Mexico: Energy Reform

On December 20, 2013, the Official Daily of the Federation published the Decree whereby constitutional articles 27 and 28 were reformed to allow the participation of the private sector in the exploration and extraction of hydrocarbons, in activities related to basic petrochemicals and the electrical power industry.

The transitional provisions of the constitutional reform establish that Congress must make the necessary adjustments to the legal framework so that the approved system may be put into effect.

In this respect, the President sent Congress a bill proposing the enactment of nine new laws and the reform of twelve existing laws, which altogether constitute the "secondary laws". After approval by Congress, the "secondary laws" were sent to the Executive Branch for signing and publication in the Official Daily of the Federation, which took place on August 11, 2014.

The most relevant aspects of the "secondary laws" on energy matters are comprised within the following points:

1. The State will carry out the activities for the exploration and extraction of oil and other hydrocarbons by means of assignments to State Productive Companies, or through contracts (license, service, shared profit or production or a combination of such contracts) with such companies or with private parties.
2. A transition period, which will not exceed two years as of the publication of the constitutional reform decree, was established in order for the decentralized entities (quasi-autonomous entities own by the State) Petróleos Mexicanos (PEMEX) and Comisión Federal de Electricidad (CFE) to become what the law designates as State Productive Companies. During this transition, PEMEX and its subsidiaries are empowered to receive assignments for the exploration areas and the production fields, provided that these entities prove that they have the technical, financial and execution skills required.
3. The rights, duties and powers of the authorities of the sector, as well as of other regulatory entities on energy matters, are specified.

Based on the "secondary laws", the new forms to carry out the exploitation of hydrocarbons in our country, as well as the "tax regime" that provides the consideration that will allow the State to obtain income from this sector, are determined.

The "tax regime" set forth in the contracts for the exploration and extraction of hydrocarbons should not be understood as a tax system, but as the contractual terms that will determine the benefits that will be obtained by the State; therefore, this regime does not release contractors from complying with their obligations on tax matters set forth in the Income Tax Law and other applicable provisions.

On income tax matters, specific rules are established, which should be applied by contractors, such as the case of the percentages for the deduction of investments, the utilization of tax losses, as well as the rules and requirements that should be met by legal entities or the State Productive Companies that group in consortiums in order to participate in the contracts.

Further, special rules are established on matters of permanent establishments of nonresidents engaged on the activities referred to in the Law of Hydrocarbons.

In the following pages we present our comments on the main aspects of the energy reform, grouped under the following.

CONSTITUTIONAL REFORM

On December 21, 2013 the constitutional reform on energy matters entered into effect. This reform, among other aspects, intends to guarantee the ownership and governance of the State related to the control of hydrocarbons, contemplating the participation of the private sector on several activities, as well as the modernization of such sector for purposes of improving the economy of families, increasing investment and the generation of employment, in addition to strengthening PEMEX and the Comisión Federal de Electricidad (Federal Electricity Commission) (CFE).

New exploration and extraction constitutional regime

It is established that in respect of the planning and control of the Mexican electric power system, and the public service for the transfer and distribution of electricity, as well as the exploration and extraction of oil and other hydrocarbons, the Nation will be in charge of these activities, exclusively under the terms set forth in the Mexican Constitution.

It is further provided that the law will establish the standards related to the administration, organization, functioning, contracting procedures and other legal acts entered into by PEMEX and the CFE, in respect of activities referred to as exclusive, as well as the regime for the remuneration to their staff, in addition to determining the other activities that they will be entitled to carry out.

As a result of the constitutional reform, PEMEX and CFE now designated as "State Productive Companies", will maintain the current administration, finance, operations, legal, technology of information and business process areas, but new procurement and logistics areas will be created, which will be in charge of having better buying conditions, greater transparency and a more efficient communication with suppliers.

Constitutional regime on hydrocarbon assignments and contracts

- Electric power

It is reaffirmed that the planning and control of the electric power system, as well as the public service for the transfer and distribution of electricity corresponds exclusively to the Nation. In these activities, despite that no concessions will be granted, the State may enter into contracts with private parties under the terms set forth in the law.

