The construction of tax efficient supply chains is not new. Many leading consumer companies have already embarked on tax efficient supply chain management (TESCM) initiatives, including companies like Unilever, Procter & Gamble, Kraft, L’Oreal and Colgate-Palmolive. The aim of any TESCM initiative is to build a supply chain that should allow a company to make supply decisions that are informed by potential tax implications.
The fundamental concept is simple. For example, a company that receives an order from a U.K. customer may have the capability to fulfill that order from France or from Spain. If the order is worth £1 million and the cost of fulfilling that order is £500,000 from France, but £550,000 from Spain, it might seem as if delivery from France is the obvious choice. But tax may alter that decision. Although the gross profit is £50,000 higher using France, if the total tax rate on a France-delivered order is 30 percent, but only 20 percent on a Spain delivered order, then the net profit on delivering from France is £350,000, but rises to £360,000 if the order is fulfilled from Spain. A profit margin is at stake which, for a large global consumer goods company, could translate into many millions of pounds, or dollars, or euros, for the whole business.
That is the theory. The reality is a lot more complex, not least because the costs of restructuring a supply chain to be able to take advantage of these tax differentials throughout a large and diverse consumer company can be considerable. Nevertheless, the increasingly globalized nature of many consumer company operations means that the potential opportunities for tax efficiency in supply chain operation are also increasing.
The taxes a company pays are in part a function of where it operates, but also of how it operates. That means that consumer companies that often have widely distributed operations in numerous countries could benefit from TESCM initiatives, because the primary characteristics of companies that can benefit from TESCM are also the characteristics of many large consumer companies.
Typically they will be multinational operations, with revenues reported in multiple locations. They will have complex supply chains, with high costs and decentralized operations, and be expanding into low-cost locations for sales, sourcing and manufacturing. They will have high levels of cross-border and inter-company transactions, are likely to have a high effective tax rate, and to hold valuable intangible assets and intellectual property.
Such companies have been paying increased attention to the design of their supply chains for some years, but KPMG believes that if supply chain design leaves out the tax dimension, it can also leave out a large slice of potential bottom line improvement. Many supply chain professionals believe that increased operational efficiency in the supply chain goes straight to the bottom line, but this is not always the case: tax can shrink these improvements by up to half. To make the most of potential cost savings, tax has to be considered.
Reduction of a company’s effective tax rate is a primary target of any TESCM initiative. The effective tax rate is the rate at which a company pays direct corporate taxes across all of its operations. According to Reuters1, the average effective tax rate for global corporations is around 25 percent, but some large companies have succeeded in reducing this to below 10 percent. However, indirect taxes like sales taxes and customs duties can also be dramatically reduced by tax efficient supply chains.
Reducing indirect taxes is also a key part of speeding returns from a TESCM investment. Reducing direct taxes can improve deferred income, while reducing indirect taxes can improve cash flow. KPMG has found that some clients have achieved a return on TESCM investment in excess of 100 percent within 12 months.
In today’s economic climate, many organizations (including many consumer companies) focus their attention on cost optimization challenges. These cover both short-term ‘quick win’ savings and longer-term structural changes, both of which TESCM can support. An example of how shorter-term wins can support a larger engagement is in procurement where a global beverage company is developing a global procurement organization under the wider cost optimization umbrella. As part of this program, a number of ‘quick win’ initiatives already include reduced direct costs in commodities, and improvements in ‘below the line’ marketing spend by leveraging the scale of the global company and sourcing from a low-cost country. These savings are partly captured through a central trading organization located in a tax efficient jurisdiction which significantly improves the return on investment in the savings program. Another quick win area is in logistics and distribution where more efficient management and logistics provider contracting led to a reduced tax and duty burden for a FTSE 100 company operating in the consumer sector.
However, the longer-term improvements that flow from reducing the direct tax burden typically require more extensive restructuring of operations. One of the key elements in such restructuring is often the consolidation of high value-adding supply chain operations in a single supply chain management subsidiary, located in a low-tax jurisdiction. The supply chain management subsidiary will coordinate operations such as contract or toll manufacturing, and logistics, most if not all of which will be provided by third parties.
For example, a global food processing company used KPMG in the U.K. to restructure its European operations. KPMG member firms mobilized a team across nine countries transforming the company’s existing regional model to a single centralized headquarters in Switzerland. This new operating model delivered reduced operating costs, a centralized European management team, business process and system standardization and a significant reduction in the overall European corporate tax rate.
Another global consumer provider recently embarked on a project to align its many disparate and largely autonomous operating companies. KPMG in the U.K. assisted by identifying significant opportunities for both reducing procurement spend and tax costs. KPMG used a cross-functional team including professionals from diverse fields including supply chain, finance, HR, IT and communications to advise on the creation of a centralized procurement company designed to handle up to 80 percent of the company’s global spend and deliver savings in the costs of goods and services of 15 percent.
Tax awareness is vital if companies are to realize savings on this scale. Both taxation rates and tax authorities’ policies are changing constantly, and the potential tax effect of corporate restructuring and location decisions may require complex modeling.
Companies also have to consider the costs and management challenges of a total TESCM approach. Locating a supply chain management company in a low-tax jurisdiction may not be easy: will highly-paid senior staff want to move to the chosen location? What will be the IT costs of integrating disparate operations? There may also be exit taxes to pay when operations are moved out of existing locations, and such taxes can be high.
Nevertheless, a TESCM investment can be worthwhile. Many global consumer companies are having to restructure their supply chains in any case, to cope with low-cost competition and the challenges of integrating acquisitions and investments in new markets. The incremental cost of making such restructuring tax efficient may be small, and the payback large. And if companies do not take advantage of the potential cost savings, their competitors surely will.
1 Supply Chain Management Review
First published in ConsumerCurrents issue 6.