China and Mexico: The Real Winner May Be Hong Kong

Chinese President Xi Jinping visited Mexico in early June and met with the Mexican President Enrique Peña Nieto. Following their meetings, the two leaders released a statement saying that both were prepared to “take their relationship to a new level” and to develop the existing trade relationship into a “strategic partnership.”
 
This suggests that both countries could form mutually beneficial commercial alliances in the form of joint ventures. For China and Hong Kong, that makes some sense because Mexico is a member of the North American Free Trade Agreement – which also includes the United States and Canada. Therefore, the prospect of Chinese companies seeking partnerships with Mexican businesses to then sell onto the lucrative U.S. market looms large.
 
But does it? If there was substance to these declarations of “strategic partnership” then we would potentially be in the wonderfully ironic position of Chinese companies, through Mexican JVs, qualifying for the U.S.-led Trans-Pacific Partnership Agreement, a trade bloc that includes Mexico and Vietnam, among others, and is largely aimed at replacing China as the primary supplier of choice for certain products (such as textiles) for the U.S. market.
 
Yet, sadly, I feel that is not going to happen. These sorts of meetings, in my opinion, are an excuse for political grandstanding and media exposure. As a result, they mean very little.
 
Hong Kong the Winner?
While the prospect of Mexican-Chinese JVs to target the U.S. market may seem appealing to both, in actual fact, the Chinese side have little incentive to do so. Mexico has no double taxation agreement (DTA) with China, meaning that Chinese investors are subject to Mexican rates of corporate income tax (CIT) and related taxes with no treaty to offset these.
 
Mexico has a higher rate of CIT at 28% than China at 25%. Although that doesn’t sound like a huge difference – it is more than enough to eat into any available profit gains in such competitive markets. Mexico also levies immediate worldwide income tax claims on all residents – something that is not likely to sit well with Chinese investors.
 
That said about Mainland China, the news may yet be of use to Hong Kong’s business community. Hong Kong signed a comprehensive DTA with Mexico on June 18, 2012, which entered into force on March 7, 2013 and will have effect in Hong Kong for years of assessment beginning on or after April 1, 2014.
 
Under the terms of the DTA, the current policy of double-taxing Mexican individuals who are resident in Hong Kong will end, and any tax paid in Mexico will be considered a tax credit against the tax payable to Hong Kong. The DTA also incorporates the Organization for Economic Cooperation and Development requirements for the exchange of tax information.
 
Specifically, the DTA lowers rates of withholding taxes in the contracting state in which the income is derived, in respect of dividends, interest and royalties. While dividend income is only taxable in the country of the recipient, interest income can be taxed in both territories.
 
But in the territory where the interest income arises, withholding tax will be capped at 4.9% if the beneficial owner is a bank, and at 10% when the recipient is the beneficial owner of the asset from which interest income is derived. If the recipient is the beneficial owner of royalties income, the withholding tax rate will be capped at 10%. 
 
Action, not just words
The two leaders released a statement suggesting that Chinese-Mexican bilateral relations would enter into a new phase and were “being upgraded.” Xinhua published the official statement through China Daily that, in condensed form, promised both sides “will view their relations from a strategic and long-term perspective” and “accommodate each other’s concerns.”
 
Along with that are statements to “maintain exchanges between high-level leaders and political parties,” as well as “agree to increase mutual investment in key areas such as energy, mining, infrastructure and high technology.”
 
China has stated that it “supports the increase of imports from Mexico, while Mexico welcomes Chinese enterprises to invest in Mexico and promises to create favorable conditions for Chinese investors.”
 
Frankly, Mexico needs to address the issue. Current Mexico-China trade figures for 2012 show an imbalance of some US$50 billion in China’s favor. According to the Mexican Central Bank, Mexico imported US$57 billion worth of Chinese goods last year, while Mexico sold just US$5.7 billion to China.
 
Although China is Mexico’s second largest trade partner, and therefore important, the size of the two economies and populations should also be taken into account. With Mexico’s population at about 115 million against China’s 1.3 billion, Mexico purchases Chinese goods at a value of US$496 per capita, while China averages US$4 per capita in buying Mexican goods. That’s a sizable disparity.
 
However, the two countries did agree to “improve cultural exchanges.” The Chinese will apparently build a Chinese cultural center in Mexico City, the first in Latin America and the Caribbean, and Mexico will establish a Mexican cultural center in Beijing.
 
Finally the communiqué said that “China and Mexico will improve multilateral coordination based on their common interests and responsibilities on major international issues.” Xi left Mexico with the promise of Chinese contracts “worth US$1 billion,” but without any details of where these would be from or in what form.
 
Investment agreement
The two countries do have an “Agreement between the Government of the United Mexican States and the Government of the People’s Republic of China on the Promotion and Reciprocal Protection of Investments.” However this dates back to 2008 and the current statements do little, if anything, to expand beyond this framework.
 
It was penned five years ago at the time of Beijing hosting the Olympics. So this could simply be another example of an agreement written by Mexico to feed their hungry media and to show off their politicians alongside countries that are firmly in the international spotlight, because it contains little of actual substance.
 
So what does the rhetoric actually mean? Without any supporting tax agreements, the Mexico-China talk remains just that – talk. Chinese companies have access to U.S. markets anyway and the Mexican tax code is unattractive to them compared with lower rates back in China.
 
A real deal with meaningful language concerning China bilateral trade would have included discussions on negotiating a bilateral double tax treaty. The fact that it didn’t suggests that, while both President Xi and President Peña Nieto may want to target the U.S. consumer market, the tax structural ability to actively do so as trade partners remains elusive.
 

What this really boils down to is that while Mexico may not have been able to extract many concessions from the bigger prize of mainland Chinese consumers, it may be able to better sell through Hong Kong importers and distributors with links to Mainland China. It will be the Hong Kong distributors with their connections in the mainland that will benefit most.

 

About the Author

Chris Devonshire-Ellis is the founding partner and principal of Dezan Shira & Associates, a specialist foreign direct investment practice that provides advisory services to multinationals investing in emerging Asia. This article was first published in Asia Briefing and was reedited for clarity and conciseness. For further details or to contact the firm, please visit www.dezshira.com.  

 

Photo credit: Shutterstock

 

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