Mexico: 2014 Tax Reform Initiative
October 2013
Summary
The Mexican government recently published its plans for comprehensive economic reforms, which include the creation of a universal old age pension and unemployment insurance system. A pension would become a human right established by the constitution. Individuals age 65 or older would be entitled to the pension, which would be “sufficient to cover basic expenses.” The government estimates that 7.8 million citizens would benefit from the pension in 2018.
To fund the new benefits and reduce systemic inequalities, the government proposes to rationalize the tax system. The draft 2014 tax reform is diverse in its approach, including the repeal of the flat business tax (IETU) and tax on cash deposits (IDE), the harmonization of the Value Added Tax (VAT) across the country, and the elimination of special tax regimes and deductions. In this report, we focus on the potential impact of the tax reform on employee benefits and individual income. While the “big” structural changes have garnered much of the attention, changes to the treatment of benefits could have an equally important impact on employers and their employees.
Social Welfare and Other Benefits
In order to "avoid breaches in the principle of tax symmetry,” in which cash benefits are 100% tax deductible to the employer and tax free for employees, cash benefits would be deductible up to 41% of the employer’s cost/contributions. This limit would include:
Social welfare benefits and food coupons/restaurant tickets; Contributions to savings funds;
Termination indemnities; Annual Christmas bonus;
Overtime and Sunday work premiums; Vacation premiums; and
One issue of particular concern to employers is the future tax treatment of employer-paid premiums for medical and life insurance, given its prevalence as market practice. The draft law does not specify the treatment of this benefit. Based on some initial consultations Aon Hewitt has carried out and our experience in this area, we believe these premiums will continue to be deductible in full, since they are not deemed “exempt compensation” to the employee. Instead, they are the payment of a benefit an employer makes to the insurance companies in exchange for a service to be provided to employees and their dependents, when required.
Under this interpretation, employer-paid insurance premiums would comply with the principle of tax symmetry because the company paying the premium deducts it as an expense, and the insurance company receiving the revenue accumulates it as income and pays the corresponding tax.
Clearly, if the draft tax reform were approved, it would impact employers’ payroll costs. In response, employers might wish to monetize certain benefits. The following table demonstrates the possible impact on employees’ income in the case of monetizing savings fund contributions and food coupons:
Income (taxable) Savings Fund (12 % of base capped pay ) Food Coupons (11% of base capped pay) Accumulated Income* Effective 2013 Tax Rate
2013 Tax 2014 Tax** Additional Tax
Additional Tax (days of income) Monthly Annual MXN 150,000 MXN 1,800,000 MXN 30,728 MXN 23,637 MXN 1,854,365 27.5% MXN 495,000 MXN 509,950 MXN 14,950 3.0 MXN 80,000 MXN 960,000 MXN 30,728 MXN 23,637 MXN 1,014,365 25.4% MXN 243,840 MXN 257,649 MXN 13,809 5.3 MXN 50,000 MXN 600,000 MXN 30,728 MXN 23,637 MXN 654,365 22.6% MXN 135,600 MXN 147,886 MXN 12,286 7.5 MXN 20,000 MXN 240,000 MXN 28,800 MXN 23,637 MXN 292,437 15.8% MXN 37,920 MXN 46,205 MXN 8,285 12.6 Notes:
*Assumes that the company would incorporate these exempt benefits in the taxable income of employees, in order to deduct them totally. **For purposes of comparison, the tax was calculated with the same 2013 tax rate and the minimum wage for economic zone “A”. Savings fund and food coupons are only shown as they constitute the highest exempt amount for employees. Employers are reminded of other benefits with lower exempt legal caps; e.g., Christmas bonus at 30 days’ minimum wage (MXN 1,970) and vacation premium and profit sharing at 15 days’ minimum wage (MXN 985).
The current tax treatment of savings fund contributions allows employees to receive and exempt income up to 1.3 times the minimum wage (MXN 30,728 annually). Aon Hewitt’s last National Compensation Survey shows a high prevalence for this benefit with a 12% contribution over base salary up to the legal cap. Similarly, 91% of employers offer food coupons to their employees with an average of 11% of base pay up to the legal cap. Currently, 80% of those companies already provide it through electronic vehicles, as required in the initiative.
Contributions to Pension and Retirement Funds
The proposed law would eliminate the annual deduction that employers could take for contributions to pension funds. The expense would be deductible up to a maximum of 41% of the company’s cost/contribution when the benefit is actually paid to the employee (at retirement or termination date in the case of vested rights).
If approved, the change would be a clear disincentive to the creation of new pension plans, resulting in the decline in employees’ quality of life upon retirement. It would challenge the long-standing philosophical principles
underpinning employer-provided retirement plans, notably the improvement of benefits offered by the Mexican Social Security Institute (IMSS) and the facilitation of “dignified” retirement.
With this change, employers might wish to consider keeping an accounting reserve to back up pension plans as a nondeductible expense.
