By Alexandra Alper
TLAXCALA, Mexico (Reuters) - Mexican assembly plants have put expansion plans on ice pending a tax overhaul that threatens their perks, but low wages and proximity to the United States should deter any mass exodus to manufacturing rivals like China.
Mexican light assembly factories, or "maquiladoras", account for nearly two-thirds of Mexico's non-oil exports at about $196 billion a year and are lobbying hard against a proposed reform they say would kill their advantage over competitors.
Leon Sametz, whose 132-person factory produces stainless steel wire in the central state of Tlaxcala, has delayed the import of a $1.36 million machine that would lift production by a third, worried by plans to scrap key perks for maquiladoras.
"This fiscal reform proposal is a nightmare for us," said Sametz, whose factory houses ovens that heat steel wire to 1,200 degrees Celsius to lengthen and narrow it for use in watering hoses and speakers.
President Enrique Pena Nieto is seeking to boost an anemic tax take partly by winding back tax breaks such as those for maquiladoras, introduced over the last 50 years to help Mexican-based firms compete with factories in Asia for the U.S. market.
Critics say the tax haven-style benefits are unfair and spur fraud, but factories complain the reform will saddle them with nearly $25 billion in sales tax payments each year that could weigh on cash flow, although they would be reimbursed later.
The reform could also boost maquiladoras' income tax more than four-fold, by raising the tax rate and the tax base and by reducing deductions, companies say.
Lawmakers are prepared to scale back the sales tax component but it is not clear how far they will go to meet demands from the industry, which has warned firms could relocate if the fiscal overhaul goes through as planned by the end of October.
Still, the government is betting firms will stay put thanks to Mexico's natural advantages, from low wages to cheap transportation to the United States. Some experts agree.
"It's ... crocodile tears," said Ehtisham Ahmad, a senior fellow at the London School of Economics who has advised Mexico to scrap the maquiladora tax regime all together. "These guys are not going to go away and stop producing."
MANUFACTURING HUB OR TAX HAVEN?
The maquiladora industry began in 1965 under a tax sweetener program for U.S. firms to set up light assembly plants for export on the border, and grew quickly through the 1990s thanks in part to a free trade deal with the United States and Canada.
But the firms faced headwinds after China joined the World Trade Organization in 2001, luring away companies with low wages and reduced tariffs and grabbing U.S. market share away from Mexico and others.
Mexico then slashed the maquiladora income tax rate from 30 percent to 17.5 percent. The new tax reform would revoke that change, returning the rate to 30 percent.
The proposed reform would also kill a provision that exempts maquiladoras from paying value added tax (VAT) on "temporary" imports if they export the final product, but would require the government to refund the payment at a later date.
That would put new cash flow demands on firms, many of which will face even higher taxes as the government moves to lift VAT in border cities to the national level of 16 percent, from a discounted 11 percent now, the industry says.
"They are making it really expensive for maquiladoras to keep growing at the same pace," said Ernesto Ocampo, a tax advisor at Ernst & Young. He said two clients had shelved investments fearing cost projections would rise.
The reform would also limit the salaries and benefits maquiladoras can deduct from their income taxes and slap a 10 percent tax on dividends, a common way for corporate parents to repatriate profits, tax experts say.
Trefilados Inoxidables de Mexico, Sametz's firm, pays its Swiss corporate parent Novametal through dividends, among other methods, a manager said.
The plan would also limit the number of companies that qualify for maquiladora benefits by only allowing companies that export 90 percent of their sales to participate, from the current 10 percent, or $500,000 a year in exports.
Lawmakers have said privately the reform will likely be modified to include a "certification program" allowing factories which export most of their products from paying VAT on imports.
"We will find a way to ensure temporary imports continue to be respected and protected," said Cesar Camacho, chairman of the ruling Institutional Revolutionary Party, or PRI.
Pena Nieto took office in December promising to pass a series of long-sought reforms aimed at boosting growth, including expanding the paltry tax base to wean the country off revenues from ailing state oil giant Pemex (PEMX.UL).
Mexico raised only 9.7 percent of GDP through taxes in 2012, excluding Pemex revenue, the lowest tax take in the 34-nation Organization for Economic Co-operation and Development.
Part of the problem is a host of special regimes, like those awarded to maquiladoras, which in turn encourage abuse.
For example, Mexican companies set up "maquiladora" subsidiaries to take advantage of lower income tax rates. They also claim VAT exemptions on imported supplies, promising to export the finished goods, only to sell them domestically -- a dodge which some estimate accounts for up to half the VAT exemptions claimed.
"We are not eliminating as such the maquiladoras' right to have different tax treatment ... We are simply regulating the maquiladoras so that they don't abuse certain schemes," said Aristoteles Nunez, head of tax collection office SAT.
Critics say the government is over-reacting.
"The government should know which companies (commit fraud) and punish them. There is no reason why they should punish an entire industry," said Raul Leyva, manager of a 150-person gutter machine manufacturing plant in Hermosillo, Sonora.
"I have instructions that if this (reform) doesn't change, starting in January, we begin sending equipment back to the United States and start shutting down the plant."
But there are plenty of reasons to stay. Most maquiladoras have U.S. parent companies, which can claim a credit from the U.S. government for income tax paid in Mexico.
Mexican manufacturing labor costs are about a fifth lower than China's and factory wages are below those of Brazil, Indonesia, and the Philippines, Bank of America analysts said.
And transport costs in Mexico are a key advantage over countries like Taiwan, whose wages remain lower.
It takes just under 3 days and $3,460 to move a 40-foot container from Mexico to the United States, compared to nearly 21 days and $4,665 to move the same cargo from China, according to A.T.Kearney, a consulting firm.
"There will be no negative impact on the economy or its competitiveness," said Benito Berber, an analyst at Nomura Securities in New York. "The ones that are abusing the system are the ones that will be affected."
(Additional reporting by Lizbeth Diaz and Michael O'Boyle; Editing by Simon Gardner, Kieran Murray and Krista Hughes)