security contributions, profit sharing obligations, and aguinaldo (year-end bonuses), which can significantly increase the labor costs in Mexico.  Additionally, Mexico imposes rigorous regulatory requirements associated with its various duty minimization regimes, encompassing registrations, authorizations, certifications, permits, inventory controls, internal audits, recordkeeping/reporting standards, among others.  Ensuring compliance with these regulations is of a paramount importance.

Local Incentives.  To attract investment into the country, the federal government of Mexico implements various incentive programs applicable nationwide; Additionally, from time to time, state governments officer various local tax incentives, including temporary exemptions from payroll taxes (impuesto sobre nóminas) and property taxes, as well as temporary exemptions from taxes and fees related to new business registration, property and vehicle registration, and real property transfers. Some states even provide funding for employment training programs.

It is advisable to engage legal and tax professionals to provide the evaluation of tax and incentive considerations and to assist with the negotiation with local governments in this regard.

Recent Trends

On October 11, 2023, the “Decree granting tax incentives to key sectors of the export industry consisting of immediate deduction of investment in new fixed assets and additional deduction of training expenses” (the “Decree”) was published in the (Mexican) Official Gazette of the Federation. The Decree entered into force the day after its publication in the Official Gazette of the Federation.

The Decree seeks to provide tax incentives to companies aiming to optimize their operations through nearshoring strategies and also to those already located in Mexico, belonging to sectors identified as key in the export industry.

Among the anticipated incentives, one notable provision includes the immediate deduction of investments made in new fixed assets, along with an extra deduction equal to 25% of the augmented expenditure on employee training.

Below is a list of the main incentives offered by the Decree:

1. Immediate deduction of investments:
   • The incentive is applicable to certain taxpayers of the income tax, such as corporations under the general regime, Simplified Trust Regime (RESICO), and individuals under the general regime of business activities and professional services.
   • Taxpayers must be engaged in the production, processing, or industrial manufacturing of specified goods and export them.
   • The deduction percentages specified in the Decree can be applied to investments in new fixed assets acquired from the date of entry into force of the Decree until December 31, 2024.
   • The stimulus can only be applied if the estimated income from exports of the regulated goods represents at least 50% of total turnover in each fiscal year of 2023 and 2024.
2. Additional deduction for training expenses:
   • The incentive allows for an additional deduction equivalent to 25% of the increase in expenditure on employee training.
   • The increase in training expenditure is calculated as the positive difference between the expenditure in the current fiscal year and the average expenditure in the years 2020, 2021, and 2022.
   • Training must be related to the taxpayer’s activity and provided to active employees registered with the Mexican Social Security Institute.
   • Taxpayers must maintain specific records of the training provided and the related documentation.

Overall, the Decree aims to support key sectors of the export industry in Mexico by providing tax incentives for immediate investment deduction and additional deductions for training expenses.

As the Mexican government persists in releasing laws and regulations to encourage and attract nearshoring investments to Mexico, our team of attorneys at Procopio will diligently monitor this legal landscape and ensure our clients are promptly informed with the latest updates.

Procopio’s U.S.-Latin America Cross-Border attorneys and Asia-Pacific Team are well-known facilitators and promoters of businesses operating in the United States and Latin America. Our practice comprises a deep bench of seasoned lawyers knowledgeable in various areas of law who also possess a clear understanding of the business mentality and culture of both the U.S. and Latin America. This depth allows us to offer our clients innovative and practical legal solutions.  At Procopio, we advise our clients throughout the various stages of their business development, starting from the planning stage through implementation, while serving as an ongoing ally in day-to-day operations and growth.