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The pros and cons of near-shoringJune 4, 2013

McGladrey LLP 1

The pros and cons of near-shoring

© 2012 McGladrey LLP. All Rights Reserved.© 2012 McGladrey LLP. All Rights Reserved.

June 4, 2013

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Leading today’s discussion

Karen KurekPartner and National Industrial Products Industry Leader

Frank JiNational China Desk Leader

Edgar Lopezlena Director, Mexican Tax Practice


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Today’s agenda

Perspectives on near-shoring China insights China insights

Considerations for Mexico

Q&A

Our presenters will answer audience questions at the end of the presentation. To submit a question, select


p q ,the Q&A button at the top of your screen.

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Perspectives on near-shoring


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What is Near-shoring and why is it so important to the U.S.?

Near-shoring

In-shoring


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On-shoring

“Made in America” is making a comeback


7Source: Time Magazine


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Factors that provide the underlying rationale for near-shoring as a supply chain strategy

Costs - Landed cost/Cost of Ownership. - Rising labor costs in emerging countries - Rising energy costs in emerging countries, decreasing energy costs

in the US

Increase in logistics costs (administrative, transportation and inventory)

Long lead times and the resultant impact on customer satisfaction and inventory

Rising and shifting consumer expectations/time to market


Increase risk (natural disasters alone cost $300b in supply chain costs in 2012)

Importance of quality IP Protection

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Why the optimism toward a manufacturing comeback?

Cheap U.S. natural gas and other

increased energy production are

helping to power U.S. factories more

Congressional approval in 2011 of

trade agreements with South Korea,

Colombia and Panama and other

efficiently, with gas especially

providing inexpensive raw materials

for U.S. manufacturers of plastics,

tires, certain pharmaceuticals and

other petrochemical products.

Higher wages in China and other

foreign export markets are making

agreements being negotiated now

with Asia and Europe are promising to

open more foreign markets to U.S.

products.

High U.S. unemployment is relieving

pressure on factory owners to

increase wages, helping to make U.S.


outsourcing less profitable to U.S.

firms.

labor costs more globally competitive.

Major technology advances have

steadily boosted factory efficiency and

worker productivity.

9Source: AP- April 4, 2013


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Near-shoring vs. Off-shoring


10Source: Alix Partners Executives’ Perspectives on Manufacturing Near-Shoring

Near-shoring vs. Off-shoring


11Source: Alix Partners Executives’ Perspectives on Manufacturing Near-Shoring


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Offshore supply chain procurement


43 percent say that foreign sourcing for their supply chain will increase in the coming 18 months .Nearly 60 percent say they are not going to increase foreign sourcing in next 12-18 months.

12Source: McGladrey Monitor- Fall 2011

Factors expected to drive jobs to the U.S.

A recent study posits that some 3 million jobs will return to the U.S. thanks to near-shoring.

Three factors expected to drive this process

The rising costs of production in China

The rising costs of transportation

The improved efficiency and productivity in the


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p y p yU.S. and Europe


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Today’s agenda


China insights China insights Considerations for Mexico

Q&A




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The Current Trend

As the cost of doing business in China is increasing, many U.S. companies are moving g y p gsome of their export oriented manufacturing operations to other locations, such as Mexico and SE Asia.

However, most of the U.S. companies that are doing business in China are not leaving China completely because of the following reasons:- As China is changing to a consumer based economy from


As China is changing to a consumer based economy from an export orientated economy, it is becoming an ever more important market for U.S. companies.

- It is extremely difficult to dissolve a foreign investment enterprise (“FIE”).

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Improved Purchasing Power


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Overview of China’s law on Liquidation

Articles 181 to 191 of the Company Law of The People’s Republic of China (revised in 2005) govern the

fdissolution and liquidation of an enterprise. If a foreign investment enterprise fails to meet its

obligation and “walks away” without going through a proper liquidation, the PRC Government will seek prosecution for foreign executives and legal representative of the enterprise and impose heavy penalties (even jail sentences). The foreign executives concerned may also be permanently barred from entry


concerned may also be permanently barred from entry to China, thus affecting their future investment opportunities in China. In addition, the PRC Government may seek prosecution against the foreign executives in their own domicile.

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Reasons for Liquidation

According to Art 181 of the Company Law, a company may be dissolved under the following circumstances:y g1. The business operation term expires and the occurrence of

other reasons for dissolution as prescribed in the company’s articles of association.

2. Shareholders pass a resolution to dissolve the company.

3. Dissolution as a result of merger or segregation of the company.

4. The company’s business license is cancelled by


government authorities or it is ordered to close down or to be dissolved according to the law.

5. The People’s Court decides to dissolve the company according to Art 183 of the Company Law.

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Timelines

Dissolving a FIE is a lengthy process, which generally takes 6-9 months to complete but could take years.

General timelines for a liquidation proceeding:1. Relevant Government authorities should be notified within 7

days from the beginning of the liquidation.2. liquidation committee should be formed within 15 days from

the date of dissolution of the liquidating company to carry out the liquidation procedure.

