Global Expansion: Enhancing Your Supply Chain's Tax Efficiency (article)
While U.S. consumer product companies traditionally have sourced products from Asia and other foreign locations, an increasing number of those companies also are looking to distribute their products in foreign markets. For example, as the consumer class in China and India has grown significantly in recent years and those consumers increasingly desire U.S.-branded products, many companies are recognizing this demand as an opportunity to expand their brand presence into a broader global marketplace.
This international growth certainly entails business risks and challenges, but it also brings opportunities to create value for the owners by building tax efficiency into their developing global business model. Although tax should not drive the business decision, once a company decides to operate internationally, it should be proactive in addressing how best to structure those operations to optimize its tax position.
International trading companies are often used in the consumer products industry. Why? It’s a tax-effective way for a U.S. business to operate globally. Since the U.S. tax system imposes taxes on the worldwide income of its residents, implementing a trading company structure will align the taxation of a company’s global profits with its business conducted outside the U.S. and also permit the deferral of U.S. taxes on those international profits until they are brought back to the U.S.
To accomplish this, a trading company typically is established in a low-taxed jurisdiction to conduct specific international activities, assume certain foreign business risks, and either own or license rights to exploit intellectual property assets offshore. Because no two companies have exactly the same business, culture and risk profile, the trading company model needs to be tailored for each company. Determining the appropriate trading company structure will therefore depend on numerous company-specific factors (in addition to those just mentioned), including its current and future business and supply chain model, the location of key employees, its intellectual property ownership and development activities, its sales and distribution channels, and the repatriation needs/objectives of its owners.
Putting an effective international trading company structure in place requires careful planning to navigate around both U.S. and foreign tax rules, which are often complex and constantly evolving. Choosing the right foreign location for the trading company, for example, will depend on various tax considerations, including local country taxation of ongoing profits and distributions, access to tax treaties and local country incentives. However, other factors such as the business and regulatory environment, the legal protection afforded to intellectual property assets and more practical concerns about whether the company actually can operate from that location are critical to this decision.
Other important tax considerations to be addressed include the tax cost of transferring brands or other intangibles to the trading company, managing U.S. tax deferral on international profits, avoiding the creation of a taxable nexus outside the trading company’s location, efficiently moving low-taxed offshore profits within the global structure, and ensuring that all intercompany sales, licenses and services comply with the transfer pricing rules of each affected country.
Perhaps the most critical requirement to achieve the tax benefits under a trading company model is having sufficient commercial “substance” (actual value from employees performing real functions as opposed to a shell) in that company to conduct its business. While the level of substance needed will vary based on the particular business and its operating model, at a minimum, the trading company must have locally based employees with the necessary experience and decision-making authority to manage its business, risks and assets.
If you are contemplating an expansion into the international markets, you need to carefully consider the tax implications of such a venture. The tax considerations highlighted in this article could have a significant impact on the outcome of your final decision and should be part of the decision-making process early on to help mitigate potential risks and take advantage of opportunities. Consulting with a global tax specialist who is highly experienced in this area can be instrumental in helping to develop and implement a tax-optimized business structure for such international expansion.
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