Business transformation: embedding tax efficiency across the supply chain 

What is tax-efficient supply chain management?

Tax-efficient supply chain management is the integration of tax planning into business and supply chain restructuring, which may involve relocating assets and functions across jurisdictions. This approach looks beyond tax rate optimization to ensure the company’s tax processes and structures support the business’ overall strategy for change. It also involves optimizing the business model to ensure profits (and losses) are allocated tax-effectively among individual entities within a group, and between group entities in different countries.

The Iberoamerican context – issues and opportunities

In the Iberoamerican context, there are significant opportunities for improving supply chain tax efficiency, for example, by taking advantage of tax preferences available in tax-free zones in Panama, Colombia and Costa Rica or the tax exemptions available under Mexico’s Maquila program. However, companies seeking to establish tax-efficient supply chains in the region face a range of distinct tax issues.

For example, many countries in the region lack extensive tax treaty networks and their competent authorities lack experience in dealing with double taxation issues, which can create challenges for companies seeking to reduce withholding taxes or achieve other treaty-based relief. In countries such as Brazil, multiple levels of indirect taxes and import duties at the federal and local levels can make it difficult to implement common supply chain structures.

Tax authorities in the region are turning their attention to outbound transactions, with particular focus on transfer pricing issues. While most Iberoamerican countries follow the Organisation for Economic Co-operation and Development’s (OECD) arm’s length approach, there are national differences that can complicate an international company’s transfer prices. Some countries limit the applicability of certain OECD-sanctioned methods, such as Argentina’s requirement for a local tested party and Mexico’s restriction on the deductibility of pro rata expenses (e.g. cost-sharing of management fees) made to foreign related parties. Some countries, such as Argentina, Uruguay and Brazil, limit the application of methods according to the transaction (e.g. commodity trades) by restricting the use of the wholesale price method.

Brazil currently does not follow the OECD model. Rather, the country takes a formulary approach to transfer pricing based on assumed profit margins, which often complicates transfer pricing decisions in cross-border situations. However, this mismatch between Brazil’s transfer pricing rules and the OECD-based approach may also be a potential source of opportunity. For example, for some Brazilian-based multinational companies that have moved trading, procurement and/or commercial functions abroad, the transfer pricing mismatch can potentially create tax efficiencies.

Tax authorities target business restructurings

Some of the most significant issues that can arise on business transformation projects involve transfer pricing. In particular, companies that are moving parts of their businesses to new locations may need to manage complexities arising from new OECD guidance on business restructurings, which effectively treats a wide range of non-tax business decisions as relevant transfer pricing issues. Among Iberoamerican countries, Mexico’s tax authority was the first to begin examining business restructurings of Mexican taxpayers, creating a domino effect as other tax authorities in the region followed suit.

The guidelines stress the importance of clearly defining the structure of the transaction in terms of functions, assets and risks both before and after the restructuring. Companies that are thinking about a change in business structure or intercompany relationships will need to document the business rationale for the business restructuring. This includes how the arm’s length standard applies in terms of their initial structure and their new structure, whether alternatives have been explored, and why the structure was chosen over alternative structures.

Tax integration with broader business is key

Business restructurings to centralize services and support functions are only one example that highlights the imperative for tax directors to be integrally involved in a transformation project’s planning, execution and post-implementation monitoring. Other supply chain optimization projects where tax involvement is vital include:

• acquisitions, mergers and Dispositions
• supply chain restructuring and plant Closures
• expansion into new markets or introduction of new channels into a market
• plans to implement, upgrade or harmonize enterprise-wide information systems.

These types of projects can carry tax implications that need to be addressed at the planning stage. If tax issues are not identified until later, it may be too late to identify a potential solution, and the cost savings or other benefits of the business project may be jeopardized. On the other hand, collaboration between the tax department and others involved in strategic business planning can ensure tax risks across the supply chain are identified and effectively mitigated.

The bottom line is that tax directors need to be fully aware of and engaged in what is happening – within the company and in the broader tax environment. That way, you can ensure that tax issues are considered in conjunction with any supply chain change, that the business rationale for the change is well documented, and that tax risk minimization and planning strategies are part-and-parcel of any supply chain optimization project.

Supply chain optimization – mitigating tax risk and complexity

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