With respect to the other activities of the electricity industry, the law will determine the form in which private parties may participate therein, emphasizing that the commercialization of electricity will no longer be the exclusive competency of the CFE.

- Oil and hydrocarbons

It is reaffirmed that oil and solid, liquid or gaseous hydrocarbons located in the subsoil, are the exclusive property of the Nation, unalienable and not subject to a statute of limitations and that no concessions will be granted for the exploitation or utilization thereof.

Notwithstanding the foregoing, it is established that, on a exclusive basis, the activities for the exploration and extraction of oil and other hydrocarbons may be carried out by means of assignments to the State Productive Companies or through contracts with the latter or with private parties, under the terms of the regulatory law, thus reaffirming that hydrocarbons in the subsoil will always be owned by the Nation and this should be evidenced in the assignments or contracts that are entered into.

New PEMEX constitutional regime

As a result of this reform, PEMEX will focus on basic activities of the oil industry. The basis of the restructuring consists of creating a single PEMEX, eliminating the duplication generated due to the four subsidiary bodies that currently exist, in addition to strengthening the functions to support the operation and increasing the transparency in the creation of the value in each of its activities.

The PEMEX subsidiary bodies will be integrated by two divisions: i) Exploration and Production, focused on the extraction of hydrocarbons (oil and gas); and ii) Industrial transformation, focused on the processing of hydrocarbons.

Secondary laws

As a consequence of the reform, nine laws were created and twelve more were reformed, which establish the legal framework that, in principle, will allow compliance with the objectives intended with the energy reform.

HYDROCARBON REVENUE LAW

The most significant aspects related to the Hydrocarbon Revenue Law, include, among others, the establishment of the income to be received by the State from the hydrocarbon exploration and extraction activities. It is also established that the State will be entitled to participate in exploration and extraction activities, either by means of assignments or through the contracts that it enters into.

Additionally, such law governs the administration and supervision of financial aspects applicable to these contracts and contains the provisions on the obligations with respect to the transparency and reports related thereto.

Income of the State

In view of the hydrocarbon exploration and extraction activities, the State may obtain income from government fees, when it carries out activities due to an assignment or from a consideration, when it performs activities in accordance with a contract. The State may also realize income from income tax payable by the assignees and the contractors that carry out the exploration and extraction activities.

Income derived from assignments

Assignments for the exploration and extraction of hydrocarbons may only be granted to State Productive Companies whose purpose consists exclusively of the exploration and extraction of hydrocarbons and that do not choose the optional regime for groups of companies for income tax purposes (also referred to as integration regime) set forth in the Income Tax Law.

It is further provided that when the extraction and production activity is carried out through an assignment, the State will receive income from the payment of three different government fees: i) shared profit fees, ii) fees for the exploration and iii) fees for the extraction of hydrocarbons. Likewise, the State will receive income through assignments from income tax paid by the assignees.

In this respect, assignees will be income taxpayers and also, parties obliged to pay the three types of fees previously referred to.

Additionally, it is established that assignees will be obliged to pay a royalty and a consideration as a percentage of their operating profit in favor of the State.

- Fee for the shared profit

It is established that the fee for the profit payable by the assignees will be paid on a yearly basis by applying a 65% rate on the difference that results between the value of the extracted hydrocarbons and the deductions allowed in accordance with the Hydrocarbon Revenue Law.

This fee will be remitted by means of a return no later than the last business day of March of the year following that to which the payment corresponds and the assignees will be obliged to file monthly estimated tax payments no later than the last day of the month following the month to which they correspond.

- Fee for the exploration of hydrocarbons

The fee for the exploration of hydrocarbons will be paid on a monthly basis with respect to that part of the assignment area that is not in the production phase, considering the fees that are stipulated, which depend on the months elapsed as of the date on which the assignment was granted; that is to say, a fee equivalent to $1,150 pesos per square kilometer will be paid during the first months of the term of the assignment contract, and a fee equivalent to $2,750 pesos per square kilometer will be paid as of month 61 and thereafter. Without prejudice to the foregoing, it is stipulated that such fees will be restated annually for purposes of reflecting the period's inflation.

