Rankings report – MEXICO
FDI undeterred by Mexico’s accounting industry legacy issues
Historical problems, pushed down the list of priorities, could hamper Mexico’s Covid recovery, while the emerging digital economy has been hampered by over-zealous taxation policies. But the changing business culture and proximity to the US market gives hope for the future. Che Golden reports
he Mexican SME sector has historically been slow to adopt good accountancy practices and corporate governance. This can hinder them when competing with foreign companies, according to Francisco Bracamonte, partner, taxes and legal at Kreston.
“In general, SMEs are reluctant to release the absolute control of the founder/main owner and set up a corporate governance system,” he says. “But business culture has been changing and the new generation are open to having a conversation with accounting consulting firms, who can expect to have a lot of work helping SMEs in improving their governance.”
Increasing pressure from international regulators is also driving SMEs toward good governance. One of the major issues of corporate governance in Mexican firms is the lack of regulation and transparency of disclosure compliance. “Most family businesses in Mexico make serious efforts for the firm to remain ‘in family hands’,” says Hector Garcia Martinez, tax partner at Gossler, a Crowe member firm. “However, larger family firms, especially those looking to compete internationally, have opened their doors to non-family members for strategic positions. We have seen an increase of independent directors being invited to become members of boards.”
Francisco Bracamonte, partner, taxes and legal at Kreston
But Gabriel Llamas Monjardin, managing partner of BDO Mexico, argues that it is not the company culture holding SMEs back, but cost.
“The tax rates have not increased in the last three years, however, the tax administration has implemented changes that impose a very expensive administrative cost for SMEs in order to comply with these modifications,” he says. “The tax reforms have not slowed and have increased the cost of operating just to comply with the new administrative and tax formal obligations.”
The last time IAB focused on Mexico, there were complaints voiced that repeated modification to tax laws was putting pressure on the accounting industry to keep pace with the changes and it seems there is no relief on the horizon.
“Mexico has yearly tax changes,” says José Jiménez, tax partner at Mazars. “They require deep study and analysis to fully comprehend the possible impacts. This administration is combating tax evasion with new reforms focused on detecting simulated operations or operations that were made solely for the purpose of having a tax benefit.”
Tax evasion has been historically high in Mexico, but not everyone thinks the government is tackling it in the right way.
“The 2022 reform involves major changes again,” says Martinez. “While the proposed changes are not intended to create new taxes or increase applicable rates, they clearly will increase the taxing authorities’ power and review rights and impose harsher penalties on taxpayers.” Martinez points out that the new rules will restrict intercompany financing and increase the level of reporting information on foreign residents participating in Mexican business. “So unfortunately, the Mexican government has returned to their not so popular strategy of highly loaded tax reforms,” he says.
“The problem as with the current administration is the lack of clarity in new tax rules,” says Alfredo Solloa, partner at Solloa CP, a Nexia member firm. “This had left the door open for multiple interpretations, as well as trying to get rid of fully legal practices, just because a few tax-payers have abused them.”
Estefy Pantoja, executive director, Latin America, PrimeGlobal
Such a heavily regulated environment brings an increase in risk to tax advisors because they now have the responsibility of formal obligations and potential fines, says Bracamonte. “The need for training is increasing quickly and the accounting firms that are not prepared risk disappearing or only attracting small, low profit clients,” he says.
However, Rafael Castellanos Perez, partner at MGI Bargalló, Cardoso and Associates, does not feel that the rate of tax reform is of particular concern to Mexican companies. “The simple evolution of business already forces us, as a profession, to be permanently updating our knowledge,” he says. “Fortunately, the accounting profession in Mexico forces its members to comply with continuing education programmes, which helps to keep it updated.”
While the pandemic has made 2020 a difficult operating year for everyone, Mexican accounting firms are facing big challenges for their stability and growth. “There have been government policies that have made Mexico less attractive for investment,” says Bracamonte. “Private investment has fallen from 21% of GDP to 18%. In 2020, GDP fell more than 8% and this year is expected to grow to only 5% and 2% in 2022. With this environment, it has been difficult for accountancy firms to keep their revenues up – most saw a drop or, best case scenario, kept revenues at the same level as 2019.”
Bracamonte points out that Mexican businesses had few stimulus and alleviation programmes during the pandemic, so lack of cash was a common issue for most industries, affecting not only their revenues but also the collectability of the accounts.
