The Letter of the Law

As a central element of the “Pacto por Mexico“, we should expect that political reform will occur, and its implications for Mexico’s political balance will be profoundly felt.

The most recent attempts to reform Mexico’s political system came during the final two years of Felipe Calderon’s presidency. The PAN government at that time proposed a series of changes including allowing independent candidates (that is, candidates not belonging to an established political party), and re-election. While the re-election proposal was rebuffed, the initiative for independent candidates was approved by the Mexican congress in the fall of 2011, and it played an important role in the past elections where an independent candidate won the government of Monterrey.

Over the past years, much of the focus in Mexico was regarding the approval of reforms that potentially could boost economic activity, competitiveness, and quality of public services. Within that, most of the attention was given to the energy and the telecommunications reforms. Although they were key, both for the issues that they change and the long-term effects that they could have, in January of 2014 a political-electoral reform was also approved, therefore it is important to highlight in my opinion the 6 key aspects of it:

1. New national electoral body. The National Electoral Institute (INE for its acronym in Spanish) replaced the Federal Electoral Institute (IFE for its acronym in Spanish). The new institution is responsible for organizing both local and federal elections. In addition, the Institute also concentrate the following responsibilities: oversight of election campaigns, regulation of surveys, preliminary results, and election monitoring, and coordination of the civil service both at the local and at the federal level, among others. The appointment of the new local electoral officials will depend on the INE, although the funding for those local bodies will still be a function of local Congresses.

2. Reelection. In support of the arguments that reelection is more representative as an electoral system and that public servants elected by popular vote have more incentives to be closer to their constituents in the presence of reelection, and against the historic rejection in Mexico against this figure, legislators allowed the reelection of Federal Deputies and Senators for up to 12 years. The first generation of public servants who may be reelected will be in the 2018 federal election.

3. Election annulment. The reform increased the grounds for annulment in elections, specifically stating that the election will be annulled if there was excess funding of it. In the same sense, auditing rules also changed to include common practices not included before in regulation, such as private financing or including other good accounting practices such as online oversight. Although this effort is important, its compliance looks complicated because, on one hand, the complexity of the rules increased for the authorities, and, on the other hand, it is not clear that the INE will have the available resources to effectively monitor the resources flowing into a political campaign, namely those in cash.

4. Sanction of electoral offenses. The reform increased sanctions and expanded the definitions under which a public servant may violate electoral rules. Additionally, some changes were included to sanction illegal funding in campaigns. Furthermore, accompanying this legal change, it included the creation of an autonomous body to prosecute electoral offenses, which would be attached to the new Attorney General Office (Fiscalí­a General de la República), an institution that will be replacing the current Procuradurí­a General de la República that depends on the President.

5. Voting abroad and gender parity. In regards to voting abroad, it expands the voting choices for Mexicans abroad to now include, not only the President, but also Senators and Governors. While the number of Mexicans voting abroad has been modest, the figures could potentially change coupled with the fact that now is easier to get the voter card outside of the country and with more options to vote, including voting in embassies and consulates abroad or electronic voting schemes. In regards to gender parity, specific rules were included to guarantee gender equality in both candidates (e.g. the fact that a female candidate must have a substitute that is also a woman) and in the national lists for proportional representation in each party (e.g. the list will have to be formed by alternating men and women).

6. Independent candidates. This was one of the issues that received a greater push by civil society. In the reform, independent candidates were regulated, establishing requirements and benefits for their participation in elections

A look at the Energy Reform

In a major turnaround, on December 20th, 2013, Mexico’s President Enrique Peña Nieto formally signed one of the most significant economic reform laws of the last several decades. The Mexican government amended its Constitution, effectively opening the oil and gas energy market (other than gas transmission and nuclear power) to private foreign and local investors for the first time since 1938.

Under the new reforms, the government continues to have exclusive ownership of the hydrocarbons when underground, but foreign contracts to explore for, develop, and produce hydrocarbons are now permitted. These agreements between the State and private companies can now go well beyond the current service contracts and include more competitive types of agreements including profit sharing, production sharing hydrocarbon licenses, or a combination of these arrangements. Once these hydrocarbons are at the wellhead, they can change ownership, and private companies will now be able to reflect these contracts and their benefits, especially in terms of reporting oil and gas production in their financial statements. SENER, the Secretariat of Energy, and the National Hydrocarbon Commission (CNH) will control the bidding process, which should provide transparency and drive decisions that are primarily driven by economics.

On December 11th, 2014, the CNH published the bidding and contract terms for the first 14 oil and gas areas in shallow waters, kicking off the first phase of Mexico’s Round One, which will continue throughout this year (2015). Although such bidding and contract terms, which are available at www.ronda1.gob.mx, only relate to shallow water contract areas, they give us a general insight into what the industry can anticipate as to the legal and administrative framework for participating in Round One.

