Advantages of tax-aligning the supply chain: powerful results can be achieved when international tax planning efforts are aligned with initiatives to improve supply chain operations.
Indeed, two-thirds of respondents to an informal poll of international tax professionals attending a recent Deloitte Tax LLP webcast said they were currently implementing or considering supply chain improvements at their organizations.
Although most enterprises strive to involve their tax departments when planning or implementing operational strategies--including two-thirds in the same Deloitte Tax poll--they all too frequently launch significant supply chain projects without considering the tax implications.
For example, one increasingly common supply chain initiative is to centralize global procurement to achieve economies of scale, eliminate redundant operating expenses and perform more strategic sourcing. Successful strategic sourcing initiatives reduce costs of inputs to productions, reducing cost of goods sold (COGS) and increasing operating profit.
If tax planning does not occur in connection with such an initiative, the resulting incremental profits will be taxed at the marginal tax rates of the various operating units that benefit from cost reduction.
It is not uncommon for income taxes to consume 30 percent to 40 percent of those incremental profits. As such, such a supply chain initiative is only 60 percent to 70 percent effective. However, if tax planning is made an integral part of the initiative, then a significant part of the incremental profits can be realized in a low-tax jurisdiction, thus increasing the proportion of the incremental profits that remain with the enterprise.
For these reasons, a strategy called tax aligning the supply chain (TASC) is advantageous. In addition to helping companies protect the increased profits and cash flows by supply chain enhancements from excessive income taxation, TASC aims to help organizations sustain a favorable effective worldwide rate. It's apparent that multinationals seeking to enhance profitability through tightening their supply chains should carefully plan any changes with tax considerations in mind.
Transitioning to the Global Enterprise
Many multinational companies have traditionally been structured into silos--typically, country-based solos but also product-oriented ones--that are managed independently of one another. Certainly, there are attempts to make aggregate results meet enterprisewide financial targets. Unfortunately, though, this siloed approach often leads to inefficiencies in the supply chain, as there can be redundant supplier bases, distribution networks and manufacturing operations scattered around the world.
Technologies are now emerging that help enterprises share information and consolidate operations across these various silos. By leveraging these technologies, companies can move to a shared infrastructure environment based on a central entrepreneur, or principal, organizational structure.
In this way, functions that might have previously been performed at the local country level can be centralized in a low-tax jurisdiction or in jurisdictions where there are significant tax-loss carryforwards that can be used to protect earnings. They can also create savings from forecasting, demand planning, production planning and transportation management. The result is the emergence of a global organization in which supply chain operations are aligned better with enterprisewide strategies.
During this transition from a multinational to a truly global strategy, the business processes embedded in supply chain operations naturally evolve as well. This is critical for tax professionals to understand, because as business processes change, the character, value and relationships in cross-border transactions change, too.
By adopting a TASC approach to improving supply chain efficiency, the tax function becomes proactively involved in crafting business processes that can improve tax benefits as a natural result of the conduct of the business, rather than attempting to graft onto the organization a tax strategy that does not fit the business model.
A TASC approach also complements other types of international tax planning strategies. Currently, many such strategies focus on optimizing tax attributes such as earnings and profits pools, foreign tax credit pools and interest deductions.
Although tax attribute planning remains an important class of tax planning, it does not automatically scale to the growth of a business and can become cumbersome as additional techniques must be continually implemented to replace those that are "burning out." Because TASC is business process-based and built into the commercial model of the enterprise, it organically improves the effective tax rate and naturally scales with the business.
Making the 'Central Entrepreneur' Concept Work
One of the current most popular tax planning strategies revolves around implementation of a "central entrepreneur" or "principal" model. Under this organizational structure, key functions are coordinated by a centralized company that concentrates the main intangible assets and business risks in a low-tax country. The other companies in the organization function as service providers to the principal company.
Companies that have considered adopting the principal company model often ask what economic substance typically exists in a principal. This is important for a host of reasons, including:
* The need to establish appropriate inter-company pricing that underpins any anticipated tax benefits.
* Qualifying for various tax treaty benefits, including reduced withholding taxes and protections from creating unwanted tax nexuses for the principal in various countries.
* Qualifying for low tax rates under the rules of some foreign jurisdictions.
