Tax-efficient Supply Chain Management (TESCM) & Transfer Pricing IFA Conference – 13 December 2008...
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Transcript of Tax-efficient Supply Chain Management (TESCM) & Transfer Pricing IFA Conference – 13 December 2008...
Tax-efficient Supply Chain Management (TESCM) & Transfer Pricing
IFA Conference – 13 December 2008 Srinivasa RaoPartner, Ernst & Young, India
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
Page 2
Contents
► TESCM
– Background
– The Concept
– Overall Structure Design
● Entity Characterization
● Alternative Structures
● Location of Principal Co
– Benefits & Key Tax Issues
– Recent Developments
● OECD Discussion Draft on Transfer Pricing Aspects of Business Restructuring
Tax-efficient Supply Chain Management
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
Page 4
Background
► Discernible change in multinational business models
► “Local” business models giving way to regional and global supply chain structures
► Growing centralization of multinational decisions at a regional or international level
► Traditional tax structures impacted by the geographical blur in cross-border business models
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
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Background
► MNEs have grown across the globe with some patterns:
– Manufacturing located near raw material sources, customer markets
– Sales organizations dispersed
– Management in the country of “origin”
► May be doing business in a number of “High Tax Jurisdictions” (“HTJs”)
► Tax base would correspond with the economic activity in the country
► Effective tax rate – cumulative weighted average tax rate
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
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Traditional Supply Chain Model
Buysmaterials
Manufacturer
► Inventory risks►Warranty risk► Intangibles►Capital investment
Buysfinished goods
Distributor
► Inventory risk►Warranty risk► Intangibles►Pricing risk►Volume risk ►Credit risk
Sells finished goods
Customer
► Each entity in the supply chain assumes risks associated with respective functions
► Profit arising from the economic activities in the respective jurisdictions attributed to the jurisdiction
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
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Issues with Traditional Supply Chain Models
► Customer relations
– Fragmented by country
– Multiple points of contact
– In some cases, “competition with ourselves”
► Duplicative functions across countries
– Increases costs
► Manufacturing managed by country
– Short production lines
► Possible results
– Higher worldwide effective tax rate
– Lower profitability
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
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What is TESCM?
► Supply Chain Management (“SCM”) is defined as the management of material and products, information, cash and work flows from the point of first supply across the enterprise to the customer and back
► Tax-efficient Supply Chain Management (“TESCM”) is the process of integrating tax planning into SCM in two fundamental ways:
– Avoiding tax and legal obstacles to achieve business objectives
– Leveraging tax benefits from business change
Information flowsInformation flows
Intelligence flows - product, customer, market needsIntelligence flows - product, customer, market needs
Cash flowsCash flowsMaterial flowsMaterial flows
SuppliersSuppliers CustomersCustomersPlanning &forecastingPlanning &forecasting ProcurementProcurement ManufacturingManufacturing Distribution &
logisticsDistribution &logistics
CustomerserviceCustomerservice
PerformancemeasurementsPerformancemeasurements
Value Chain
Value Chain
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
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Supply Chain Planning – First Principles
► Alignment and compatibility with business model
► Integration of tax planning into business changes
► Review of the allocation of the group’s:
– Value-adding functions
– Income-earning assets
– Commercial risks with a view to optimizing tax costs
► Aggregation of entrepreneurial risks at a Hub entity – Principal Co
► Overall profit of an enterprise:
– Remuneration for the normal functions/risks
– Residual profit – reflecting entrepreneurial remuneration
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
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Supply Chain Planning – First Principles
► Allocation of profits:
– Operating entities entitled for normal profits
– Hub entity entitled for residual (entrepreneurial) profits
► Hub entity
– Located in Low Tax Jurisdiction (“LTJ”)
– Centralization of management, control & business risks
– Entitled for residual (entrepreneurial) profits
► Operating entities
– Location based on business & tax considerations
– Perform routine functions and bear subordinate risks
– Receive a stable and relatively low profit level
– Profit level can be controlled
Overall Structure Design
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
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Supply Chain Design Overview
Factory
After SalesService
Headquarters
Purchase Materials
DeliverMaterials
DeliverGoods
ProcessingServices
Arrange Sales
Sale Of Finished Goods
ManagementServices
ResearchServices
AdminServices
Supplier
Shared Services Centre Commission Agent/LRDR&D Centre
Principal CompanyCustomer
Product Flow
Services
Title Flow
Legend
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
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Key Triggers
Drivers Benefits
Business Drivers Profitable growth
GlobalizationBetter customer
serviceLower costs
Shareholder value
Tax DriversHigh domestic
effective tax ratesTransfer pricing
auditsTax Incentives
More aggressive tax authorities
Trapped tax losses
Alignment of tax & business structure
Improved cash flow
More stable effective tax rate
Less transfer pricing risk
Lower effective tax rate
Centralization of planning and mgmt
Shared services
Integrated supply chain management
Global/regional business units
Centralized Tax Structure
Higher earnings
Actions
Optimized supply chains
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
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► Principal Co
- Hub entity and principal trading company
- Exercises direction, supervision & control over the supply chain
- Bears all significant risks of the supply chain
- Can either own Intellectual Property (“IP”) or license IP from an IP Holding Co
- Would need to have “substance” and some level of senior management/ decision-making functions
► IP Holding Co
- Can either be the Principal Co or a separate entity which owns IP and licenses to Principal Co
Entity Characterization – Principal Company
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
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► Full-fledged Manufacturer
– Significant manufacturing functions risks and manufacturing/ process intangibles
► Contract Manufacturer
– Manufactures goods for Principal Co under a guaranteed sale arrangement, could bear some risks
