Buyer Beware! A Tax Efficient Supply Chain is Not a Tax Effective Supply Chain!

Many global consultancies with large tax practices and some supply chain capability like to preach tax efficient supply chains and how they can help you optimize your global supply chain to minimize the overall tax that you pay. As many multinationals know all too well, sometimes the biggest cost after the product cost is not the logistics cost, but the tax. Depending on where you are buying from, where you are storing your goods, and where you intend to sell the goods, you can end up paying a plethora of taxes that can add up real fast.

The country you are buying from likely imposes federal and state taxes on all sales, and might even impose municipal taxes as well (especially if there is a value-added service component). Then you have to get those goods to a port (air or sea), and guess what, there will be taxes on the transportation. Then the dock or carrier likely charges a loading service fee, which is, of course, taxed. And let’s not forget the export duties. Ka-ching! And then there’s the air or sea transportation tax (as the carrier is registered somewhere). And, of course, landing/docking unloading fees when you get back to land. And then, Free/Foreign Trade Zone be damned, when you (finally want to) import those goods, import duties! Ka-ching! Then you have local transportation costs, taxed, and local warehouse costs, taxed, and even final transportation costs to the store or consumer, taxed again. Taxes. Taxes. Taxes. And if you have to pay all those taxes, you might as well just source from the closest factory because, regardless of how much more their unit cost is, we guarantee it will be cheaper.

However, if you have what the tax consultants call a tax efficient supply chain, then, because you are theoretically sourcing from countries you are not doing (much) business in (or selling in), then your organization is not responsible for most of these taxes, and the rest of the taxes, through clever classification and trade agreements, are minimized.

But just because you are not responsible for a tax doesn’t mean that you don’t have to pay the tax up front (and then file for reimbursement later). In many countries, unless you have an exemption id to provide the seller or [logistics, etc.] service provider (which may or may not exist or which might only be granted to non profits, etc.), the seller / service provider still has to collect the tax. And if it takes six, nine, or even twelve months to recover the tax, this is not exactly tax efficient.

First of all, your working capital is tied up, and there is a cost to having this tied up, which is the greater of what it costs you to borrow that working capital from your lender, the average early payment discount you are giving up, or the investment opportunity your Finance department has at its disposal (through factoring, short term GICs, etc.).

Secondly, there is a cost associated with the recovery of that tax. It will consist of at least the time required to submit the paperwork for recovery, and fees associated with submitting the paperwork for recovery, and, if the process is so involved or onerous that you really need a best-of-breed software solution to help you, the cost of that solution. (Note that you might need multiple such solutions, as many as one for each country you have to to through a submission process as some countries might only certify in-country vendors to connect to their e-document submission systems or accept, without [mandatory] audit, documents produced by an in-country provider.)

Third, and most important, the supply chain is not cost efficient if the cost of minimizing the tax ends up creating a considerably more dispersed supply chain that ends up significantly increasing the logistics cost, and, as an effect, the overall cost. Tax efficiency is supposed to minimize overall cost and cannot always be considered on its own.

In other words, unless the consultant creates a model that takes all of this into account (and many don’t due to the overall complexity of such a model), the “tax efficient” supply chain is not a “tax effective” supply chain and is not necessarily one you want to pursue.

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