3. After the liquidation committee is formed, the liquidation committee should notify the known creditors in writing within


y g10 days and place public announcement in a national newspaper within 60 days.

4. Creditors should declare their claims within 30 days from the receipt of the written notices or within 45 days from the issuance of the public announcement.

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Timelines (Continued)

5. If an enterprise terminates its business operation during a tax year, the annual Enterprise Income Tax (“EIT”) for the current tax period should be settled within 60 days from the date oftax period should be settled within 60 days from the date of the actual termination of the business operation.

6. Within 180 days upon the formation of the liquidation committee, the liquidation committee should write up a liquidation report and submit the same to the Board of Directors and relevant Government authorities for approval.

7. Deregistration with the original registration authorities (e.g. State Administration for Industry and Commerce, Customs Bureau and State Administration of Foreign Exchange, etc) should be applied within 30 days from the date of the


should be applied within 30 days from the date of the submission of the liquidation report.

8. The liquidated enterprise should file an enterprise liquidation income tax return and settle tax liabilities within 15 days from the date of the completion of the liquidation procedures.

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Liquidation Audit

liquidation audits are generally required twice:i. When the termination application is submitted to the

authorities and the application approved by the government authorities;

ii. When all the termination procedures have been completed.

The liquidation audit procedures are similar to statutory audit procedures but with more emphasize on the following :- The financial performance of the company for the six months

before the date of declaring liquidation;


before the date of declaring liquidation;- The completeness and truthfulness of the information on

assets;- The liabilities of the company;- The liquidation expenses .

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Major Issues for Tax Deregistration

1. Clearance of outstanding tax liabilities – All existing tax liabilities, such as Enterprise Incomeexisting tax liabilities, such as Enterprise Income Tax (“EIT”), Value Added Tax (“VAT”), Business Tax (“BT”), Stamp Duties, should be settled.

2. New tax liabilities during liquidation - The liquidation itself may result new liabilities. For example, employee compensation will be subject to individual income tax and assets disposal will be


to individual income tax and assets disposal will be subject to turnover tax.

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Severance

Employees’ salaries should be fully paid as at the end of the month preceding the announcement ofend of the month preceding the announcement of the liquidation. The employment contracts would indicate how long each employee has officially worked for the company and the compensation for termination of employment would be calculated based on the salary and length of employment. In general, an employee can receive a month of pay


(based on the average salary they earned during the current year of employment) for every year they have worked for the company

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Other Government Agencies Involved

Government authorities Liquidation Process

Ministry of Commerce To deregister and terminate the Approval CertificateCertificate

SAIC To apply for business deregistration

SAFE To close all bank accounts

Customs Bureaus To apply for Customs deregistration


General Administration of Quality Supervision, Inspection and Quarantine of the People’s Republic of China

To apply for deregistration of Unified Code

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Today’s agenda


China insights China insights

Considerations for Mexico Q&A




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Mexico At-a-glance

Size 1,200,000 sq mi

States 31 + Mexico City, D.F.

Geographic • US Border: 1,900 mig pBoundaries • Guatemala / Belize Border:

750 mi• Coastline: 6,000 mi

Official Language Spanish

Currency Mexican Peso (MXN)

Population • 110,000,000 people• Mexico City pop. 20,000,000• Majority of population live in Mexico City has the largest


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urban areas

Economy • World’s 11th largest economy• GDP (2012): US$1.7 Trillion• GDP Per Capita (2012):

US$15,000• Considered a local power

(Latin America Area of Influence)

y gpopulation of U.S. expatriates in the world (600,000 est.)

Why Mexico?

Logistics- Geographic proximity to North American marketsGeographic proximity to North American markets

- First rate port / communications infrastructure

- Natural hub for growing Central and South American markets

- Hub for APEC and EU shipments (extensive shores on both oceans)

- Similarities in business practices between the U.S. and Mexico


Mexico

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Regulatory

100% foreign investment allowed (except certain specific sectors)specific sectors)

Minimum initial capital requirements

Cero foreign currency restrictions

Liability concerns not as heavy as in the U.S.

Government agencies familiar with U.S. investment


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Tax

Competitive corporate tax rates: Flat 30% (No state taxes on income))

Attractive incentives for export operations (Maquiladoras)- Tax rate can be potentially reduced to approximately 17%- Exemption from VAT and import duties (in most cases)- Simplified transfer pricing compliance

Generous tax environment to repatriate excess cash


cash Comprehensive free trade agreements (NAFTA,

EU, APEC, South America) Comprehensive network of tax treaties

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Labor

58 million people employed or employable

Competitive labor costs (Minimum wage averagesCompetitive labor costs (Minimum wage averages US$9.00 per day)

Well trained labor force

Some of the most recognized (and oldest) higher learning institutions in Latin America (UNAM – First university in the Americas – ca. 1551)


)

Hard working culture

Examples: Aerospace, high-end automotive manufacturing, medical equipment, chemical products

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Economics

Robust economy – 11th largest economy in the world

Outperformed other economies during the 2008 crisisOutperformed other economies during the 2008 crisis