* Establishing that the principal performs a vital role in the success for the enterprise.
A TASC approach addresses this by making supply chain management and other important centralized management activities the centerpiece of the principal. These activities occur in the principal because the enterprise realizes better financial results operating in that manner.
Tax planning is an augmentation and magnification of the financial benefits from such centralization, not the driving force for the organizational approach. As such, the economic substance necessary to meet the tax needs described above arises automatically from the regular activity of the principal.
An Incremental Strategy
Supply chain globalization does not happen completely overnight. Indeed, many supply chain enhancements happen incrementally and in no predictable order. Thus, waiting for a large-scale overhaul of the supply chain before attempting to involve tax professionals causes organizations to miss significant opportunities for bolstering enterprise profitability. Instead, tax professionals need to follow three key tenets:
1. Seize upon tax planning opportunities with each incremental supply chain enhancement. By adopting the mindset that each change in the supply chain presents unique tax planning opportunities, organizations can begin reaping the benefits of a TASC strategy immediately.
2. Realize that benefits can and will be cumulative. Even if the benefits seem negligible at first, once an organization starts down the road with a TASC strategy, such benefits will accumulate and result in significant bottom-line enhancements over time.
3. Put the basic framework in place to continue reaping benefits. By putting the right organizational framework into place to take advantage of these supply chain changes as they occur, organizations will build a powerful and robust tax-aligned supply chain model that can continue to evolve over time.
Supply chain improvement initiatives have the potential, on their own, to generate substantial savings and contribute to bottom-line earnings. But if no special tax planning is done, those earnings will be taxed at the marginal tax rates in the countries of the various operating units.
A successful TASC strategy can prevent this from happening and allow organizations to reap the full benefits of their hard-earned supply chain improvement projects.
DAN LANGE (email@example.com) is Managing Partner, U.S. International Tax Services, Deloitte Tax LLP and MAURICE EMMER (firstname.lastname@example.org) is a Partner in Deloitte Tax LLP's International Tax practice.
RELATED ARTICLE: TASC in Action
Aglobal manufacturer and distributor of consumer goods with $15 billion in annual sales was operating in highly decentralized mode that, over time, had resulted in excess manufacturing capacity and redundant distribution facilities. The company undertook a tax-aligning the supply chain (TASC) restructuring project that included consolidating manufacturing and logistics capacity, centralizing back-office functions in a shared services center and globalizing the procurement function.
The initiative included creation of a tax-aligned central entrepreneur model that the company expects will produce $100 million in annual cost savings. It will also sustain an effective tax rate of between 25 percent and 30 percent, down significantly from that of the past.
There were four phases to the successful completion of the project:
1. Defining and refining a TASC strategy that would meet overall operational and financial goals;
2. Designing a supply chain architecture that optimized inter-company transactions and relationships;
3. Creating business processes that supported that architecture; and
4. Going live, first in Europe and then in Asia.
Throughout each of the four phases, a cross-functional team implemented multiple work streams representing all the key functions impacted by the project. The team comprised professionals from tax, treasury and finance, legal, project management, human resources, information technology, operations, risk management, facilities and intellectual property development and management.
A strong project management organization pulled all of this together and put into place a well-defined project roadmap with clear action steps, milestones and deliverables. The company committed sufficient experienced personnel to the project, including an empowered project sponsor. And the company provided for the appropriate level of quality control to mitigate tax and business risk during implementation and beyond.
Additionally, the organization put a framework in place that allows it to continue evolving its TASC strategy to achieve further centralization of business activities while withstanding tax scrutiny in multiple jurisdictions.
RELATED ARTICLE: TAKE AWAYS
** A company's supply chain can account for 75 percent of its spending, and even relatively small increases in efficiency can impact profitability.
** A majority of companies polled by Deloitte said they are currently implementing or considering supply chain improvements.
** Tax aligning the supply chain (TASC) is a strategy that, among other things, aims to help organizations sustain a favorable effective worldwide rate. Companies are encouraged to carefully plan supply-chain changes with tax considerations in mind.
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|Title Annotation:||INTERNATIONAL TAX|
|Author:||Emmer, Maurice; Lange, Dan|
|Date:||Oct 1, 2007|
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