- Fee for the extraction of hydrocarbons

The fee for the extraction of hydrocarbons will be paid on a monthly basis by applying the rate that corresponds to the value of the related extracted hydrocarbon, therefore, the rate will vary depending on the nature of the hydrocarbon, that is to say, it will depend on whether the object of the extraction is oil, natural gas or condensates.

- Tax on the hydrocarbon exploration and extraction activity

Assignees and contractors are obliged to pay the tax on the exploration and extraction activity. This tax should be calculated on a monthly basis by applying specific fees per each square kilometer that comprises the contractual or assigned area, as applicable. The tax calculated in accordance with the foregoing, will be paid no later than the 17th day of the month following that to which the payment corresponds.

In line with the purpose of the Hydrocarbon Revenue Law, income realized from the tax on the exploration and extraction activity will be allocated to the Fund for the States and Municipalities that are Hydrocarbon Producers, and for purposes of the Tax Coordination Law this income will not be included in the federal revenues subject to participation.

Income derived from contracts

In contrast with the case of assignments, it is established that contracts may be entered into by the State Productive Companies and by private parties as well.

When the extraction and production activity is carried out through a contract, the State may realize income from the following items: i) bonus upon execution, ii) contractual fee for the exploration phase, iii) royalties, iv) consideration on the value of the hydrocarbons or profit percentage, and v) tax on the hydrocarbon exploration and extraction activity.

- Bonus upon execution

The bonus upon execution is an amount per each contract that will be stipulated by the Ministry of Finance and Public Credit (SHCP) that the related contractor must pay to the State in cash through the Mexican Oil Fund.

- Contractual fee for the exploration phase

As in the case of the obligation to pay the fee for the exploration of hydrocarbons when it relates to assignments, in the case of contracts, it is established that contractors will be obliged to pay the contractual fee for the exploration phase, which will be paid by the contractual area that is not in the production phase in accordance with the fee equivalent to $1,150 pesos per square kilometer during the first months of the term of the assignment contract, and a fee equivalent to $2,750 pesos per square kilometer as of month 61 and thereafter. Notwithstanding the foregoing, it is stipulated that such fees will be restated annually for purposes of reflecting the period's inflation.

- Royalties

Likewise, it is established that contracts will stipulate a periodic consideration in favor of the State, designated as royalties, which will be determined by applying different rates to the contractual value depending on the type of the related hydrocarbon, either oil, natural gas or condensates.

- Consideration on the value of hydrocarbons or profit percentage

A consideration is established in favor of the State on the value of the related hydrocarbons or the application of a percentage on the operating profit, when the related contract is executed on the modality of shared profit.

With the presumed intention of allowing the State to obtain the extraordinary profitability generated as a result of the extraction of hydrocarbons, it is established that the rate applicable to the value of the hydrocarbons will be modified through the adjustment procedure that is established in the related contract and in the bidding terms.

- Tax on the hydrocarbon exploration and extraction activity

The payment of the tax on the exploration and extraction activity should be carried out equally by the assignees and the contractors; in this manner, both types of participants should determine this tax on a monthly basis by applying specific rates per each square kilometer comprised either of the contractual area or the assigned area, as applicable.

Types of Contracts

The several types of contracts that may be entered into for the exploration and extraction of hydrocarbons may be grouped in the following five categories: i) license contract, ii) shared profit contract, iii) shared production contract, iv) service contract, and v) hybrid contract, product of the combination of any of the previous contracts.

License contracts

Under this modality of contract, the contractor will receive the onerous transfer of the hydrocarbon when extracted from the subsoil.

Shared profit contracts

In this type of contracts, contractors will deliver the entire contractual production to the trader and the latter, in turn, will deliver income derived from the commercialization of the production to the Mexican Oil Fund, which will assume responsibility to pay the contractor, the consideration that may apply in accordance with the contract.

