The current unprecedented market conditions pose strategic and financial challenges-and opportuni- ties-for automakers. In these circumstances, lean is ?in? for all.
Tax-efficient supply chain management (TESCM) is a process that teams supply chain (logistics, manufacturing, distribution, inventory) efficiencies with tax (direct and indirect) to develop and implement a business model, wherein the functions and risks within the multinational group are allocated in such a way that higher profit attribution (from a transfer pricing perspective) can be made to lower tax jurisdictions.
Take the case of an auto MNC with manufacturing facilities in India and customers across the European region?served by subsidiary distributor companies set up in a couple of countries (say countries A and B) in the region. The tax rate in India is, say, 35%, whereas the tax rate for A and B is 38% and 40% respectively. The effective tax rate (ETR) of the group is around 38%. If it implements the toll manufacturing model, it could achieve considerable savings by centralisation of functions and risks and optimisation of tax costs.
Conceptually, a toller converts raw material into finished product for a service fee on behalf of a principal company located in a low-tax jurisdiction. The MNC could identify a suitable jurisdiction, having regard to commercial and tax considerations that could act as the principal company for the group in the region. The tax rate of the principal company could be, say, 25%.
The principal company will undertake key strategic func-tions, own critical intangibles and largely assume the risks of the business. It would also act as a distributor for sales to the entities in A and B, make marke- ting efforts and bear the credit/ sales risks. The entities in coun- tries A and B would act as limi- ted distributors undertaking some distribution functions and associated insignificant risks. Thus, while the manufacturing and distribution entities will have limited profits, taxed at local tax rates (35%, 38% and 40%), the residual income would accrue to the principal company situated in a jurisdic- tion enjoying a comparatively lower tax rate (25%). Effective implementation of a TESCM model is likely to bring down the ETR and thereby rationalise the tax cost of the MNC group.
TESCM can be a useful mechanism to have a lean and efficient business structure geared to achieve significant economies by centralisation of functions, avoidance of duplication and tax-cost optimisation. For some in the auto sector it could be ?the? antidote for the current crisis.
The authors are senior professionals at Ernst & Young, India