Tax Alignment and Optimisation of International Supply Chains
Import duties continue to be significant elements in the cost of international trade. Customs duties, unlike VAT, represent a cost for the importer. A reduction of customs duties immediately improves the cash flow and costs of the importer. To achieve this, various customs procedures have been designed to reduce or avoid the customs duty burden.
Unfortunately, optimisation strategies can no longer only focus on the reduction of customs duties in isolation. Globalization has caused many businesses to divide their products or services into components. So instead of producing the components themselves or obtaining them from domestic suppliers, businesses outsource certain aspects of the work to other countries. Traditional custom duty reduction strategies may have adverse direct tax consequences and issues like the existing international tax structure of the group, transfer pricing and withholding taxes must be taken into account when designing an optimal cross-border supply chain. Conversely, the design of the international tax structure of a group must consider the duty implications of international procurement and sourcing strategies as well as cross-border movement of products.
Data & System Constraints – The Visibility Gap between Transactional and Operational Information
Almost as a rule, the information, documentation and data required for the identification and management of duty optimisation opportunities are not visible to the company and are in fact controlled by outside parties (e.g. freight forwarder and/or clearing agents). There is, in fact, a growing gap between transactional information (generally contained within the ERP) and operational information, distributed throughout the supply chain, which resides in various operational systems. Important indirect tax triggers are determined by operational product movements, making visibility of both transactional and operational information imperative for the effective management of risk and compliance.
International Tax & Customs Duties – The conflict between OECD and the WTO in respect of valuation
Direct tax authorities tend to follow the arm’s length principle and OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines) which set the international standard for transfer pricing. Customs authorities apply the relevant provisions of the WTO Customs Valuation Agreement (the WTO Agreement). Furthermore, practices in applying certain provisions of these international standards at the national level by customs and tax authorities can vary, to a certain degree, from country to country.
As a basic principle, both sets of rules require that an “arm’s length” or "fair" value be set for cross-border transactions between related parties and associated enterprises. That is, the transfer price must not be influenced by the relationship between the parties or it must be set in the same way as if the parties were not related. However, there are significant differences in the application of this broad principle, e.g. in relation to such major factors as policy objectives, operational functioning, timing of valuation, valuation methods, documentation requirements and dispute resolution mechanisms.
Institutionally it is often the case that two administrative bodies value or review the valuation of international transactions between related parties or associated enterprises. A striking point is that customs and revenue authorities within the same country can often have conflicting interests. On a given import transaction, a customs officer’s natural inclination would be to verify whether or not the value declared by the importer was under-estimated, as the customs officer would be interested in collecting more duties, while a revenue authority’s natural inclination would be to verify whether or not the import value declared was over-estimated, as the revenue officer would be interested in limiting what would be regarded as an excessive tax deductible amount in his/her jurisdiction. Or to put it in another way, where the “arm’s length” or “fair” value is not clear, might the customs specialist within a multinational enterprise be tempted to declare an import value on the lowest side of the range, while his/her tax colleague might possibly be interested in higher transfer prices if they can generate greater deductions.
Reduction of Customs Duties
Customs duties are generally a percentage of the value of imported goods. The Customs regulations of various countries set out a number of factors that must be added to the purchase price such as freight and insurance costs, certain royalty payments etc. Conversely, companies can also deduct certain elements, such as buying commissions, finance charges, settlement discounts etc., from the purchase price to reduce duty costs. We are proactively assisting a growing list of multi-national clients active in more than 70 countries to ensure that the duty component in their respective supply chains is kept to the lowest percentage possible.
The amount of duties paid depends on four key aspects and the effective management the impact of these aspects will, generally, allow you to optimise the cross-border movement of products:
- What the goods are, (i.e. their nature and characteristics) determines tariff code and therefore the duty rate;
- What the origin of the goods is, (i.e. where mined, grown, farmed, further manufactured or processed NOT just shipped from) determines whether preferential, standard or additional duties are payable;
- What the commercial structure of the transaction is (i.e. whether sale, leased, loaned, free of charge, under warranty or repair arrangement) determines customs value;
- What happens to the goods once imported (i.e. sold, further manufactured, repaired and returned, stored and re-exported) determines whether various reliefs are available.