Further, this type of contract establishes the recovery of costs in favor of the contractor. Nevertheless, the consideration on the recovery of costs is subject to certain restrictions established in the Hydrocarbon Revenue Law. Likewise, a consideration in favor of the contractor is established, which will be equivalent to the remainder of the operating profit once the consideration is paid to the State, consisting of the application of a specific percentage to the same operating profit.

Shared production contracts

In the case of shared production contracts, the consideration in favor of the contractors is established, consisting of the recovery of costs and the remainder of the operating profit set forth in the regime applicable to shared profit contracts.

Nevertheless, in line with the nature of shared production contracts, it is established that the payment of the consideration to contractors will be carried out in kind with a proportion of the contractual production of hydrocarbons.

Service contracts

When service contracts for the exploration and extraction of hydrocarbons are executed, contractors should deliver the contractual production to the State, and the consideration in favor of the contractor, in contrast to the case of shared production contracts, will be paid in cash and should be stipulated in each of the contracts considering the standards or uses of the industry. It is further provided that this consideration should be paid by the Mexican Oil Fund with the resources arising from the commercialization of the contractual production that derives from each service contract.

Regardless of the specific characteristics inherent to each type of contract previously described, it will be possible to utilize a combination thereof for purposes of carrying out the activities for the exploration and extraction of hydrocarbons.

Consortium

The possibility of participating in the contracts of this sector by means of the concept of "consortium" is established. This concept consists of two or more State Productive Companies and/or ordinary legal entities jointly filing a proposal within the bidding process for the awarding of a contract, with no need of incorporating a specific purpose entity to this effect.

In any event, the parties integrating the consortium should comply with the following requirements: i) they should be Mexican residents for tax purposes; ii) their purpose should consist exclusively in the exploration and extraction of hydrocarbons; and iii) they choose not to pay taxes under the optional regime for groups of companies for income tax purposes (also referred to as integration regime).

In contrast to the fiscal "asociación en participación", the concept of consortium does not have any legal capacity for purposes of tax law, other than that of the associates thereof, thus endowing this legal concept with a complete tax transparency.

The entities grouped in a consortium should enter into a joint operation agreement through which: i) they appoint one of the associates of the consortium as the "operator" to carry out transactions in the name and on account thereof, ii) they accept that the tax receipts supporting expenses disbursed for the development of the activities necessary for the execution of the contracts should be issued in the name of the operator and, iii) they reflect the percentage of participation applicable to each associate.

The operator is required to deliver to each associate a list of the transactions carried out in accordance with the contract and a copy of the tax receipts that are received.

Further, the operator should inform the Tax Administration Service (SAT), no later than February 15 of each year, the transactions carried out by the consortium, identifying the portion applicable to each associate.

On an individual basis, each associate of the consortium - including the operator - will deduct the portion of costs and expenses incurred and investments made proportionately to their participation; for this purpose, the operator should issue, in favor of each associate, a tax receipt supporting the amount of their proportional part, and such receipt should comply with the requirements set forth in the applicable tax provisions.

It is established that amounts received from the associates of the consortium for purposes of incurring expenses on their account, will not be deemed taxable income for the operator, to the extent that these amounts are supported with tax receipts issued by the operator.

The associates of the consortium may request that the Mexican Oil Fund deliver on an individual basis to each of the associates of the consortium the contractual consideration applicable to each of them, or that the consideration be delivered to the operator, who should distribute it to the associates.

In line with the regime, it is established that in the event that it is requested that the consideration be delivered to the operator and that the latter distribute it to the associates, the operator should not treat as taxable income, the amount of the consideration delivered to it and that it actually distributes to the associates; also, the consideration that it distributes to such associates should not be treated as a deductible item.

The associates of the consortium should comply with all the tax obligations individually; therefore, each of them should have to include in taxable income and deduct the proportion of the income and deductions derived from the contracts.

