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How to Pay Contractors in Mexico

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Mexico’s economy, location, and business practices make the country an attractive location for international business expansion. It is geographically close to trading partners like the United States and Canada. Mexico also enjoys the economic benefits of the United States-Mexico-Canada Agreement (USMCA), which replaced the North American Free Trade Agreement (NAFTA). Companies that expand to Mexico gain access to large, lucrative markets. Mexico also has relatively low labor expenses, political stability, competitive manufacturing capabilities, and a large, growing economy that readily appeals to new business.

As your company builds teams in Mexico, you’ll need to know best practices for paying Mexican contractors, including how to differentiate your contractors from your employees, handle tax considerations, and get payments to your contractors most effectively.

What is the difference between employees and independent contractors?

The essential difference between employees and contractors is that employees go onto your company’s payroll, while contractors do not. With employees, you withhold payroll taxes from their paychecks for every pay period. You also make the required contributions to social programs for health insurance funds, retirement pensions, unemployment payments, and disability funds.

Your Mexican employees are usually also entitled to receive benefits that your contractors do not receive. Employees typically receive benefits such as paid time off, health insurance coverage, and retirement plans. Mexican contractors generally do not gain access to these benefits. For this reason, contractors often, though not always, ask for and receive a higher rate of pay than employees since they receive fewer benefits and pay their own payroll taxes.

Contractors and employees also differ in how they receive work and compensation. Employees usually receive a much higher level of employer oversight. They get training and supervision from your company and have tasks assigned to them, and your company has significant control over their labors. On the other hand, contractors are more likely to submit quotes or bids for the projects they wish to take on instead of receiving assignments. They have more freedom in the way they accomplish their work and can manage themselves, and they often submit invoices for payment rather than receiving paychecks through a company’s payroll department.

Essentially, your Mexican employees work for you, whereas your Mexican contractors work for themselves, taking your company on as a client. Your company is likely the primary source of income for most of its employees, whereas you might be just one of many clients in your contractors’ portfolios.

Many labor laws that apply to employees do not apply to contractors. For example, the law generally dictates how many hours your employees can work, what wages they must receive, and the benefits to which they are entitled. It specifies how and when you may terminate employees and what their notice periods and severance must look like. Contractors are not entitled to these protections, which is another reason they can often command higher pay than employees.

Criteria for classifying employees vs. contractors

Mexican tax authorities have specific criteria to determine whether workers should receive classification as employees or contractors. They might look at factors like these:

  • Behavioral: The law considers how much influence a company has over its workers’ behavior. In Mexico, the main criterion for determining an employment relationship is subordination. If the company exerts significant control over what its workers do and how they perform their job duties, the workers likely require classification as employees. If not, they are likely contractors.
  • Financial: This criterion considers whether the company controls the business aspects of the workers’ jobs. If the company determines how the workers receive payment, whether expenses can receive reimbursement, and who provides the necessary supplies or tools, the workers likely require classification as employees. If not, they are likely contractors.
  • Type of relationship: Companies should ask themselves questions about whether the workers have formal business agreement contracts, receive benefits such as insurance, vacation pay, and pension plans, perform work integral to the company’s business, and have a reasonably continuous relationship with the company. If the company can answer most of these questions affirmatively, the workers likely require classification as employees. If not, they are likely contractors.

In some cases, the distinction may not be clear-cut. Some aspects of your Mexican workers’ responsibilities may make them more like employees, and other elements may make them more like contractors. Companies should weigh the various factors to make their determination and may want to seek advice from Mexican employment law experts.

Why companies should classify and pay their contractors properly

Classifying and paying contractors correctly is critical for any company because failure to do so can have immense legal and financial ramifications.

When you hire contractors, they are responsible for their entire tax liability instead of sharing part of that liability with your company. They go without financial support in the form of paid holidays, vacation days, sick leave, insurance, and employer contributions to social programs. They also forfeit their right to wage and overtime protections under labor laws. Companies stand to benefit from this arrangement, while contractors lose benefits.

Countries like Mexico have enacted strict laws to make sure workers receive the fair treatment and protection they deserve. If the law finds instances of contractor misclassification, a company can become liable for years of back taxes, potentially totaling hundreds of thousands of dollars. Companies can also become responsible for thousands of dollars of back pay in the form of the overtime pay, benefits, and vacation pay they owe. In Mexico, misclassified contractors also become entitled to their portion of the required employer profit-sharing. Because this situation creates tremendous legal, financial, and logistical challenges, companies must be extremely careful to classify their employees and contractors correctly.

However, in many cases, employers genuinely need contract work performed, and hiring contractors is the right process. In that case, your company will need to know how to hire and pay contractors in compliance with the law.

Hiring an independent contractor in Mexico

The Mexican Federal Labor Law, or the Ley Federal del Trabajo, governs employer-employee relationships and mandates the standard employee protections and benefits. On the other hand, civil and commercial codes regulate independent contractors’ work, offering fewer protections.

Contract labor in Mexico is becoming increasingly popular because of the flexibility and cost savings it offers. However, historically, some international companies have used independent contractors to avoid establishing a taxable presence in Mexico or becoming responsible for contributions to Mexico’s robust social security system. To address this issue, the Mexican government has enacted amendments to federal labor laws that impose penalties for contractor misclassification.

