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May 6, 2010

Multinational businesses have extensively applied the use of tax effective procurement companies to deliver efficiencies in the sourcing of goods and materials to achieve fiscal benefits. However, businesses are often resistant to significant operational change across the entire supply chain as it can prove to be costly and time consuming. Procurement, on the other hand, offers an opportunity to achieve supply chain savings through a single process.

The Concept

  1. Isolate procurement activities and identify the functions, assets and risks associated with this process. (See illustration below)
  2. Centralise the performance of strategic procurement activities and management of key risks in one location.
  3. The local operating companies pay a fee (often a percentage of total procurement spend) to the centralised company in return for the performance of strategic activities and management of key risks.

By centralising the procurement company in a tax efficient jurisdiction, multinational organizations can exponentially increase commercial benefits. Placing the procurement company in a tax efficient jurisdiction effectively allows cost savings and other commercial benefits that are achieved as a result of establishing a central procurement company to be taxed at an optimal rate.

Operational Drivers and Benefits of Centralisation
There are a number of operational matters that encourage centralisation, particularly for international businesses. Equally, for a business expanding internationally, whether organically or through acquisition, the use of shared functions can help to maximise operating efficiency and speed by:

  • Consolidating volumes of purchased raw materials and using this as a lever to drive down price and negotiate better commercial terms;
  • Bringing dispersed procurement team members (i.e., Asia-Pacific sourcing teams) together to create a larger more capable organisation focussed on key categories;
  • Identifying and capitalising upon opportunities to optimise the international supply chain, reducing total supply chain cost, improving customer service while decreasing working capital.

Tax Considerations
Transfer Pricing

The intra-group pricing structure is critical to sustaining the benefits. This structure must be:

  • Non-aggressive - A reasonable charge commensurate with competitors / comparable transactions;
  • Supported by robust analysis - Isolating the economic significance of the relevant activities and risks; and
  • Commercially justified - For example, the company may already possess senior procurement expertise in a particular jurisdiction such as Singapore for Asia-Pacific sourcing.

The key to leaving cost savings and other commercial benefits in the centralised procurement company lies in the ability to identify strategic functions and ensure the assets and risks associated with providing those functions are borne by the procurement company. The level of income left in the principal company must be commensurate with the functions and risks and, ultimately, supported by what third parties earn engaging in similar activities in the free market.

VAT and Customs

It is important to ensure that changes in procurement patterns (such as the flow of goods and materials) do not trigger indirect tax issues. With effective planning, there are often indirect tax savings that can be achieved as part of the process.

Anti-Avoidance Measures

Commercially-based tax planning is difficult to attack with anti-avoidance tax measures. Conversely, a structure enacted purely for tax purposes will be challenged and may lead to a significant adjustment with penalties. It is necessary to place economic substance in the procurement company that is consistent with the income it earns.

Controlled foreign company legislation exists in many jurisdictions, however, recent ECJ case law has provided credibility to bona-fide commercial structures with sound motives.

The OECD Business Restructuring paper has also provided international support for legitimate business change irrespective of the fiscal benefits. It is accepted by the OECD that multinational businesses are increasingly reorganising their structures to provide more centralised control and management of manufacturing, research, procurement, intellectual property and distribution functions. The paper states that: “The pressure of competition in a globalized economy, savings from economies of scale, the need for specialization and the need to increase efficiency and lower costs are all clearly important in driving business restructuring.”

Conclusion

  • Centralising procurement does not require a significant change to the business operating model and does not need to involve the movement / relocation of personnel.
  • Benefits can be significant; recent projects have demonstrated that 5-10 per cent on total procurement spend can be allocated to a tax efficient jurisdiction.
  • It is difficult for tax authorities to challenge the structure, if executed in line with commercial objectives.

In summary, centralising procurement can provide multinational businesses with supply chain savings, tax efficiencies and other economic benefits, bypassing many of anticipated cost and time issues that arise simply through effective planning.

Author:
Ed Browne
Senior Director, London

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Transfer Pricing

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This newsletter is not intended or written by Alvarez & Marsal Taxand UK LLP to be used, and cannot be used, by a client or any other person or entity for the purpose of avoiding tax penalties that may be imposed on any taxpayer. Readers should not consider this document to be a recommendation to undertake any tax position, nor consider the information contained therein to be complete, and should thoroughly evaluate their specific facts and circumstances and obtain the advice and assistance of qualified tax advisers.

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