Power of the Ministry of Finance and Public Credit

Guidelines of the energy reform include the power that will be granted to the Ministry of Finance and Public Credit (SHCP, Spanish acronym) on these matters, highlighting the following:

1. The bonus upon execution and the amount and conditions thereof will be determined by the SHCP for each contract that is entered into and will be included either in the bidding terms for purposes awarded there of or in the contract derived from a migration (when an assignment is converted into a contract).
2. In the case of shared profit and shared production contracts, the SHCP will determine the percentage of the shared profit and the percentage of the shared production, as applicable.
3. The SHCP will determine the value rate of hydrocarbons in license contracts, as well as the amount of royalties and the consideration in favor of the State in each of the different contracts, based on the nature of the related hydrocarbon.

Tax Regime

Below we will establish several specific characteristics related to the tax regime that will be applicable to taxpayers that enter into contracts for the exploration and extraction of hydrocarbons.

It should be noted that the existing tax laws were not modified; however in the new Hydrocarbon Revenue Law specific tax issues were regulated, which have a direct impact on income tax payable by the contractors.

Tax Boundaries (cerco fiscal)

The Hydrocarbon Revenue Law includes a system designated as "cerco fiscal", consisting of provisions that restrict and govern the tax aspects related to taxpayers entitled to enter into contracts or that govern or restrict the manner in which these taxpayers should pay the tax.

In this respect, it is established that the bidding terms for the contracts and the contract itself may only be formalized with State Productive Companies or legal entities that comply with the following requirements: i) they should be Mexican residents for tax purposes; ii) their purpose should consist exclusively of the exploration and extraction of hydrocarbons; and iii) they should not pay taxes under the optional regime for groups of companies (also referred to as integration regime).

It is established that the State Productive Companies, legal entities, asociaciones en participación and consortiums that participate in the contract, may be the holders of more than one contract, which would allow the carry forward of losses incurred in one project against profits generated in a different one.

Determination of income for the contractor per type of contract

- Shared profit and production contracts

In the case of contractors, the stipulated consideration and the recovery of costs and expenses will constitute taxable income.

In this respect, stipulated consideration should be understood as the remainder of the operating profit net of the consideration payable to the State.

The operating profit will be determined each period and will be the result of reducing from the contractual value of the hydrocarbons, the amount of royalties actually paid by the contractor and the recovery of costs and expenses.

The operating profit referred to in the preceding paragraph is a contractual and not fiscal concept, therefore, when the Hydrocarbon Revenue Law establishes fifteen concepts that are non-deductible items for purposes of the determination of the operating profit, which is the basis of the contractual consideration, this does not mean that for tax purposes, such concepts are necessarily non-deductible, but that the concepts referred to in the law are not subject to be subtracted for the determination of the operating profit. In view of the foregoing, contractors should observe the general tax requirements in order to determine which concepts are deductible.

In respect of the recovery of costs and expenses, the consideration will be the amount equivalent to costs, expenses and investments that are recognized in accordance with the guidelines issued to this effect by the SHCP. This consideration should not exceed the limit of the recovery of expenses in each period.

Once the guidelines for costs and expenses that can be recovered have been determined, there will be a restriction for the recovery of costs and expenses per each period and, in the event that such restriction is exceeded, the excess will be included in the consideration applicable to the recovery of costs of subsequent periods.

With respect to income for income tax purposes due to the consideration, the new law makes a distinction depending on whether the contract is a shared profit or a shared production contract, in accordance with the following

1. In shared profit contracts, the hydrocarbons that are extracted will be delivered to a trader that will carry out the sale thereof and the proceeds of such sale will be delivered to the Mexican Oil Fund, which will pay the contractor the applicable consideration in cash.
2. In the case of shared production contracts, the collection should be made in kind, due to the fact that a portion of the extracted hydrocarbons equivalent to the value of the applicable consideration will be delivered to the contractor. In view of the foregoing, income for the contractor will be that derived from the subsequent sale of the product.

