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From SCDigest's On-Target e-Magazine

- Oct. 29, 2014 -

Supply Chain News: Procurement, Tax Considerations, and a Procurement Operating Company Part 2

With a Global Procurement Center in Low Tax Location, Companies Need to Optimize Legal Title Flows of Procured Goods and Materials

SDigest Editorial Staff

In part 1 of this series, we summarized an interesting article from a group of Deloitte Tax partners published in the International Tax Review Journal that argued the procurement and tax management groups within a company need to work more closely together to make optimal sourcing decisions.

Towards that end, the authors also suggested that more companies should consider the creation of a "Procurement Operating Company" (POC), in which strategic procurement functions are co-located in a tax-efficient jurisdiction such as Ireland, the Netherlands, Switzerland, or Singapore, in support of local procurement activities. (See Procurement, Tax Considerations, and a Procurement Operating Company.)

SCDigest Says:

There is strong evidence that multi-national companies that put in the effort to create tax-efficient supply chains are well rewarded for their work

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This week, with the concept of a POC established, we'll look at how it should interact with local procurement functions and critically, what will be the legal title flows of procurement goods must be designed.

Deloitte, however, says a POC should not be a one-size-fits-all approach to defining the correct tax-aligned procurement model.

While some company's look at procurement globally, so that a "hub and spoke" model embodied by a POC may make sense, other companies may have a regional or commodity-driven model that allows for a simpler "single central sourcing hub" approach.

Additionally, some companies may source most of their materials from a single country like China and therefore choose to use more targeted business and tax planning to capture the savings.

"In all these cases, procurement and key stakeholders must first drive how the business can most efficiently deliver value and grow over time," the Deloitte author write. "The role of tax is to share with the business the opportunities to align the model from a tax perspective (POC-type model, single central sourcing hub, country sourcing hub, etc.) by explaining the tax requirements the business would need to live within so that both the tax and business benefits would be sustainable over the long term."

The business, including procurement and key stakeholders, then decides whether it can live within the tax requirements.

"It is only when the business and tax are aligned that a truly sustainable tax-aligned procurement model can be implemented to drive sustainable tax and non-tax benefits," the authors say.

(Sourcing and Procurement Article Continues Below)

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A key tax question overall and certainly under the operation of a POC relates to the legal title flows of procured goods and materials. This can be very complex from a tax and legal perspective, but is key to also achieving maximum savings.

For example, should the POC buy directly from the suppliers and then sell on to affiliates under a buy/sell model? Or should the affiliates purchase directly from the suppliers and pay a commission or service fee to the POC?

"From an economic perspective, the remuneration attributable to the POC may be similar under either approach as that value is driven by the functions, risks, and assets the POC manages," Deloitte notes. "However, the title flows will affect the tax requirements analysis when it comes to managing permanent establishment concerns (who is binding whom) and indirect tax and customs issues."

Deloitte also says that regardless of how the legal title flows operate, the POC will have to compensate the regional centers of excellence or spokes for their functions, risks, and assets.

"Typically, the regional spokes would be compensated on a cost-plus basis for the routine functions they are providing, while the POC captures the residual from managing the overall group risk," Deloitte notes.

The authors cite as an alternative to the buy/sell or commission model a hybrid buy/sell/service framework in which the POC and its spokes negotiate global pricing and rebates with suppliers.

Under this model, the local affiliates purchase goods directly from the suppliers and retain the value of the group buying power through lower supplier prices, Deloitte says. In addition, the POC may be compensated for its services by retaining a portion of the rebates it collects from the suppliers if the group achieves its volume goals.

The Bottom Line: This is all very complex and hard to achieve, but there is strong evidence that multi-national companies that put in the effort to create tax-efficient supply chains are well rewarded for their work. As the Deloitte authors conclude: "It is up to tax departments to sit down with their supply chain and procurement leadership to make sure tax has a seat at the table as long-term procurement design decisions are made." Similarly, purchasing executives need to invite tax into the discussions to really deliver lowest total landed cost.

Should procurement decisions be more informed by the tax implications? What do you think of the POC concept? Let us know your thoughts at the Feedback button (email) or section (web form) below.

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