Over the last several years, unprecedented supply chain disruptions caused by both the pandemic and geopolitical stress have affected the global availability of raw materials, finished goods, labor, and talent. These issues have increased prices for businesses and consumers alike, contributing to inflation in the global economy.
In the wake of these disruptions, many companies have been forced to modify their international procurement strategies and operations. With new suppliers, assemblers, manufacturers, or centers of talent identified—often in different regions or countries—companies must realign their international assets, operations, and personnel accordingly.
For example, nearshoring is a strategy where a business relocates third party operations or services to a nearby country to leverage the advantages of its proximity while keeping costs down and maintaining close collaboration with the parent company. Nearshoring allows for shorter transit times. A US-based company might decide to nearshore its manufacturing to Mexico instead of China to avoid supply chain issues in ports, save on taxes, and keep shipping timelines tighter.
But the tax implications of modifying cross-border supply chains can be complex, requiring integration of new tax jurisdictions, modification of distribution routes, realignment of funding channels, and modification or creation of new legal agreements. It may also require relocation of key assets, functions, or people. Below are some of the key areas where potential changes to manage supply chain issues will result in international tax consequences.
Legal entity restructuring
A realignment of the international supply chain often requires legal entity restructuring, such as liquidating one or more entities, forming new ones, or engaging in some other legal entity change affecting the cross-border structure.
This legal entity restructuring warrants the identification and consideration of various tax-efficient options for carrying out the proposed restructuring. Additionally, it provides opportunity to revisit the entire cross-border ownership structure and operations to ensure it provides maximum tax efficiency across the revised legal structure and supply chain.
Transfer pricing is a term used to describe the practice of setting prices for goods or services transferred between related parties in an international supply chain. These related parties can be different parts of the same company or can be different companies under common ownership or control.
Transfer pricing can have a significant impact on the profits and tax liabilities of companies operating in different countries. In an international supply chain, a company sells goods or services to its subsidiary or parent company in another country, and the price charged for those goods or services can affect the amount of profit attributed to each company and the amount of required tax.
When a company has multiple entities in different countries and is pressed to realign its global supply chain, this will often call for a review of transfer pricing policies to accommodate the change in transactions and/or countries. Such review will be aimed at ensuring income and taxes are reported and paid consistent with the transfer pricing guidelines in each relevant jurisdiction.
Withholding taxes are taxes withheld or deducted from payments made by a vendor, customer, or related company in Country A to a non-resident individual or company in Country B.
In an international supply chain, withholding taxes can apply to payments for goods, services, or intellectual property rights as they flow up the chain from one legal entity to another. Withholding taxes also apply to interest charges on cross-border financing.
The amount of withholding tax applied can vary depending on the country, the type of payment being made, and any existing tax treaties between countries. If a supply chain requires modification to accommodate transactions with a vendor or group entity in a non-treaty country, tax planning is especially recommended to ensure cross-border payments can be made with minimal withholding tax cost.
Tax treaties can help companies to navigate the complex tax implications of an international supply chain and can have an important impact on the tax liabilities of companies that operate in multiple countries.
Under a tax treaty, the countries involved agree on how income or profit will be taxed, and which country will have the primary right to tax that income or profit, helping to ensure companies are not subject to double taxation. They provide greater certainty and predictability around tax liabilities, helping companies to plan and make strategic decisions.
Wherever possible, a company involved in supply chain restructuring should aim to leverage relevant tax treaties. Where treaties are not available, there may other planning options that can help to minimize the tax costs of cross border transactions.
In addition to benefits for businesses, tax treaties can also be beneficial for the countries involved, helping to attract foreign investment and promote economic growth as businesses tend to want to invest in countries where there is a clear and predictable tax system.
Value-added tax (VAT)
Many countries outside the U.S. have a VAT system, which is a consumption tax on goods and services charged on the value added at each stage of the production and distribution process of a good or service.
VAT is typically calculated as a percentage of the price of the good or service, and it is usually collected by the seller at each stage of the supply chain. The seller then remits the VAT collected to the local tax authority, minus any VAT they have paid on their own purchases. This system helps to prevent double taxation, as each seller in the supply chain is only charged VAT on the value they have added to the product or service.
The amount of VAT charged can vary depending on the country and the type of goods or services sold. Some countries have a single VAT rate for all goods and services, while others have multiple rates depending on the category of the goods or services.
When a company changes the source country for a supply of goods, it may have to consider modified customs duties involved in bringing those newly sourced goods into its manufacturing or sales location. When goods are imported into a country, relevant authorities of that country assess a customs duty based on the type and value of the goods, the country of origin, and the type of goods being imported. These customs duties protect domestic industries of a country by making foreign goods more expensive. They also generate revenue for the government and regulate the flow of goods into the country.
Customs duties can be specific—like a fixed amount of money that is charged per unit of a particular good—or ad valorem, which is a percentage of the value of the goods being imported.
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It is important for companies to work with experienced tax professionals and to stay up to date with the tax laws and regulations of the countries involved in their international supply chain to ensure compliance and avoid penalties. Our new service line Mowery & Schoenfeld International is committed to empowering our clients’ transformative, international growth with a keen understanding of foreign tax regulations and cross-border transactions.