- License contracts

The Hydrocarbon Revenue Law provides that in the case of contractors, the consideration will be the onerous transfer of the hydrocarbons once extracted from the subsoil, provided that, in accordance with the terms of the contract, the contractor has no outstanding balance in respect of the payments that should be made to the State. In view of the foregoing, income for contractors will be that derived from the sale of the hydrocarbons.

- Service contracts

For this type of contracts, the Hydrocarbon Revenue Law establishes that with respect to contractors, the amount stipulated in each contract will constitute income, which will be determined considering the standards and uses of the industry. It should be noted that such amounts will be paid by the Mexican Oil Fund in cash.

Consideration due and payable

Another concept which makes a distinction between the contractual and fiscal effect, is the due payment of the consideration in favor of the contractor.

In accordance with the Hydrocarbon Revenue Law, the consideration will be paid once the contractual production is obtained; therefore, the consideration will not be due and payable as long as there is no extraction of hydrocarbons, and no advanced payment will be granted to contractors.

We consider that such provision does not intend to modify the date for the obtainment of income set forth in the Income Tax Law but that it is a procedure to protect the State so that it does not make the related payments to contractors until they are actually extracting the hydrocarbons.

Even in the Preamble to the Law it is established that one of the obligations of contractors consists of utilizing their own funds to finance the activities of the contract.

In view of the foregoing, we consider that the timing for the inclusion of income in taxable income set forth in the Income Tax Law, should prevail.

Depreciation

On matters related to the depreciation of investments for income tax purposes, the depreciation procedure based on the straight line method is maintained.

However, in the Hydrocarbon Revenue Law it is established that instead of applying the deduction percentages set forth in the Income Tax Law, the following percentages will be applied:

1. 100% of the original amount of investments made for the exploration, secondary and improved recovery and maintenance not subject to be capitalized, in the tax year in which they are carried out.
2. 25% of the original amount of investments made for the development and exploitation of oil fields and natural gas, in each tax year.
3. 10% of the original amount of investments made in infrastructure for storage and transportation indispensable for the execution of the contracts such as oil pipelines, gas pipelines, terminals, transportation or storage tanks that are necessary to transport the contractual production to the points of delivery, measurement or supervision determined in each contract for each tax year.

In accordance with the Preamble to the Law, the inclusion of these percentages in the Hydrocarbon Revenue Law derives from the fact that in the Income Tax Law currently in effect no specific percentages are established for this type of property or investments of the hydrocarbon sector.

In respect of the depreciation of investments made for the exploration, secondary and improved recovery and maintenance not subject to be capitalized, the percentage of which is 100%, in the wording of the norm, it is established that it will be applicable in the tax year in which this investments are made.

Transfer of property to the Nation

Due to the fact that in shared profit and shared production contracts, contractors recover the costs, expenses and investments incurred through the consideration that will be paid by the State, in the event that the contractor sells assets whose price had been recovered in accordance with this scheme, it is established that the funds realized from such sale will correspond to the state.

In accordance with the above, the contractor should deliver the funds derived from the sale to the Mexican Oil Fund or, if applicable, such amount may be discounted from the consideration applicable to the contractor in the period in which the sale is carried out.

The preceding means that the State acquires title to the assets generated in the projects through the payments made to the contractors due to the recovery of their costs, expenses and investments.

In this respect, there is no specific regulation that should be applied to this property; therefore, for tax purposes, the entities that fall within this situation should treat the gain generated or the loss incurred on the sale of the related assets, as taxable income or, if applicable, as an authorized deduction.

Tax losses related to deep water activities

Considering that in deep water projects for the exploration and extraction of hydrocarbons defined as those regions of the sea where the water is over 500 meters deep, and production usually begins after several years, taxpayers engaged in the aforementioned activities may offset tax losses incurred in a tax year, against profits, if any, realized in the following fifteen tax years, instead of the ten tax-year term set forth in the Income Tax Law.