The squeeze on customer cash flow has forced firms to change their approach with clients. “At the beginning of the pandemic, clients asked to reduce their bills, stopped their payments, or settled payment plans,” says Estefy Pantoja, executive director for Latin America, PrimeGlobal. “PrimeGlobal Mexican firms started offering advisory services which helped to maintain and build stronger relationships with their clients. Mexican firms are recovering after the pandemic, but also facing different challenges given the changes to tax laws.”
While some firms decreased their fees, Solloa believes this to be a mistake and his firm has not gone down this route. “We do not believe in cannibalizing our business,” he says. “Recovery is coming from new business, not increase in fees.”
Lockdown has given the digital economy a boom everywhere and it is another area where the Mexican government has issued a flurry of tax reforms. This has led to a bumpy transition to the internet age. In Mexico around 15% of GDP is created by companies operating in digital environments. Regulations on digital taxation came into effect in 2020 covering income tax and the imposition of VAT on digital services. Lockdown led to a rapid increase in online payments and it is expected that e-commerce will bring in additional revenue of USD 200 million this year.
“Some aspects of digital services tax reform are impacting the operation in Mexico of foreign companies, mainly the obligation of having a Mexican tax representative who is personally responsible for taxes,” says Bracamonte. “On the other hand, this has a positive impact because Mexican companies are able to compete in fair conditions with foreign players.”
Hector Garcia Martinez, tax partner at Gossler, a Crowe member firm
But Gustavo Leal Cueva, CEO of Fiscalia, who consults for BKR International, argues that while government may have created a level playing field for domestic and international companies alike, the changes have been onerous for everyone. “Starting on June 2020, tax withholding on individuals earning income through digital platforms was implemented,” he says. “These rates were part of a progressive withholding system that proved inefficient. A 50% withholding rate was also imposed on VAT, meaning half of VAT was withheld.”
The withholding system was modified for 2021, reducing rates and leaving a single tax rate per industry, while VAT withholding remained at 50%. Individuals not providing their tax ID are withheld at a 20% income tax on their income, and 100% rate on VAT. “The Mexican tax authority has raised a total of USD 27.13 million from June 2020 to June 2021, registering a total of 222,396 individuals under this regime as of March 2021. This numbers are still not as expected,” says Cueva.
Because a lot of the reforms were brought in during the pandemic, the process to register digital services’ providers could be frustrating.
“When the register period started, tax officials were not all familiar with the process and this resulted in longer response times, repeated visits to the tax authorities, and increased fees for digital services providers,” says Jiménez. “Finally, the tax burden was placed on the users, and this meant an increased cost of the different digital platforms. Despite the new tax environment, the use of these platforms kept increasing and there is no reason to believe it will decrease in the future.”
Rafael Castellanos Perez, partner at MGI Bargalló, Cardoso and Associates
Despite these teething problems, Martinez sees the establishment of Netflix in Mexico, motivated by public pressure from the media and the government, as a sign of good things to come. “After this decision, other technology companies will follow their model in the next two years making them fully taxable for all the revenue generated in the Mexican territory,” he says.
Manuel Rangel de la Garza, partner at CPC Rangel, a member of BKR International, agrees that while the digital economy pushed the government into implementing unprecedented taxation principles, it does not seem to be putting off foreign investors. “The existing official lists of foreign corporations or individuals operating through digital platforms and platform operators performing intermediation activities have substantially increased in recent months,” he says. “Currently, there are no changes specific to the digital economy in the tax reform submitted for the Congress’s approval, although it is likely that the tax authorities will improve the existing controls and information gathering-processes to increase collection.”
Despite the slow growth predicted for the economy over the next two years, the mood is optimistic.
“We expect growth in our activity with international clients” says Perez. “Mexico has become an ideal place to do business due to its proximity to the US, the largest market in the world. With the disruption in the way of doing business that originated with the pandemic, the mere fact of not having to travel to the other side of the world places us in an unmatchable competitive position.”
Everything seems to indicate that the profession in Mexico will continue to grow, even considering several issues that will be happening during 2022, says Martinez.
“For the firms there are two major issues - adoption of the ISQM1 and the tendency of the government to increase the revision of the work of accountants. Both are somewhat connected as they will represent a deep cultural change on how the firms manage quality. If this is well managed, firms can turn it into a value-add for its clients, who then will be willing to pay higher fees.”
While GDP projection may be low, de la Garza feels there is no doubt that Mexico is recovering. Getting the tourist industry kick started again will prove crucial. “The opening of commercial business to the public will be essential,” he says. “The hospitality industry is very important for our economy, so we expect an accelerated recovery in this area over the next few months.”