FURTHER REACTION TO MEXICAN FISCAL REFORM PLAN

UNCLAS SECTION 01 OF 04 MEXICO 004151 SIPDIS SENSITIVE SIPDIS STATE FOR A/S SHANNON STATE FOR WHA/MEX, WHA/EPSC, EB/IFD/OMA, AND DRL/AWH STATE FOR EB/ESC MCMANUS AND IZZO USDOC FOR 4320/ITA/MAC/WH/ONAFTA/GERI WORD USDOC FOR ITS/TD/ENERGY DIVISION TREASURY FOR IA (ALICE FAIBISHENKO) DOE FOR INTERNATIONAL AFFAIRS KDEUTSCH AND ALOCKWOOD NSC FOR DAN TOMLINSON STATE PASS TO USTR (EISSENSTAT/MELLE) STATE PASS TO FEDERAL RESERVE (CARLOS ARTETA) E.O. 12958: N/A TAGS: ECON ELAB EFIN PINR PGOV MX SUBJECT: FURTHER REACTION TO MEXICAN FISCAL REFORM PLAN REF: A. MEXICO 3246 ¶B. MEXICO 3859 ¶C. MONTERREY 725 -------------- Summary -------------- ¶1. (SBU) Six weeks after the introduction of the Calderon Administration's proposal for fiscal reform (ref A), companies and business organizations continue their objections to the most controversial aspects of the plan, a flat minimum tax on revenues (CETU) and a tax on cash deposits (ICI). Some Congressional analysts have called the plan unconstitutional. Mexico's labor-intensive maquiladora sector warns its tax burden will increase 600%. Business organizations are calling for reduced rates, more deductibility of expenses, and improved government spending oversight. U.S. firms could be particularly hard-hit if the CETU is not creditable against U.S. taxes. U.S. pension plans have raised this and other concerns with the Embassy. Japanese firms apparently do not face this double taxation threat. Mexican Finance Ministry officials have raised the double taxation concern with U.S. Treasury. Meanwhile, Calderon and Government economists defend the plan as essential to pay down government pension and infrastructure debt and to construct future infrastructure projects. End Summary. -------------- Controversial Minimum Business Tax -------------- ¶2. (U) The centerpiece of President Calderon's June 20 fiscal reform proposal is an alternative minimum tax, CETU (Single Business Contribution) (ref A). Administration analysts expect the additional tax revenue generated by the CETU to be 1.8% of GDP. Though the Mexican Congress may change the proposed CETU rate, now set at 16 percent in 2008 and 19 percent starting in 2009. Many in the private sector have vocally opposed this tax and demanded that it be reduced to 12% or that it allow labor deductions. The private sector's main complaint has been that CETU does not allow companies to deduct the cost of labor, payroll, social security contributions, pensions, and other allowances, from income. Although the government has reassured the private sector that a salary credit included in the reform would compensate companies for the losses, business, employers, financial, outsourcing, maquiladoras and many other associations argue that CETU will hurt job creation, investment plans, and competitiveness. -------------- Risk of being an unconstitutional tax -------------- ¶3. (U) Recently, the Chamber of Deputy's Parliamentary Law and Investigations Research Center called both the CETU and the tax on the informal economy (ICI),also included in the Calderon reform plan, unconstitutional because they violate the Constitution's principles of equity and proportionality. According to the Center, the CETU violated the proportionality principle because it includes revenues without allowing deductions. The Center warned about a wave of injunctions or "amparos" against the CETU if it is approved. The Research Center also determined that the tax on the informal economy violated the principle of equity by levying only deposits in cash while exempting deposits made by electronic means. In order to formally declare the CETU unconstitutional, legislators would have to challenge it and file a case before the Mexican Supreme Court of Justice. However, the Chairman of the Finance Committee of the Chamber of Deputies, Jorge Estefan (PRI),believes that the CETU is MEXICO 00004151 002 OF 004 the cornerstone of the reform, and announcing "there will be no reform, without the CETU". -------------- Ministry of Finance Defends CETU -------------- ¶4. (U) Juan Manuel Perez Porrua, Head of the Revenue Policies Unit of the Ministry of Finance (Hacienda) met with members of the Parliamentary Research Center. He explained that the tax reform's overall goal was to generate additional tax revenue totaling 3% of GDP. Without the CETU, the GOM would not be able to reach that goal and address the country's infrastructure and social needs. The National College of Economists also recommended that legislators not reduce the CETU to 12% as proposed by many in the private sector since such a drop would reduce overall collections under the reform from 3% of GDP to only 1.2 to 1.4% of GDP. -------------- Industry Complaints About the CETU -------------- ¶5. (SBU) The National Maquila Industry Council (CNIME), raised its concern over member firms being subject to double taxation as a result of the CETU. CNIME has reports that the CETU will increase member firms tax burden by as much as 600% because the sector is so labor intensive. Outsourcing services are in a similar situation. The Mexican Human Capital Association (AMECH) has said that outsourcing companies may see their tax payments increase 500%, affecting job creation or promoting the creation of poor-quality or temporary jobs with no benefits. Large employers and trade associations, such as CCE (Business Coordinating Council), Coparmex (Mexican Employers' Confederation),Concamin (Mexican Confederation of Industrial Chambers),Concanaco (National Confederation of Commerce Chambers),ANTAD (Department