Employee profit-sharing (PTU)

The Bill from the executive branch established that profits realized by contractors and beneficiaries will not be shared with their employees, which implied that these companies were not obliged to pay PTU, but the Chamber of Deputies modified the proposed wording on these matters, eliminating this exception. The foregoing situation will represent a cost that should be incorporated to the evaluation models of these projects because, indirectly, this charge may impact the competitiveness of the Mexican energy sector, with respect to others worldwide.

Other tax effects

By virtue of the fact that companies involved in energy projects should comply with the tax laws the same as any other taxpayer, except in respect of presumptive situations specifically governed differently in the laws set forth herein, we consider that certain undesired effects, which will affect the competitiveness of this sector for foreign investors, may be triggered. It is expected that these situations would be subsequently regulated specifically for this sector.

Some examples are the withholding of the tax on dividends that should be carried out when such dividends are paid to nonresidents (10%), the implicit cost of investing in Mexico, which implies the payment of PTU, as previously stated, as well as the periods for the recovery of value added tax credit balances that are generated which until now, a special expedite and efficient regime.

Nonresidents

A new presumptive situation is established for purposes of considering that there is a permanent establishment for nonresidents engaged on the activities referred to in the Law of Hydrocarbons in national territory or in the exclusive economic zone, when such activities are carried out for more than 30 days in any 12-month period. For this purpose, activities carried out by related parties in respect of the same project, are included.

It is further provided that salaries paid to nonresidents, by nonresidents with no permanent establishment in Mexico, for the rendering of subordinated services related to the activities of contractors and beneficiaries carried out in Mexico or in the exclusive economic zone, will be subject to tax in Mexico, when such services are rendered in a term exceeding 30 days within a 12-month period.

In this case, such income will be taxed under the terms of the provisions of the Income Tax Law, which imposes taxes on nonresidents that render services in Mexico.

Value Added Tax (VAT)

Acts and activities carried out by contractors that give rise to the consideration, as defined in the VAT Law, will enjoy the preferential regime consisting of applying the 0% rate to the activities subject to the tax for which the consideration should be paid.

To avoid this treatment be extended to contractor's other activities, it is clarified that the cited 0% rate will not be applicable in respect of other contracts or transactions entered into by the contractors with third parties.

Foreign Trade

Another relevant issue of the reform in question, is the impact that it will have on foreign trade matters, the main change to which centers on the opening of importation and exportation of hydrocarbons and oil-bearing products by persons other than PEMEX; the determination of the national content requirements for this industry in general, and the rules to establish the percentages of this content in each of the types of contracts and assignments that may be tendered.

Opening to the importation of hydrocarbons and oil-bearing products

As previously commented, to date, the international foreign trade of hydrocarbons and oil-bearing is reserved to the Mexican State through PEMEX, by means of special permits granted to such entities by the Ministry of Economy.

A significant change in the reform is the opening to the private sector as of 2015, for purposes of the importation and exportation of hydrocarbons and oil-bearing, which will now be governed by permits issued by the Ministry of Energy.

Please bear in mind that such opening has certain special rules applicable to some types of oil-bearing products, as is the case of gasoline and diesel, as well as liquid propane gas (LP Gas). In this respect, by means of Transitory Articles of the Law of Hydrocarbons it is established that until December 31, 2016, permits for the importation of gasoline and diesel can be granted solely to PEMEX or its productive subsidiaries.

However, beginning January 1, 2017, or earlier if market conditions allow it, the permits for the importation of gasoline and diesel may be granted to any interested party that complies with the applicable legal provisions.

With respect to the permits related to the importation of LP Gas, it is established that until December 31, 2015, permits for the importation thereof can only be granted to PEMEX, its subsidiaries and affiliates.

However, beginning January 1, 2016, or earlier if market conditions allow it, the permits for the importation of LP Gas may be granted to any interested party that complies with the applicable legal provisions.

- Adaptations of the regulatory framework for importation and exportation transactions

As a result of the aforementioned opening, it will be necessary to carry out significant adaptations to the regulatory framework related to the importation and exportation of this type of products into and from the country because, currently, there is only a procedure for this purpose applicable to PEMEX in a norm set forth in the General Rules on Foreign Trade Matters issued by the SAT.

