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According to TP experts, COVID and war have brought to light how unprepared businesses are to handle unforeseen geopolitical shocks.
According to internal and advisory sources, multinationals should be extremely aware of the transfer pricing ramifications of supply chain interruptions.
The calls coincide with the intense economic competition between the US and China and come in the wake of a rise in political tensions following Russia's invasion of Ukraine in February. The harsh lessons from the severe supply constraints of the COVID-19 epidemic are still weighing heavily on countries.
These trade, political, and health-related issues have brought to light how unprepared businesses are to handle rapid shifts in political and economic circumstances. The requirement to apply strong TP standards has increased as a result.
Companies have been compelled to evaluate their supply chains, distribution networks, and the locations of the producer and consumer markets.
The recurring waves of health and political crises were simply too much for the tax and TP functions to handle, according to Jesper Anker Howes, tax director at the Copenhagen law firm Gorrissen Federspiel, "In Europe, a lot of companies have been completely unprepared."
According to Ramesh Khaitan, senior vice president for taxation at pharmaceutical company Lupin India in Mumbai, geopolitical tensions and China's rigorous zero-COVID policy are causing a drastic upheaval in global supply chains.
"Companies are looking to maximise synergies and economies of scale, while streamlining business lines, improving the efficiency of supply chains, and preserving profitability or limiting losses," he stated.
A number of steps have been taken by businesses to safeguard their supply chains. The EU Chamber of Commerce in China stated in a report published in September 2022 that companies were considering a variety of potential solutions to supply chain issues.
These include initiatives to relocate manufacturing to domestic markets, sites located near consumers, or nations seen as reliable partners.
According to the paper, "this represents opportunities to other emerging markets that are ready to welcome investment and jobs."
Tax authorities have cautioned businesses to fully assess all TP opportunities and risks before moving through with supply chain reforms.
Khaitan points out that the OECD Model Tax Convention's Article 9—which addresses the taxation of transactions between linked enterprises—applies to corporate restructuring.
"It is critical for the taxpayer to factor in the country-specific regulations while addressing their business restructuring issues," he says.
He continues by saying that a company's reorganization must be driven by sensible business considerations that any other party would have made as well.
"There would then be no TP implications subject to the requirement that there is appropriate risk allocation, compensation and the quantum of compensation for post and pre-restructuring remunerationThere would then be no TP implications subject to the requirement that there is appropriate risk allocation, compensation and the quantum of compensation for post and pre-restructuring remuneration," according to Khaitan.
Before undertaking any supply chain reorganization, businesses should carefully assess their business models, according to Krishna Gupta, global head of TP at Dutch health and wellness major DSM.
The importance of the production function or warehousing, whether the change in location would have a significant impact on the profit and loss account, and whether the decision to change supply chains would be made locally or by head office are the three main value drivers, according to Gupta, that should underpin any decision to change supply chains or distribution channels.
"If headquarters decides to move manufacturing or warehousing from one country to another then whatever associated costs, risks and benefits of that decision should belong to the central administration," asserts Gupta, who adds that the same holds true for decisions made by local entities.
According to Howes, many tax authorities would be prone to regard this as a TP problem if the decision to change supplier chains came from the head office since they would believe that a corporation tried to appease the interests of foreign shareholders.
Howes describes the perspective frequently held by revenue services in jurisdictions other than a multinational's home base: "It gives the impression that you have done this to save on taxes in our countries."
Even if there are three reasons for relocations, supply chains require additional processes to be moved effectively.
These include presenting the necessary evidence to support the choice, assessing the financial impact, performing a functional study in the new location, figuring out the compensation for the new firm, and deciding whether an exit tax would be applicable.
Conducting interviews with key individuals who make choices about supply chains is one way to accomplish this.
A company may only distribute the risks, profits, and expenses to the proper entities after going through this process.
However, according to Gupta, the process does not finish with the shift of site or supply chain. After a re-evaluation to make sure that the operations and risk components are still the same in the new location, businesses also need to evaluate the compensation for the entity in the location.
Is there an exit tax that multinational corporations must pay when moving their operations? This is a crucial issue that is occasionally disregarded.
Exit taxes typically apply when a business transfers fixed assets or writes off investments, according to Jose Antonio Nuviala, worldwide head of tax and law at Merit Automotive Electronics Systems in Spain.
He claims that tax authorities frequently conduct in-depth audits of transactions they claim are not tax deductible, including purchases, sales, losses, transfers, and supply chain adjustments.
As for how supply chain modifications are handled in disputes with Spanish tax authorities, he says, "In court you then have to demonstrate that they were not part of any transfer, and if they were, that you’ve been compensated."
According to Nuviala, it occasionally appears as though the Spanish tax authorities are content to give enterprises permission to change their supply chains as long as they are profitable and adding to the tax base. But when a company is losing money, they do not seem as pleased by the same restructuring measures, which can occasionally lead to conflict.
Howes advises enterprises to exercise caution while moving supply chains so as not to arouse the suspicion of tax authorities.
One of the biggest threats to multinational corporations is the possibility that tax authorities may view changes to supply chains, including changes to locations and distribution routes, as a kind of corporate restructuring.
Howes notes that "Even though this might be a transfer of a low-value service provider, you’re still transferring something of value and you might then be facing some sort of exit tax."
According to him, problems could occur if tax authorities object to the relocation of a local business organization on the grounds that it entails a cross-border sale of a profitable activity, which would then result in tax liabilities.
When shifting production entities between countries, corporations have made mistakes including centralizing supply chain decision-making and then incorrectly assigning the expenses of that move to the old company rather than the new one.
"Tax authorities then challenge the reasoning for keeping the costs of moving a warehouse or production facility in their country rather than allocating them to the entity in the new jurisdiction," according to Gupta.
When shifting production facilities or warehouses across borders, businesses must make sure they do complete analyses, including looking at how profits or losses are allocated.
"There should be sound business reasons, there must be compensation or reward at arm's length, and it [restructuring] is not done for profit shifting or base erosion," Khaitan continues.
It has become increasingly obvious that, on important topics like trade, the world is moving not closer but further apart as the conflict in Ukraine dominated this week's G20 summit in Indonesia.
Tax and TP specialists will not likely find much solace in these developments because it will be up to them to handle the tax ramifications of multinational corporations abruptly leaving major markets.
By fLEXI tEAM