As organisations reshape their upended supply chains, they must be aware of the tax consequences of shifting substance across jurisdictions. Deirdre Hogan explains.
The centralised operating model with a single global or regional hub location has dominated the business world for many years – but, the traditional model may be about to change.
Continued digitalisation, the onward march of online sales channels, increase in state-imposed trade barriers, and talent constraints brought about by COVID-19 are just some of many reasons businesses are reconsidering their operating models.
The more important factors for reimagining operating models are, however, the impact of Base Erosion and Profit Sharing (BEPS) Pillar One and Pillar Two.
Pillar One provides for a new means of attributing profit. Pillar Two, meanwhile, proposes the introduction of a global minimum effective tax rate.
The old model
The centralised operating model has served businesses well, and countries like Ireland have benefited.
This old model reduces duplication of effort and functions, enabling organisations to take advantage of incentives offered by jurisdictions seeking to attract global investment. Ireland has been particularly successful in this regard over the past two decades.
And yet, the efficacy of the centralised model is now being challenged by the ongoing BEPS process introduced by the Organisation for Economic Co-operation and Development.
Its aims include reducing the tax advantages of the old, centralised model by focusing on transparency, substance, and coherence.
The result has been an increase in the cost and complexity of tax compliance for globalised organisations employing the centralised model. This, in turn, is driving these organisations to concentrate activities in larger economies.
Meanwhile, should the new means of attributing profit—and the global minimum effective tax rate—be introduced, the tax advantages enjoyed by the centralised model will be further eroded.
What’s the alternative?
A loose definition of a multi-hub model is one in which a single, centralised structure is replaced by one with high-value business functions in multiple countries.
Its potential benefits include increased agility, the ability to tap into wider and deeper talent pools in different jurisdictions, closer proximity to customers, and improved ability to customise goods and services to meet their specific needs.
Furthermore, by adopting a fully distributed tax operating model to reflect this operating model—and spreading income in a more decentralised manner—an organisation may be better able to deal with future tax risk.
Indeed, from a tax and talent point-of-view, organisations may have to deploy a more significant number of people, functions, and assets in certain countries to meet economic substance requirements. The multi-hub model lends itself to such actions.
Supply chain resilience
The fragility of highly complex global supply chains was exposed during the COVID-19 pandemic. Traditional just-in-time production models halted, resulting in global shortages of products ranging from cars to kiwi fruit. The response has been to increase supply chain resilience by nearshoring or onshoring.
As organisations seek to reshape their supply chains, however, they must also be aware of tax consequences, ranging from corporate to indirect tax, as they shift substance across jurisdictions.
Geopolitical dimensions
Also driving decentralisation is the move by governments worldwide to increase trade regulation.
One example is Brexit. Britain’s exit from the European Union has added a new layer of complexity to trade with the UK, which may require companies to consider establishing an in-market presence.
At another level, regulations curbing the activities of overseas companies in certain markets may also require companies to establish operations with real substance in territories deemed of sufficient value to them.
Sustainability matters
‘LATTE’ isn’t just a coffee drink; it is also the acronym for local, authentic, traceable, transparent, and ethical consumer products. Increasing demand for these ethically sound goods is accelerating the drive to nearshoring and onshoring – consequently furthering the move to a decentralised multi-hub business model.
It is not enough to simply apply a label to a product as a means to make it appeal to ESG-conscious consumer cohorts. Businesses will need to have the right people located in-market to customise products to meet local needs and preferences.
The pros and cons
A fear of inadvertently increasing the effective tax rate paid by corporations has been one of the main obstacles to adopting the decentralised model.
The BEPS process will all but eliminate the potential cost difference, however, while the increased focus on the taxation of income from intangibles on the part of several major economies is further reducing the perceived tax advantages of the centralised model.
There are also concerns that the administration of a decentralised model may be more complex than traditional models, but arrangements can be put in place to eliminate this complexity.
That said, any organisation considering a switch to a decentralised model should carry out a thorough cost-benefit analysis and business risk assessment to ensure the benefits outweigh any potential increase in cost or complexity.
While the model may not suit every organisation—and is more important in some industries than others—many global businesses would benefit from the move.
The switch to a multi-hub model can help organisations to build supply chain resilience while also protecting against future tax risk by enabling them to spread their income in a more decentralised manner.
There are no predetermined rules for adopting a fully distributed tax operating model. Based on their individual needs, organisations need to choose how many hubs they should have, what functions should be dispersed, and where they should be based.
Deirdre Hogan is Tax Partner at EY.