Stores National Association) agree that Mexico needs a tax reform, but they are demanding changes to CETU and a commitment from the government that the additional resources would be used to alleviate poverty and not for the government's current expenses. (Comment: Former Finance Minister Pedro Aspe (protect) who now heads one of Mexico's leading consultant companies, told Econoffs that almost all the increased tax revenue would go to fund additional salaries for teachers agreed to by President Fox with the national teacher's union in October/November 2006, an agreement quietly ratified by the Calderon Administration in May 2007. As part of the effort to resolve the teacher's strike in Oaxaca, Fox agreed to raise teachers' salaries in order to eliminate the three-tier system that had teachers in southern and other parts of Northern Mexico earning less than their counterparts in more prosperous parts of the country. END COMMENT) ¶6. (U) Citibank, Procter & Gamble, Daimler Chrysler, and 33 other multinationals under the Executive Council of Global Corporations (CEEG) requested that Congress amend the tax reform. In a letter to the GOM, the organization asked it to expand the taxpayers' base, control government spending, and give large companies the certainty that resources will be spent on social programs, such as health, education, housing, and infrastructure. The organization had already announced its member firms' planned USD 3 billion in investment could be postponed until there is more certainty about the reform. Although large banks largely agree that the tax reform is fundamental to generate the needed resources to help the country grow, they also consider that the tax on cash deposits more than 20,000 pesos that attempts to capture the informal sector and the CETU affect their interests since they will be forced to invest in order to comply with the new law. MEXICO 00004151 003 OF 004 -------------- Will U.S. Firms be Hurt by Double Taxation? -------------- ¶7. (SBU) Refs B and C report strong concerns by U.S. firms that the CETU is not creditable against U.S. income tax, leading to double taxation under the U.S.-Mexico tax treaty. Ministry of Finance officials have raised this issue with the U.S. Department of Treasury. Post sent Treasury a July 11 letter to the Embassy from Prudential's Chief Operating Officer for Real Estate Investors in Latin America, Maite Igareda (protect). In the letter, Igareda says that under U.S. Federal Regulation 1.901-2, the CETU does not meet the requirements to qualify as a foreign income tax that is creditable by U.S. tax residents against their U.S. income tax. Japanese Embassy Economic Counselor Yoshiko Kajima told Econoff her country's firms are not concerned about double taxation, because the Mexico-Japan "tax arrangement" would cover the CETU. (COMMENT: Post will be querying other countries' representatives to see if they fear double taxation. END COMMENT) -------------- Japanese View -------------- ¶8. (SBU) Kajima said the Japanese Society of Companies in Mexico was "very seriously concerned," however because the CETU would be a "big shock" to Japanese maquiladoras, raising taxes on them 600% to 900% because several have large numbers of employees. The Japanese Ambassador is planning to raise this concern with the Ministries of Finance and Economy. Kajima said Japanese maquiladoras have been cooperating with US, Mexican, Korean maquiladoras to raise their concerns with the Mexican Congress, and found some Mexican Senators shared their concerns and planned to amend the fiscal reform to lessen the impact on maquiladoras. (COMMENT: Current taxes on maquiladoras are extremely low, possibly around 3 percent. END COMMENT) -------------- U.S. Pension Funds Concerned -------------- . ¶9. (SBU) In the July 11 letter, Igareda the proposed tax reform would have a "very negative impact" on "United States pensions plans and non-tax investors." In addition to the problem of double taxation, she says the CETU does not grant to non-Mexican private and public pension plans the same tax-exempt status that Mexican Income Tax Law grants with respect to income from rental payments, capital gains and interest payments. The CETU would therefore tax pensions plans that are currently tax-exempt in Mexico. Finally, she says the CETU does not consider fiscal year 2007 as a creditable year for its purposes, which would generate a large amount of CETU payable in 2008 for payments made before ¶2008. Igareda notes that Prudential Real Estate Investors currently sponsors six estate funds in Mexico with commitments in excess of USD 1.2 billion. Post has been working with Igareda, who is preparing a paper for the USG on the views of the wider pension plan sector on the proposed tax reform. -------------- Calderon Urges Congress to Approve the Reform -------------- ¶10. (U) President Calderon asked Congressmen to approve the tax reform to address the imminent financial pressures from increased pension liabilities and "Pidiregas" (off-government balance sheet infrastructure borrowing) maturities next year. The President also warned that without a tax reform, the government would not be able to develop the infrastructure MEXICO 00004151 004 OF 004 projects that the country needs. Congress would have to approve the tax reform during a special session before September 8, when the Executive has to send forward its FY 2008 budget package. Visit Mexico City's Classified Web Site at http://www.state.sgov.gov/p/wha/mexicocity and the North American Partnership Blog at http://www.intelink.gov/communities/state/nap / GARZA