The pros and cons of near-shoring

The pros and cons of near-shoring Welcome We will address your questions at the end of the presentation. To submit a question, select the Q&A window at the top of the screen. In the window that opens, type your question into the dialog box, and press the Ask button. Please disable all webcams. Download a PDF copy of the slides by pressing the Handouts Button located on the tool bar at the top of your screen. 1 McGladrey LLP 1

Awarding CPE To receive CPE credit One person per computer Must stay connected for at least 50 minutes and answer each of the four (4) polling questions NASBA requires that we monitor your participation Your interactions will be tracked through the system Your audio and computer connections will be tracked through the system 2 Leading today s discussion Karen Kurek Partner and National Industrial Products Industry Leader Frank Ji National China Desk Leader Edgar Lopezlena Director, Mexican Tax Practice 3 McGladrey LLP 2

Today s agenda Perspectives on near-shoring China insights Considerations for Mexico Q&A Our presenters will answer audience questions at the end of the presentation. To submit a question, select the Q&A button at the top of your screen. 4 Perspectives on near-shoring 5 McGladrey LLP 3

What is Near-shoring and why is it so important to the U.S.? Near-shoring In-shoring On-shoring 6 Made in America is making a comeback Source: Time Magazine 7 McGladrey LLP 4

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 8 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 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 outsourcing less profitable to U.S. firms. Congressional approval in 2011 of trade agreements with South Korea, Colombia and Panama and other 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. labor costs more globally competitive. Major technology advances have steadily boosted factory efficiency and worker productivity. Source: AP- April 4, 2013 9 McGladrey LLP 5

Near-shoring vs. Off-shoring Source: Alix Partners Executives Perspectives on Manufacturing Near-Shoring 10 Near-shoring vs. Off-shoring Source: Alix Partners Executives Perspectives on Manufacturing Near-Shoring 11 McGladrey LLP 6

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. Source: McGladrey Monitor- Fall 2011 12 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 U.S. and Europe 13 McGladrey LLP 7

Today s agenda Perspectives on near-shoring China insights Considerations for Mexico Q&A Our presenters will answer audience questions at the end of the presentation. To submit a question, select the Q&A button at the top of your screen. 14 The Current Trend As the cost of doing business in China is increasing, many U.S. companies are moving some 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 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 ). 15 McGladrey LLP 8

Improved Purchasing Power 16 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 dissolution 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 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. 17 McGladrey LLP 9

Reasons for Liquidation According to Art 181 of the Company Law, a company may be dissolved under the following circumstances: 1. 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. 18 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 10 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. 19 McGladrey LLP 10

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 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 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. 20 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; - The completeness and truthfulness of the information on assets; - The liabilities of the company; - The liquidation expenses. 21 McGladrey LLP 11

Major Issues for Tax Deregistration 1. Clearance of outstanding tax liabilities All existing 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 subject to turnover tax. 22 Severance Employees salaries should be fully paid as at the end 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 23 McGladrey LLP 12

Other Government Agencies Involved Government authorities Ministry of Commerce SAIC Liquidation Process To deregister and terminate the Approval Certificate 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 24 Today s agenda Perspectives on near-shoring China insights Considerations for Mexico Q&A Our presenters will answer audience questions at the end of the presentation. To submit a question, select the Q&A button at the top of your screen. 25 McGladrey LLP 13

Mexico At-a-glance Mexico City has the largest population of U.S. expatriates in the world (600,000 est.) Size States Geographic Boundaries Official Language Currency Population Economy 1,200,000 sq mi 31 + Mexico City, D.F. US Border: 1,900 mi Guatemala / Belize Border: 750 mi Coastline: 6,000 mi Spanish Mexican Peso (MXN) 110,000,000 people Mexico City pop. 20,000,000 Majority of population live in urban areas World s 11 th largest economy GDP (2012): US$1.7 Trillion GDP Per Capita (2012): US$15,000 Considered a local power (Latin America Area of 26 Influence) Why Mexico? Logistics - Geographic 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 27 McGladrey LLP 14

Regulatory 100% foreign investment allowed (except certain 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 28 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 Comprehensive free trade agreements (NAFTA, EU, APEC, South America) Comprehensive network of tax treaties 29 McGladrey LLP 15

Labor 58 million people employed or employable Competitive 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 30 Economics Robust economy 11 th largest economy in the world Outperformed 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 world U.S. investments into Mexico average US$10 Billion ever year 31 McGladrey LLP 16

Inflation Rate 32 Trade Balance 33 McGladrey LLP 17

U.S. Mexico Trade Balance Millions of U.S. Dollars 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 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 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 34 Why Mexico? And of course, great food! 35 McGladrey LLP 18

Challenges in Mexico Too much dependency on U.S. economy ( If the U.S. gets 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 employees! Security Has not affected investment significantly, but still an important factor 36 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 (Estimated time is fifteen business days) Transfer pricing strategy Tax withholdings 37 McGladrey LLP 19

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 38 Maquiladora / IMMEX Program Principal benefits: - Reduction 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 39 McGladrey LLP 20

Myth Maquiladoras have to be located in the border with the U.S. Fact 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. I can transfer my Maquiladora (IMMEX) authorization Maquiladoras are required to maintain accounting and tax books and records in their location 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) I have to pay Mexican taxes on the sale of products manufactured or assembled by my Maquiladora 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 If transfer pricing requirements are met, sales of products manufactured in Mexico will generally escape Mexican taxation 40 Final considerations Be patient, things in Mexico do not happen 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. Hire a good accountant and a good attorney in Mexico 41 McGladrey LLP 21

Who to contact Karen Kurek Chicago 312.634.3920 Karen.Kurek@McGladrey.com Frank Ji Schaumburg, IL 847.413.6471 Frank.Ji@McGladrey.com Edgar Lopezlena Schaumburg, IL 847-413-6378 Edgar.Lopezlena@McGladrey.com 42 Thank you. Thank you for joining us today! Join McGladrey for these upcoming webcasts: June 19: Strategies for growth: The 2013 Manufacturing & Distribution Monitor June 20: Ireland Update: Considerations for US companies. Register today at McGladrey.com/Events 43 McGladrey LLP 22

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