Value-Chain Report -- Structuring Supply Chains To Minimize Taxes

With a little planning, businesses can take advantage of several benefits.

If there is one common denominator in the business world, it is that companies seek to maximize net operating profit to drive increased shareholder value. Although the tax implications of the supply chain, particularly as they relate to inventory and sales, can differ widely from site to site, the primary focus in constructing internal and external supply-chain networks tends to be on operating costs and asset utilization. Often only an afterthought, the tax consequences of alternative supply-chain structures can vary significantly. A proactive approach, where ownership (title to products or inventory) resides and/or transfers, and other tax management techniques enable both domestic and multinational companies to minimize their overall tax bills. With some foresight and planning, manufacturing plants, distribution centers, and other operating facilities, along with sales companies and other corporate entities, can be positioned to take advantage of a positive business climate, tax credits, incentives, and other benefits of specific locales to help yield the lowest possible overall tax rate. Marketplace Realities In today's competitive environment, companies are facing numerous challenges in the quest to maximize net operating profit. Customers are more demanding than ever before, price and margin pressures are intensifying, competition is more aggressive in the global arena, and shareholders are demanding improved financial performance. These marketplace pressures are forcing companies to explore every option for maximizing the bottom line. Driven by the need to optimize costs, efficiency, and operating productivity, companies are challenging their supply chains to optimize product flow and increase inventory turnover rates. In order to achieve these goals, management of information in an integrated, real-time environment has become critical. Effective supply-chain management is viewed as a key element in optimizing asset utilization, net operating profit and, as a result, shareholder value. However, in formulating supply-chain strategies, the tax effectiveness of the supply-chain structure may drive a significant portion of net operating profit. Therefore, creating an overall supply-chain structure that has favorable tax implications compared to alternative structures is gaining management attention. Structuring Tax Friendly Supply Chains In addition to constructing a supply-chain model that has the characteristics necessary to achieve the strategic imperatives of the business, the structure should be proactively planned to take advantage of environments that maximize net operating profit via reduction of "above the line" and "below the line" taxes. Above the Line While most business managers recognize that taxes are levied on operating profits, there are many "above the line" tax obligations created that can result in a significant tax burden. Depending on the country or locality involved, these taxes include:

  • Customs Duties
  • Value-Added Tax (VAT)
  • Sales / Use Taxes
  • Excise Taxes
  • Property Taxes
  • Employment Taxes
  • Net Worth / Franchise Taxes
Supply chains can and should be structured to take advantage of local differentials and/or incentives that may be available to minimize "above the line" taxes. Below the Line In addition to managing "above the line" tax matters, attention also should be paid to the typical "below the line" taxes that may apply, including:
  • Federal Income Taxes
  • State Income Taxes
  • Foreign Income Taxes
Numerous financial, legal, and operating strategies can be applied to the supply-chain structure to minimize the impact of these taxes. In proactively structuring the supply chain to minimize taxes, the following strategies should be considered:
  • Generation of foreign source income
  • Foreign sales corporations
  • Bonded warehouses and foreign trade zones
  • Hybrid financing
  • Transfer pricing policies
  • Inventory valuation alternatives
For example, title to inventories destined for sale in Europe may transfer from producer to a sales corporation in the Netherlands, where the tax rate is 10%, while products may physically move through Italy, where the tax rate is 37%, via limited risk distributors. Even within the U.S., there are many opportunities to structure supply chains to minimize taxes. Case Study This client was a $50 million division of a $2 billion U.S. holding company. The division manufactured handheld electronic devices in two facilities on Long Island and one facility in South Florida. Its factories were running at sub-optimum capacity (Kevin P. O'Brien is a Cap Gemini Ernst & Young practice leader for supply-chain consulting with high-growth and middle-market companies. Bryan Cooper is a Cap Gemini Ernst & Young senior manager for supply-chain consulting with high-growth and middle-market companies as well.
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