Production-sharing contracts with 3 to 5-year exploration terms will be awarded for the first 14 oil and gas areas in shallow waters pursuant to economic criteria contained in the bidders proposals, based on a weighted formula that includes consideration of the share of operating profits offered to the State and a multiplier of the minimum investment commitment per contract area.

Non-Mexican companies may validly participate in all phases of the bidding. However, upon selection of a winning bidder, the CNH may only execute exploration and production contracts with Mexican-incorporated commercial entities, meaning that winning bidders that have previously not formed a Mexican corporation or other Mexican entity will need to do so at that time. Pemex will also be able to bid by itself or in association with others pursuant to the same bidding terms.

A look at the Fiscal Reform

The primary goal of the Mexican Tax Reform was to increase Mexico’s tax base while decreasing administrative burdens on companies. The tax increases were necessary to help balance a Federal budget that included increased spending for social programs initiated by President Peña Nieto in his first year in office.

Several changes were made in the calculation of the tax base for businesses, pension funds, and individuals.

For Businesses

• The tax rate will remain at 30%.

• The business flat tax (IETU) is repealed for years after 2013.

• The tax on cash deposits is repealed for years after 2013.

• Sales made on credit will be considered income at the time of the transaction rather than at the time funds are collected.

• Dividends paid to non-residents of Mexico will be subject to an additional 10% withholding. The withholding is only on earnings (CUFIN) earned after 2013. The withholding tax is a tax on the shareholder and may be reduced under provisions of applicable treaties. The withholding will also apply to deemed dividends from adjustments made to related party transactions.

• Deductions for payments of exempt fringe benefits (i.e. contributions to pension plans, medical benefits) will be limited to 47% of amounts paid. If benefits are the same (or higher) as in the previous year, the deduction increases to 53% of the amount paid.

• The previous consolidation regime is eliminated. Holding companies must determine income tax deferred prior to December 31, 2013. Taxes deferred prior to 2007 will be paid in accordance with current provisions. Taxes deferred from 2008 to 2013 must be paid over a five year period.

Individuals

• The top rate for individuals will increase from 30% to 35%.

• The new top rate of 35% will also be the withholding rate for payments made to non-residents and capital gains realized by foreign shareholders on the sale of Mexican shares when an exemption is not obtained or available.

Pension Funds

• Non-resident pension funds are exempt from taxes on sales of real estate or shares of entities with more than 50% real estate when the minimum leasing period is one year or more. The new law increases the minimum lease period to four years.

Tax Administration Changes

The new law simplifies the administrative burdens for many companies:

• The corporate flat tax (“IETU“) has been eliminated for the 2014 calendar tax year.

• The cash deposits tax has also been eliminated for the 2014 calendar tax year.

• The requirement for a company to complete a statutory audit tax report (Dictamen fiscal) is eliminated.

• Taxpayers with income of more than MXP64.6 million, publicly traded companies, and taxpayers electing to file consolidated returns under the New Regime, Mexican citizens living abroad, and entities that have one-or-more related party transaction will be required to submit additional tax information to authorities by June 30th.

• An electronic “tax inbox“ will be implemented that will allow tax authorities and taxpayers to send and receive tax notifications electronically.

•Administrative or operational reasons for non-issuance of receipts (facturas) are eliminated.

Value Added and Excise Taxes

The new law eliminates certain lower rates for the value-added tax and has increased certain excise taxes:

• The VAT in the border region will increase from 11% to the general rate of 16%.

• VAT exemptions on products imported by IMMEX companies are generally eliminated. However, IMMEX entities may receive a certification that allows for continue exemption from VAT for imported products. The certification process requires that the IMMEX company be in compliance with all aspects of the IMMEX law.

• A new excise tax equal to MXP1 per liter will apply to flavored drinks, i.e. soda pops, flavored drinks, powders, extracts, and essences.

• A new 8% excise tax will apply to imported foods with more than 275 calories per 100 grams.

A look at the Telecommunication Reform

Approved on June 11, Mexico’s telecommunications reform created a new autonomous telecommunications regulator; the Federal Institute of Telecommunications (Ifetel), this new regulator can revoke operating licenses for companies employing monopolistic practices. A second new regulator, the Federal Commission of Economic Competition, will promote competition and seek to prevent companies from controlling more than 50 percent of market share.

The legislation creates two open television channels, and makes access to information and communication technologies a constitutional right. It also allows foreign investment in telecoms to grow from 49 percent to 100 percent, though it limits foreign investment in radio to 49 percent. The reform defines rules around “must carry, must offer,“ requiring paid TV operators to offer free channels, and for open TV operators to provide free transmissions to paid operators. Finally, the reform aims to improve access to broadband and other telecom services.