Remember that in Mexico, the main difference between contractors and employees involves subordination. Employees have a subordinate relationship to their employers, receiving management and direction from the companies they work for. Contractors work independently of employer management, defining their own work schedules and determining how they perform their labor.

Companies that hire independent contractors should be able to answer several questions affirmatively:

  • Will you involve your independent contractors in a range of workplace activities?
  • Can you justify your independent contractors’ specialized services?
  • Do your independent contractors have the authority to hire additional personnel as they need to?
  • Do your independent contractors have more than a single source of income?

If you can answer most of these questions with a yes, hiring workers as independent contractors is likely appropriate.

Requirements for hiring independent contractors in Mexico

Historically, many contract relationships in Mexico relied on informal, verbal contracts. However, emendations to the Ley Federal del Trabajo have specified that companies must record contractors’ working conditions in writing as long as no Collective Bargaining Agreements (CBAs) apply.

For this reason, your company should draft and sign strong written contracts for all its independent contractors. You should make at least two copies, keeping one and providing one to the contractor. The contracts should give monetary amounts in Mexican pesos, and you may also want to write the contracts in Spanish to ensure clarity and understanding.

Emendations to the Ley Federal del Trabajo also define the specific types of contracts companies should use to hire contractors. The following types of contracts are permissible under Mexican federal law:

  • Contracts for a fixed time, when required by the nature of the work
  • Contracts for an indeterminate time
  • Contracts for seasonal work
  • Contracts for a trial period

Companies that hire independent contractors in Mexico should have those workers register with the Mexican tax authorities as independent service providers. They should also provide and keep official, signed pay receipts. They should also avoid creating exclusive relationships or imposing non-compete requirements, which could indicate the presence of an employer-employee relationship instead.

Where to hire Mexican contractors

Once you understand the basics of hiring Mexican contractors, you’ll need to know where to locate qualified personnel for your contractor positions.

Some companies that want to hire contractors in Mexico post job descriptions on sites like LinkedIn or Craigslist. Some companies also have success in searching for service providers on bid boards or directories designed specifically for certain industries, such as construction. The listings often present an exhaustive list of potential contractor services with the necessary skills and experience.

Requirements governing contractor pay in Mexico

To know how contractor pay differs from employee pay, you’ll need to understand the legal requirements for employee pay and benefits in Mexico. Mexican labor law requires Mexican employees to receive specific compensation, benefits, and protections. These benefits include bonuses, paid vacation time, sick leave, maternity and paternity leave, and pensions and allowances. Employers also need to create a written contract for their employees and follow laws regarding working hours, overtime, and termination.

Independent contractors do not receive these protections and benefits. They do not receive paid leave, and they are not entitled to severance pay with the termination of a contract. They also do not receive minimum wage, hourly protections, or overtime for extra work.

Independent contractors also do not receive any profit-sharing benefits. In Mexico, the Ley Federal del Trabajo requires employers to share 10 percent of their profits with employees. Contractor relationships are exempt from this requirement.

Tax practices for hiring contractors in Mexico

Generally, with Mexican contractors, your tax obligations are minimal, since you will not add your contractors to your payroll or withhold any taxes from their pay. You will also make no contributions to social programs on their behalf. The contractors pay full income taxes, known as Impuesto Sobre la Renta (ISR), to the Mexican tax authorities.

Contractor services in Mexico are subject to value-added taxes (VAT), which the company must pay.

Ways to pay contractors in Mexico

When you hire independent contractors, you need a reliable way to pay them legally and on time. Let’s consider a few common methods and how well they work for contractor payments.

  1. Payroll services: In general, internal payroll is not the right option for contractor payments. Because contractors are distinct from employees, you will not add them to your payroll, and you will not withhold or pay payroll taxes. However, some payroll services companies allow you to pay independent contractors through their platforms. These services can be expensive and do not always enable international payments.
  2. Banks: Your company could consider partnering with a bank to facilitate independent contractors’ payments. However, you may find the process challenging if your company has not officially incorporated in Mexico, and setting up a bank account may involve too many logistical hurdles and red tape to be feasible.
  3. PayPal: Digital wallets like PayPal are often popular because they allow for quick, convenient transactions. However, recent government crackdowns have made PayPal tricky to use in Mexico. To prevent users from holding balances in their PayPal accounts without paying taxes on them, PayPal automatically transfers PayPal payments to the linked Mexican bank accounts, which receive strict government monitoring. Currency other than Mexican pesos undergoes that automatic transfer at a relatively unfavorable exchange rate.
  4. Money transfer services: Money transfer services can sometimes be a good option forpaying contractors in Mexico. Money transfers are relatively quick — sometimes instantaneous. Your contractors will receive timely payments, so you’ll be able to maintain positive working relationships with them. Money transfer services often offer high transfer limits, a variety of transfer methods, and robust security. However, one potential drawback is that you will likely incur currency transfer fees if you pay your contractors in a currency other than Mexican pesos. A large transfer, even at a relatively low percentage rate, can cost your company significantly. Money transfer services also sometimes impose inconvenient transfer minimums or add fees to smaller transfer amounts.

Build international teams in Mexico with Globalization Partners

When you’re ready to expand into Mexico, work with Globalization Partners for dependable recruiting, hiring, and management support. Our comprehensive, AI-driven solution means we can take over much of the work of onboarding employees, so you know you’ll be working with qualified personnel, and you’ll have more time to focus on your company’s essential projects and people.

Request a proposal today, or contact us to learn more.

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