Beyond the pandemic: rethinking the supply chain
Sound international tax planning ensures that income is properly allocated among the functions, risks and assets employed by the supply chain. Moreover, indirect taxes are tied to how goods and services flow between countries.
Manufacturers rethinking their global supply chains should therefore be aware of the following issues.
If, as part of supply chain reorganisation or relocation, companies, assets (including intellectual property) or future profit potential are moved into a new jurisdiction, it could trigger some form of ‘exit taxation’ in the former jurisdiction.
These adverse tax consequences may be (partially) compensated if such assets are appraised with their fair-market value in the new jurisdiction, and thus create higher depreciation volume in the future.
Potential re-allocation of IP should be checked because:
- exit taxation could be triggered (see above);
- profits resulting from the exploitation of IP need to be allocated based on the new OECD DEMPE (development, enhancement, maintenance, protection and exploitation) concept (see the OECD transfer pricing guidelines); and
- the withholding tax burden for cross-border licence payments can be different if the IP owner is in a new jurisdiction.
Changes in the supply chain need to be analysed from a transfer-pricing perspective before implementation. For example, arm’s-length transfer prices for a Chinese supplier will most likely differ from proper transfer prices for its eastern European substitute. That said, the COVID-19 pandemic makes comparisons more complicated.
Profit distributions of subsidiaries in the supply chain could be subject to different withholding tax rates if such subsidiaries are relocated to a jurisdiction that has no favourable double-tax treaty with the manufacturer’s home jurisdiction.
Where a supply chain is reorganised, the sales tax treatment of the newly structured supply chain will have to be analysed, as different export tax rules might apply or certain exemptions might no longer be available.
Advising a German manufacturer of high-tech machinery on the transfer of certain production functions to China.
We advised on the IP and transfer-tax aspects of research and development agreements under which a Chinese group company entrusted the German parent to provide such services.
Advising an engineering group on transforming its supply chain for the European market to a principal/entrepreneur company structure.
We had to ensure that the client’s procurement, manufacturing, R&D and sales functions were centralised while mitigating any adverse tax consequences (eg exit-taxation, shift-of-function taxation) and establishing a robust transfer-pricing model.