Deductions for Individuals
Other proposed changes would have a direct impact on the income of employees and their families. The top marginal tax rate would increase from 30% to 32% for individuals whose annual taxable income exceeds MXN 500,000.
The deduction of various personal expenses would be significantly limited, a change that would affect most taxpayers. If the new law were approved, the maximum amount taxpayers could deduct when filing their annual tax declaration would be the lesser of 10% of annual income or two times the minimum annual wage of Mexico City (currently MXN 47,275). This change would include the following deductions frequently taken by taxpayers: Medical, dental, and hospital expenses and medical insurance premiums, provided that the beneficiary is the
taxpayer, spouse, or partner and dependent children or parents; Mandatory school transportation for dependent children;
Contributions to personal retirement plans (PPRs) or complementary contributions to the retirement subaccount (Afore), as authorized by law; and
Real interest actually paid on mortgages.
These deductions, as currently structured under the tax code, represent important financial support for taxpayers, as they incentivize long-term financial planning and asset protection.
Income (taxable) Personal Deductions ISR 2013 Law(1) Personal Deductions ISR 2014 Law(2) Impact on the Total Deductible Amount Effective Tax Rate Additional Tax Additional Tax (days of income) Additional Tax (% over income) (3) Monthly Annual 10% Minimum Between 10% or 2MW MXN 150,000 MXN 1,800,000 MXN 180,000 MXN 47,275 MXN 132,725 27.5% MXN 36,499 7.4 8.2% MXN 80,000 MXN 960,000 MXN 96,000 MXN 47,275 MXN 48,725 25.4% MXN 12,376 4.7 5.6% MXN 50,000 MXN 600,000 MXN 60,000 MXN 47,275 MXN 12,725 22.6% MXN 2,876 1.7 2.4% MXN 20,000 MXN 240,000 MXN 24,000 MXN 24,000 MXN 0 15.8% MXN 0 0.0 0.0% Notes:
(1) ISR (Impuesto Sobre la Renta) refers to individual income tax. The 10% “personal deduction” includes medical insurance premium, medical expenses, contributions to a PPR, school fees and mandatory school transportation, and real interest actually paid on mortgages, among other deductions.
(2) Employees with annual income less than MXN 400,000 are not required to present an annual filing; but they can do so in order to obtain a tax return.
(3) Tax increase to be paid in 2014 as compared to the 2013 tax. It is obtained by multiplying the effective rate times the annual income less any deductions.
It is important to emphasize that in terms of long-term savings, this reform would have a direct impact on the incentive to create retirement plans built from the savings of participants. Today, one of the main attractions of PPRs is the ability to deduct annual contributions, up to a maximum of five times the annual minimum wage, currently MXN 118,185. In the absence of this incentive, individuals may prefer to allocate their income to short-term needs rather than long-term financial planning.
Next Steps
Given the profound impact these changes may have on employers and employees, various organizations such as the Mexican Association of Insurance Institutions, the Mexican Association of Consulting Actuaries, and the Mexican Institute of Finance Executives, among others, are working together to provide greater clarity and awareness of the consequences of these initiatives on employee benefits, particularly retirement plans. As the draft 2014 tax reform moves through the legislative process, it is important that employers carry out a detailed analysis, with their internal and external tax advisors, to determine how their benefit plans would be affected and plan for any redesign. Employers may consider an overall increase in base pay, which would still be deductible, rather than granting benefits that are not tax deductible. It should be noted that the cumulative impact of the proposed reforms may be to discourage long-term savings for retirement purposes, as the “savings culture” is not strong without tax incentives.
At Aon Hewitt, we will continue to monitor these developments in Congress and equip clients with the analysis needed to understand their impact on employer resources and employee engagement. We reiterate our commitment to provide any support you consider to be of value for a better understanding and use of your resources.
For additional information on the proposed 2014 income tax reform, please contact Patricia Barra
([email protected]) or Rosalba Del Castillo ([email protected]) in our Mexico City office or your local Aon Hewitt consultant.
About Aon Hewitt
Aon Hewitt empowers organizations and individuals to secure a better future through innovative talent, retirement and health solutions. We advise, design and execute a wide range of solutions that enable clients to cultivate talent to drive organizational and personal performance and growth, navigate retirement risk while providing new levels of financial security, and redefine health solutions for greater choice, affordability and wellness. Aon Hewitt is the global leader in human resource solutions, with over 30,000 professionals in 90 countries serving more than 20,000 clients worldwide. For more information on Aon Hewitt, please visit www.aonhewitt.com.
Copyright 2013 Aon plc
This document is intended for general information purposes only and should not be construed as advice or opinions on any specific facts or circumstances. The comments in this summary are based upon Aon Hewitt's preliminary analysis of publicly available information. The content of this document is made available on an “as is” basis, without warranty of any kind. Aon Hewitt disclaims any legal liability to any person or organization for loss or damage caused by or resulting from any reliance placed on that content. Aon Hewitt reserves all rights to the content of this document.
