New regulations introduced for outsourcing services

Introduction
Limitations on outsourcing services
Consequences of non-compliance
Comment

Introduction

On December 1 2012 the Federal Labour Law was amended for the first time in more than 40 years. One of many relevant aspects of the new law is the inclusion of new regulations for outsourcing services.

Although the outsourcing industry has been growing rapidly in Mexico, previously there was no specific legislation dealing with this activity, which originally needed to comply only with the general law governing:

• contracts between clients and service providers;
• transfer pricing rules for contracting services among related parties; and
• labour and social security obligations with respect to the personnel used for such services.

However, as of December 1 2012 every company in Mexico using the services or work of a third party must observe several new rules, each of which presents its own challenges and potential risks.

Limitations on outsourcing services

The new Article 15-A of the law defines the 'sub-contracting regime', whereby an employer referred to as the 'service provider' will perform work or services through its own personnel and under its control and direction for the benefit of a person or entity referred to as the 'contracting party', which will direct and supervise the work or services to be performed.

Article 15-A also requires that every contracting party must comply with the following three provisions.

Sub-contracting regime must not include all activities developed at work site
The labour authorities have begun to interpret this limitation as prohibiting the existence of legal entities without employees. This poses a challenge for companies doing business in Mexico, as there are several examples of entities that may operate without employees (eg, holding companies, real estate entities and investment or joint venture vehicles).

The major issue that companies – in particular, multinational corporations – face relates to the corporate structure under which many of them conduct their business in Mexico. It is common for foreign companies to set up their businesses in Mexico through the incorporation of two or more legal entities. For example, a Mexican entity may be incorporated to act as:

• a holding company;
• the owner of assets, inventory and raw materials; or
• the holder of trademarks, patents or licences to operate in the country.

Meanwhile, another entity would be created to hire the personnel assigned to work for the entire business. Through inter-company services agreements and by observing transfer pricing rules, the 'services entity' would charge a fee to its related companies.

Mexican authorities have expressed their dislike of this type of structure, because a significant portion of the revenues does not reach the service company and thus the employees do not gain a substantial share, as the new law envisages. The new law provides for a mandatory benefit of 10% profit sharing, distributable among all employees that were active in the preceding fiscal year (January to December). Accordingly, although a service entity generates profits based on the fee charged to other entities, such profits are not comparable to those of the entity that sells the products or services, charges for the use of a licensed trademark or collects rent from its real estate. These companies are also obliged to pay the mandatory 10% profit sharing to the extent that they hire at least one employee (which is rare).

Sub-contracting services must be specialised services
The broad and vague wording of this condition for outsourced services from a third party has created some confusion. Hiring IT services from a well-established international firm may be easy to corroborate as specialised services, as would ensuring safety conditions in a submergible oil rig; but what about cleaning services at a corporate building in the financial district of Mexico City, or transportation services for workers at a maquiladora (a type of manufacturing operation) on the northern border of the country? It may be difficult to elaborate on the specialisation of certain activities that may or may not be related to the core business of a company. It is also unclear whether an outsourcing company may be considered specialised if it provides a variety of services, or whether it must instead be narrowly focused on a certain type of activity, or if the specialisation should be based on the employees' academic or professional credentials.

Sub-contracting services cannot involve similar or identical activities that are performed by employees of the contracting party
The aim of this rule is to avoid having two or more employees rendering similar or identical services, but with different salaries or employment conditions. It has been common practice in Mexico for outsourced personnel not to be given the same benefits and compensation as those employees directly hired by the client or beneficiary of the services.

Companies are reviewing their positions filled by directly hired employees and their job descriptions in order to compare them with outsourced personnel. However, the lack of guidance as to what can be considered 'similar activities' will eventually be tested in court, and additional clarity may be provided once certain judicial precedents have been set.

Consequences of non-compliance

Article 15-A further provides that an employer (the contracting party) that fails to comply with the new conditions for outsourced services will be considered as the employer of the outsourced personnel "for all legal purposes, including social security obligations". This consequence is quite harsh for companies hiring services from third parties or from related entities within the same corporate group; the contracting party would be considered an employer and therefore liable for any labour and social security obligations.

The law already contained rules for joint responsibility, whereby a company hiring outsourcing services from a person or entity lacking sufficient means and assets to comply with its obligations would become jointly liable with such service provider. The joint liability entails that in the event that the service provider cannot meet its obligations to the employees, the beneficiary of the services would become responsible.

However, the new provisions of the law set the stage for more serious consequences by treating the contracting party or beneficiary of the services as the employer of the personnel (ie, as if it had directly hired the personnel in the beginning). In such case, the labour and social security obligations will not depend on whether the service provider can face its own obligations as an employer of the personnel, but rather will become the direct responsibility of the contracting party.

Among these obligations, the one most feared by companies is that of statutory profit sharing. If a labour court rules that the contracting party failed to comply with all of the new rules for outsourcing services, there is a potential risk that the contracting party will be required to pay 10% of its annual income tax to the employees that rendered services in its favour (if paid from either a third-party payroll or from a related corporate entity's payroll).

Moreover, enhanced penalties for failure to comply with the new outsourcing rules may reach up to 5,000 times the current minimum wage in Mexico (approximately $25,000) for each affected employee.

Comment

It is critical that Mexican subsidiaries analyse their current situation in light of the new obligations for outsourcing services. At the very least, companies should review the following information and documents:

• incorporation deeds of Mexican subsidiaries and their current corporate purpose, as well as those of external providers and contractors;
• inter-company services agreements entered into by and among Mexican subsidiaries and services agreements with external providers and contractors;
• employment contracts used by Mexican subsidiaries and those used by external providers and contractors;
• verification of labour and social security obligations properly fulfilled by external contractors;
• positions and job descriptions of the Mexican entity's personnel and those of personnel supplied by external providers and contractors;
• collective bargaining agreements executed by the Mexican entity and those executed by external providers and contractors; and
• internal policies, employee manuals and internal work regulations.

In order to comply with the new legislation, companies should seek legal assistance to complete any of the following important actions:

• personnel transfer;
• restructuring of job descriptions;
• modification of services and employment contracts;
• implementing protocols for verifying external providers' compliance with the law; and
• diversifying or replacing external contractors.

For further information on this topic please contact Alfredo Kupfer-Dominguez at Sanchez-DeVanny Eseverri SC's Mexico City office by telephone (+52 55 5029 8500), fax (+52 55 5029 8501) or email (akupfer@sanchezdevanny.com). Alternatively, contact David Puente-Tostado at Sanchez-DeVanny Eseverri SC's Monterrey office by telephone (+52 81 8153 3900), fax (+52 81 8153 3901) or email (dpt@sanchezdevanny.com).