Additionally, the Law of Hydrocarbons estates that it is necessary to create new Official Mexican Norms related to the characteristics of this property (for purposes of preventing the alteration thereof) the transportation and storage of the same; which in some cases, compliance thereof, will be due at the time the aforementioned property is brought into the country, which implies that it is likely that there would be modifications to the requirements necessary for the importation and exportation of the aforementioned merchandise.

- Uncertainty concerning the temporary importation of fixed assets

Currently, there is uncertainty in respect of the importation of the fixed assets that will be utilized in activities related to exploration and extraction.

In fact, the Customs Law currently in effect establishes a restrictive catalog of property that may be imported on a temporary basis in order to be returned abroad in the same state, with the main benefit of being exempt from the payment of general import duties and value added tax. This regime is commonly utilized to import equipment related to the operations for the extraction of hydrocarbons (for example, semi-submersible platforms and related equipment).

However, the cited provision is not clear when establishing the type of property or equipment that may be imported on a temporary basis (for example fixed sea or land platforms and the respected equipment, among others), which has caused problems to the providers of services to PEMEX and it will likely continue causing problems when the different ways of contracting with private parties for these activities are implemented.

The fact that the cited Customs Law does not expressly include the possibility of temporarily importing merchandise, to be returned abroad in the same state, the assets related to the industry for the exploration and extraction of hydrocarbons, as well as for the generation of electric power when it does establish such possibility for other types of industries (land and air transportation, etc.) may be questioned.

Likewise, it is worth mentioning that currently there are no mechanisms for the transfer of merchandise imported on a temporary basis that is utilized in this type of industry among companies in the sector. Currently, the Customs Law only allows the transfer of property imported temporarily between companies with a program for the promotion of exportation (e.g. among IMMEX companies) and for the automobile industry.

In our opinion, allowing the transfer of this type of property will generate more efficiency in industry's operation, as a result of avoiding costs for physically taking it out of the country in order for it to be subsequently re-introduced by another party that will utilize it in several activities.

Requirement of national content

The new Law of Hydrocarbons establishes that the set of activities for the exploration and extraction of hydrocarbons that are carried out in national territory through assignments and exploration and extraction contracts should include, an average, of at least 35% of Mexican content.

By means of a transitory provision, it is established that the minimum average percentage of national content on matters related to the exploration and extraction of hydrocarbons, will start at 25% in 2015 and will be gradually increased until it reaches at least 35% in 2025. This should be reviewed subsequently every five years.

It is worth mentioning that such national content goal excludes activities in deep and ultra-deep waters; for this purpose, the Ministry of Economy will establish, if applicable, the percentage applicable thereto.

Additionally, the cited law establishes that each of the bases of the contracts that are tendered will include the percentage of Mexican content that the authorities deem convenient for each specific project.

It should be noted that the Ministry of Economy will be in charge of establishing the methodology to measure the national content in the hydrocarbon industry, as well as the verification thereof; for this purpose, the Ministry may be assisted by an independent third party or the authorities of the sector.

It is worth mentioning that for purposes of establishing the methodology to measure the national content, the Ministry of Economy will utilize, among others, the following items: contracted property and services, considering the origin thereof; skilled national labor force; training for the national labor force; the investment in physical, local and regional infrastructure and the transfer of technology.

In this respect, it is stipulated that the Ministry of Economy will establish the methodology to measure the national content within a 90 calendar-day-term as of the date on which the law takes effect. However, until the Ministry of Economy issues the methodology, the assignments will establish that the minimum Mexican percentage to which they will be subject will be subsequently defined by means of a modification to the terms and conditions thereof.

In this respect, it would be advisable to review each of the bidding terms that are formulated and the Mexican content requirement or methodology thereof in order to determine whether it constitutes a commercial barrier that violates the several commercial agreements signed by Mexico.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.