Outsourcing in Mexico presents several complications for foreign companies that arise for three principal reasons: (1) Mexico’s strict labor and employment laws pertaining to severance, (2) costly social security and government benefits, and (3) on-going tax filing compliance requirements. Despite this, Mexico continues to remain an attractive destination for companies wishing to decrease operational costs, retain high-quality and educated employees, and expand into overseas markets. Let’s have a look.
Before beginning, there is confusion as to what “outsourcing” actually is because the term in Spanish is used differently than in English. In commonly accepted business language in Mexico, the term “outsourcing” is directly used without translation, referring to what would be considered a service provided by a PEO (Professional Employment Organization). This is where the employees of one company are directly hired by a third-party company that handles all matters or payroll compliance, tax payments, and direct deposit of salaries, among other activities. The workers are essentially the employees of the third-party company and not of the actual company for whom the work is performed and where the employee undertakes their day-to-day activities.
In English, the term outsourcing is used in a different sense. Generally, the term refers to the subcontracting of another company, usually located abroad, for the provision of services by lower wage workers, to perform activities that would normally be undertaken by the domestic Company’s own employees internally. Think call centers, when you’re trying to book a flight or calling technical support and are transferred to a foreign country.
Outsourcing in the sense of the English language definition above is common in Mexico for many purposes like hiring programmers, logistics support, back-office employees, and engineers, to name a few examples.
The first step to successful outsourcing is establishing a local legal entity like an LLC in Mexico or contracting a local PEO service provider. For more on how to form an LLC in Mexico or similar legal entity, please consult our other articles at the following link: https://www.mexicanincorporation.com/incorporating-in-mexico/basics-of-llcs-in-mexico/
Be aware of the differences in Mexican labor laws. Mexican labor law does not embrace the concept of “at will employment”. That is to say, once an employee is contracted there are only a few limited circumstances under which an employee may be dismissed for cause without facing penalties. The standard penalties include the following: three-month severance pay, with accumulated unused vacation pay and pro rata annual year-end bonus up until the date of dismissal.
Except for a few limited exceptions, firing an employee will trigger the required severance payment, referred to as a “finiquito” or “indemnización”. Avoiding this penalty is limited to only a few circumstances under the Mexican Federal Labor Law, including: the employee having accumulated three unjustified absences within a thirty-day period, the employee’s showing up to work under the influence of alcohol or drugs, incarceration, or where the worker poses a danger to the safety or security, or threatens or commits acts of physical violence in the workplace.
All companies seeking to outsource in Mexico, should seek the services of labor attorney who can design an employment agreement that mitigates potential exposure to payment of severance by implementing probationary or training period clauses, that permit an employee to be dismissed without payment of severance during a period ranging from one month, three months or six months. The length of this “grace period” is determined by the nature of the worker’s employment and whether the employee is managerial or has a particular specialized or technical skill. There is also the ability to provide a contract for a specific duration, at the end of which the worker’s employment will cease without penalty. However, caution should be exercised, as there are limitations as to when these techniques can be implemented legally.
Be aware of Mexican payroll taxes and social security benefits. Social benefits and payroll taxes are another area of cost and concern for foreign companies outsourcing in Mexico. Mexico has an extensive government social safety net for employees including public healthcare, government-funded housing benefits, childcare, pensions, and retirement. The cost of these programs falls 90% upon the employer to cover as will be outlined below. These costs often come a shock to companies, especially those from the United States, where such expenses are lower relatively speaking. Nevertheless, even when taking into account these expenses, the cost of hiring workers is generally between 60% and 75% lower than hiring the same employees in countries with more developed economies.
Check out our wage calculator on our website to see an overview of taxes at various wage levels at the following link: payroll calculator Mexico.
For example, if a worker’s base salary is 35,000 Mexican Pesos, the employer will pay a total of 7,519.43 Mexican Pesos for social security and government benefits at established rates for fiscal year 2021. The total cost to the employer will therefore be 42,519.43 Mexican Pesos. This is about 22% of the employee’s wage. When we take into account accumulated vacation pay and annualized bonus, this number increases slightly. On the other hand, the employee will have to pay income taxes out of pocket and an additional social security deduction, for a total of 7,223.03 Mexican Pesos, for a final take home salary of 27,776.97 Mexican Pesos.
Finally, be aware of high compliance and administrative costs. Mexico has high administrative and compliance costs. The payment of taxes and payroll deductions must all be calculated on a monthly basis for each pay period and filed with the relevant authority – of which there are several. Coordination of these calculations and deductions is a complicated matter involving a significant number of administrative hours and specialized skill that must be handled by a qualified accountant. A grave error that many new companies make is thinking that they can handle this themselves. Do not attempt this on your own. The process of calculation and simply making payments is complex and rife with levels of bureaucracy and proprietary government software. Penalties are by default 40% of taxes due even in the case of the slightest error, which is in our opinion draconian and excessive.
Any company seeking to outsource in Mexico should be prepared to pay a premium for accounting and compliance services for not only payroll, but tax compliance in general. Unfortunately, this stifles the expansion of the formal economy and economic development generally, and also increases the cost for foreign companies doing business and outsourcing in Mexico.