Mexico’s Outsourcing Ban Leaves Businesses with Limited Options

On April 23, Mexico’s populist President Andrés Manuel López Obrador (AMLO) signed off on a bill effectively banning companies from outsourcing jobs for “core business activities”. While this will have little impact on the country’s massive Nearshore economy, it could have serious repercussions for other businesses, given how commonplace outsourcing arrangements in the country are.

The bill passed through the Mexican Senate with surprising speed, after receiving 118 votes in favour, no opposing votes, and only two abstentions. That came less than a week after it had passed through the Chamber of Deputies with a resounding majority and just days before AMLO endorsed the bill and put most of it into immediate force.

For those doing business in Mexico who will be affected by it, a number of options are available. However, first let’s look at how we got here.

The Road to Mexico’s Outsourcing Ban

In what appears to be a case of throwing the baby out with the bathwater, the AMLO administration has pushed its outsourcing bill through in order to confront a very real challenge: corporate avoidance of financial obligations.

In recent years, Mexico had seen a significant uptick in outsourcing, as numbers of subcontracted or outsourced employees rose from around 1 million in 2003 to approximately 4.6 million in 2018. That was partly driven by firms taking advantage of a regulatory loophole that allowed them to use outsourcing arrangements to avoid certain taxes and employee benefits, including statutory obligations on profit sharing.

Forcing companies to go through a time-consuming process of verifying if outsourced staff are considered to be involved in core activities, could prove to be a barrier that forces investors to look elsewhere

The new law closes that loophole by giving employers three months to put all jobs related to “core activities” onto their own payroll, while outsourcing firms will face more scrutiny in their obligations to pay such benefits and share their profits with outsourced workers providing “specialized services”. 

This all follows years of stalled attempts to regulate the outsourcing industry, and months of public efforts by AMLO to bring in legislation on the matter, despite the fact that analysts have warned it could come at deep cost to the economy.

What it Means for Business in Mexico

Beyond the obvious pinch that will be felt by businesses who have been taking advantage of the loophole, the bill effectively eliminates employer of record (EOR) services in Mexico for any staff who could be deemed to be performing a role related to “core activities.” 

That kills a type of service that is widespread throughout Latin America and particularly convenient for staffing shorter-term or limited-scale projects, and which many foreign investors count on. Given that the sometimes lengthy process of company formation in Mexico can prove a barrier to companies seeking to get to work right away, or who know they will not be there for long, the new regulations could drive away investment. 

It is unclear how “core activities” will be defined and, thus, exactly how this will affect the outsourcing of highly skilled specialists through an EOR. However, in the case of a company that just needs short-term entry level help, or, for example, an IT company in the US that wishes to hire programmers in Mexico on a temporary basis, the EOR arrangement may not be available to them.

Beyond that, in many cases investors who are unfamiliar with a new market, or who want to build familiarity before deepening their commitment, will often seek to hire via an EOR in order to get to know the market ahead of company formation, or while the incorporation process is underway.

It is unclear how “core activities” will be defined and, thus, exactly how this will affect the outsourcing of highly skilled specialists

Eliminating this as a possibility, or forcing companies to go through a time-consuming process of verifying if outsourced staff are considered to be involved in core activities, could prove to be a barrier that forces investors to look elsewhere. 

That is where this bill could be seen to be throwing the baby out with the bathwater. Because while the tax and benefits avoidance loophole needed closing, to do so at the possible cost of future investment seems potentially self-harming.

What Can Businesses Do About the Outsourcing Ban?

For businesses affected by this new law, a number of options are available. Investors with outsourced staff based in Mexico who could be deemed to perform “core” activities could seek out some sort of Nearshore solution, contracting a local firm to undertake the jobs of those staff. 

The obvious downside to is that if you already have staff you have built up a good working relationship with, they may not be able to participate in such an arrangement because the Nearshore provider will in many cases already have its own team.

A second option is to establish an entity. This is likely to be most attractive to companies who have a significant number of outsourced employees or long-standing involvement in Mexico – or whose plans involve a deeper commitment to the market in the coming future. 

The reality is that many other countries from the region are able to offer highly competitive alternatives

Whether they do that through company incorporation, or prefer to form a branch or subsidiary will depend on how the business is structured and how much control they wish to have over the new entity. However, it is unclear what will happen if that process takes longer than the three-month grace period during which core employees are supposed to become direct hires. While common sense should prevail and companies demonstrably acting to become compliant with the new law should avoid fines, AMLO cannot always be expected to act with common sense when there are populist points to be scored, and it is worth keeping in mind that penalties for non-compliance can reach MX$4.4 million (close to US$220,000). 

The final option available to current or potential EOR clients is to simply take their business elsewhere. Because while there are a great many opportunities for doing business in Mexico and the country’s access to the massive US market is a significant draw, Mexican entities do have to meet that profit sharing obligation, and the reality is that many other countries from the region are able to offer highly competitive alternatives. 

That could be in Central America, where labor costs are lower and a growing pool of skilled workers is making the sub-region increasingly attractive to foreign investors. Or it could be one of Mexico’s more traditional outsourcing rivals, such as Colombia or Chile, where the governments are particularly encouraging of foreign investment.

Whichever route might be best, investors exposed to this new law should know that they do have options available.