Stability – Economic indicators have been relatively stable (except during the 2008 – 2009 post-crisis period)

Low inflation

Strong middle class with strong purchasing power

U.S. – Mexico one of the largest trade partnerships in the


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U.S. Mexico one of the largest trade partnerships in the world

U.S. investments into Mexico average US$10 Billion ever year


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Inflation Rate


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Trade Balance


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U.S. – Mexico Trade Balance

Month Exports Imports Balance

January 2012 17,254.7 21,493.6 -4,238.9

February 2012 16,893.2 22,707.9 -5,814.7

Millions of U.S. Dollars

y , , ,

March 2012 18,954.9 25,094.2 -6,139.4

April 2012 17,293.0 22,740.4 -5,447.4

May 2012 18,528.8 24,877.2 -6,348.4

June 2012 17,548.9 23,483.7 -5,934.7

July 2012 17,550.9 22,539.2 -4,988.4

August 2012 19,168.8 23,688.3 -4,519.5

September 2012 17,450.6 22,213.0 -4,762.3

October 2012 20,458.2 24,818.0 -4,359.8

November 2012 18,828.4 23,692.4 -4,864.0


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December 2012 16,400.6 20,304.9 -3,904.3

TOTAL 2012 216,330.9 277,652.7 -61,321.8

2012 : U.S. trade in goods with Mexico NOTE: All figures are in millions of U.S. dollars on a nominal basis, not seasonally adjusted unless otherwise specified. Details may not equal totals due to rounding.Source: www.census.org

Why Mexico?

And of course, great food!


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Challenges in Mexico

Too much dependency on U.S. economy (“If the U.S. gets a cold, Mexico gets pneumonia”)a cold, Mexico gets pneumonia )

Red tape – Still too much paperwork and time consuming registration, formation processes. Uncertainty on how to do things, in some cases

Aggressive tax / social security audits

Overprotective labor laws – 10% of the Profits go to the


p gemployees!

Security – Has not affected investment significantly, but still an important factor

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Initial Considerations

Investment vehicles• Branch?• Legal entity?• What type? • How many?• U.S. tax treatment?

Set up of Maquiladora (IMMEX) program – Ideal vehicle for export operations

Initial tax registrations and requirements Checklist


Initial tax registrations and requirements – Checklist (Estimated time is fifteen business days)

Transfer pricing strategy Tax withholdings

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Investment vehicles – How many entities?

Segregating different functions into separate legal entities can be a good planning strategy:

- Increase protection of valuable assets

- Facilitate sales into Mexico of Maquiladora products

Downside: Potential increase in Mexican tax liability / increased cost of administration

Separate entity for employees used to be an effective planning technique to save on PTU (*). New labor law rules eliminate this planning strategy (“Look-Through” provisions)


* PTU: a mandatory profit sharing payment to all employees. It is 10% of the employer’s net taxable income with no carry forward of NOLS allowed

eliminate this planning strategy ( Look Through provisions)

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Maquiladora / IMMEX Program

Principal benefits:- Reduction or elimination of import dutiesReduction or elimination of import duties

- Expeditious customs paperwork when importing and exporting

- Expeditious refund of Value-Added tax recoverable balances

- Certain reductions in Mexican income taxes

- Simplified transfer pricing regulatory framework


- CAUTION: Heavily regulated and scrutinized

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Myth Fact

Maquiladoras have to be located in the border with the U.S.

Maquiladoras can be located anywhere within Mexico where state laws allow

Maquiladoras have to ship product back to the U.S.

Maquiladoras can ship product to any country outside of Mexico

Maquiladoras cannot produce goods for local markets

Maquiladoras can produce goods for local markets, although certain tax implications may arise

I can keep books and records for my Maquiladora in my headquarters in the U.S.

Maquiladoras are required to maintain accounting and tax books and records in their location

I can transfer my Maquiladora (IMMEX) authorization

The Maquiladora (IMMEX) Program is non-transferable and can only be used by the Mexican legal entity that owns it


Maquiladoras are simply an extension of my manufacturing operation (same entity concept)

Maquiladoras are entities independent of their owners. They serve as contract manufacturers to their owners and are expected to maintain an arm’s-length relationship with those owners

I have to pay Mexican taxes on the sale of products manufactured or assembled by my Maquiladora

If transfer pricing requirements are met, sales of products manufactured in Mexico will generally escape Mexican taxation

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Final considerations

Be patient, things in Mexico do not h f t ld t ihappen as fast as you would expect in the U.S.

Always ask before acting; do not try to look at things as you would if you were setting up an operation in the U S


setting up an operation in the U.S.

Hire a good accountant and a good attorney in Mexico

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Who to contact

Karen KurekChicago

312.634.3920 [email protected]

Frank JiSchaumburg, IL

847.413.6471 [email protected]

Edgar Lopezlena Schaumburg, IL

[email protected]


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Thank you.

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DisclaimerThe information contained herein is general in nature and based on authorities that are subject to change. McGladrey LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. McGladrey LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors

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