► Toll Manufacturer/ Consignment Manufacturer
– Converts raw materials supplied by Principal Co into finished goods;
– Does not take title to either the raw materials or finished goods
– Bears insignificant risks and performs minimal functions
Entity Characterization – Manufacturing
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
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► Full-fledged Distributor
– Significant sales and marketing functions, risks and marketing intangibles
► Limited Risk Distributor (“LRD”)
– Almost similar functions as a full-fledged distributor; assumes significantly lower risks
► Commissionaire/ Commission Agent:
– Sales and marketing services to Principal Co;
– Enters into sales contracts on behalf of Principal Co and does not assume title to goods;
– Does not bear any significant risks
Entity Characterization – Sales
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
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► Management Services Co
► Contract R&D Co
► Shared Service Centers
► Co-ordination Centers
Entity Characterization – Services
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
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Contract Manufacturing / LRD Model
► Manufacturing, Sales and Marketing Intangibles/Risks Shifted to Low-taxed Principal Co;
► Operating Cos perform their functions with limited risks
Manufacturer
►Capital investment►Limited inventory risk
Make
Sales price
Principal
Supplier
Sale
LRD agreement
LRD
►Pricing risk (short-term)►Volume risk (short-term)
Sale
Customer
►Warranty risk►Intangibles ►Inventory risks►Credit risk►Pricing risk (long-term)►Volume risk (long-term)
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
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Customer
Arranges sale
►Warranty risk►Intangibles ►Inventory risks►Credit risk►Pricing risk►Volume risk
►Capital investment
CommissionAgentPrincipalManufacturer
Supplier
Service Fee
Make Commission
Agencyservices
Sale
Toller / Commission Agent Model
► Manufacturing, Sales and Marketing Intangibles / Risks Shifted to Low-taxed Principal Co;
► Operating Cos perform their functions with limited risks
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
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Location of Principal Co
► Tax Factors
– Low effective tax rate
– Favorable tax regime for foreign source income
– Favorable tax treaty network
– Liberal advance ruling regime
– Nil/ low withholding tax on outbound payments
► Non-tax Factors
– Good regulatory and legal framework
– Conducive environment for expatriate personnel
– Liberal exchange control regime
– Minimal regulations on cross-border commerce
– Political and economic stability
Structure Benefits & Key Tax Issues
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
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► Integration of tax planning into business change processes
► Reduction in worldwide effective tax rate:
– Principal Co located in a LTJ earns substantial profits
– Operating Cos earn low and stable profits
► Minimization in repatriation costs:
– Low profit level of operating entities
– Reduced repatriation tax costs
► Consolidation of losses:
- Aggregation of losses arising from global operations in a single entity
- Avoids inefficiencies of dispersed losses
► Ensures that cash flow is freely accessible within the group
Structure Benefits
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
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Key Tax Issues
► Conversion/ Migration related issues
– Starting point for tax authorities
● “Gap” between current and future local profit levels
– Points challenged by tax authorities
● Lack of commercial purpose/ substance in business change
● Conduct of parties not consistent with agreements/ documentation
● Transfer of Intangibles (patents, know-how, brand names, trademarks, etc.) upon conversion and valuation
● Deemed migration of “goodwill” upon conversion
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
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Key Tax Issues
► Permanent Establishment (“PE”) Exposure
– Appropriate structuring of arrangement (including movement of personnel) to shield from PE exposure
– Potential PE risk under Toller/ Commissionaire structures in some countries
► Transfer Pricing
– Appropriate documentation of allocation of functions/ risks to support lower income allocation to operating entities
– Intangible/ Buy-in payment valuation
► Indirect Tax/ VAT
– Not optimizing indirect taxes may reduce or negate corporate tax benefits
Recent Developments
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
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OECD Discussion Draft on Business Restructuring
► CTPA Roundtable in January 2005
– Treaty, transfer pricing, and indirect tax issues
– Business and governments
– OECD and Non-OECD Economies
► A Joint WP1 / WP6 Working Group set up
– transfer pricing and treaty aspects
► A small advisory group of business representatives and academics formed
► Objective to release a discussion draft for public comment by the end of 2008
► Discussion Draft on application of Transfer Pricing Guidelines released in Sept 2008
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
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Recent OECD Discussion Draft
► The OECD has recently released a discussion draft entitled “Transfer Pricing Aspects of Business Restructurings”
► Consists of four issues notes:
– General guidance on the allocation of risks
– Arm’s-length compensation for the restructuring itself
– Post-restructuring arrangements
– Exceptional non-recognition of transactions
► Recognition at an OECD level that these transactions are taking place
► Practical guidance on treatment of transactions
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
Page 28
Key Messages
► Strong focus on business alignment in evaluating restructurings
► Contractually defined relationships are the starting point but can be set aside in “exceptional” circumstances
► Compensation payments to restructured entity to be evaluated and set on arm’s length principles by reference to realistic available alternatives
► Restatement of bilateral approach to functional analysis including Principals as foundation for method selection
► Economic framework for allocating location savings
► Functions, assets and risks drive TP method – not the other way round
Tax-efficient Supply Chain Management & Transfer PricingIFA Conference – 13 December 2008
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Key Implications
► The OECD is clearly signalling a view that transfer pricing models should be driven by and aligned with the business model
– Transfer pricing analysis now a central element in evaluating tax impacts of business restructuring
– Evaluation of options available to the parties at arm’s length central to that analysis
– Ensure alignment of transfer pricing and legal documentation with business substance
– Need for continual and structured review of behaviour to ensure continuing conformity with transfer pricing model
Thank you