Integrating Operations and Tax Planning Into a Procurement Operating Model

As procurement organizations evolve, they commonly adopt a different procurement operating model (POMs) at different stages of their development. A global KPMG survey of chief procurement officers (CPOs) found that 83% of organizations changed their POM within the last 5 years and just over half of them over the previous year. In this context, the paths that procurement organizations follow appear to be similar: moving from a decentralized to a center-led model.

However, as organizations transition through operating models, the sole focus is often on the benefits derived from the new POM within the procurement organization and among its immediate stakeholders. In doing so, however, they miss a significant opportunity: to integrate tax planning into the design of the POM and thereby realize significant incremental benefits.
The current global tax environment, including the Organization for Economic Cooperation and Development’s (OECD) global project to address tax base erosion and profit shifting (BEPS), is placing many tax planning strategies under increased scrutiny. Nevertheless, properly designed and implemented tax-efficient operating models continue to be adopted by multinational corporations: If a strategic procurement company operating in a low-tax jurisdiction is able to demonstrate appropriate substance, i.e., its employees perform strategic functions designed to maximize business efficiency around sourcing and procurement initiatives (including determining vendors, products, volumes and prices), and it assumes sufficient risk with respect to the successful performance of these activities, it should continue to be deliver opportunities for significant sustainable tax benefits.

Ultimately, this type of tax-efficient structure should be evaluated by every purchasing organization.

Operating Models

Companies that integrate tax planning into the design of their POM frequently seek to create a centralized procurement company that leverages the scale and scope of a business globally or in a specific region, and locate it in a low-tax jurisdiction. The procurement company performs key procurement and sourcing functions for all suppliers, for example:

• procurement strategy and planning
• definition of category and fulfillment strategies
• sourcing
• supplier selection criteria and exit decisions
• supplier relationship management

The procurement company may be designed to meet the specific requirements of the procurement organization — e.g., the procurement company can manage spend globally or for a specific region of the world. Similarly, a procurement company may manage all categories of spend or it can be focused on specific categories.

Within this framework, different operating models have been tailored to the needs of individual organizations. Most of them are variations of two models: the purchase/resale model and the service fee model.

The main difference between the two models is that under the purchase/resale model, the procurement company negotiates and concludes contracts directly with suppliers. The procurement company issues purchase orders to the suppliers for the products, takes title to them and resells them to the operating companies based on an arm’s length transfer price, taking into account the value-added activities of the procurement company organization. Purchase orders are raised by the procurement company on the supplier and the supplier invoices the procurement company.

Under the service fee model, by contrast, the procurement company does not enter into contracts with suppliers; instead, it performs key value-added sourcing and procurement activities with respect to the suppliers for the specific categories of spend managed by the procurement company employees. The procurement company does not issue purchase orders to suppliers nor does it take title to the products (although, in certain situations the procurement company may enter into master sourcing agreements with global suppliers). However, all purchase orders are raised by the operating companies and invoices are raised directly by the supplier on the operating companies. The operating companies will pay a service fee to the procurement company reflecting the arm’s length value of the sourcing and procurement activities rendered by the procurement company employees.

The choice of operating model depends on the magnitude of change required to transition from current to target operating model, as well as the strategy of the business as a whole for delivering value and growth. In this context, tax plays a critical role in explaining the requirements the business will need to live within in order to ensure tax and business benefits are sustainable over the long term. In some cases, applicable tax rules (either income tax or transactional tax in nature) may dictate a particular operating model to be utilized to achieve optimal tax efficiency outcomes.

Benefits

The benefits of centralized POMs are well documented — e.g., they:

• leverage the full global or regional spend of an organization across categories
• enable standardized business processes
• create operational synergies
• facilitate faster decision making

Integrating tax planning into the operating model generates incremental benefits by reducing a company’s effective tax rate through lowering both direct (i.e., corporate) and indirect (i.e., customs and VAT) taxes. The combined tax benefits may significantly exceed the benefits that a company may gain from centralizing its key value-added procurement function in a location that does not offer similar tax efficiencies. Overall savings will depend on the size of the procurement activities, the current maturity of the procurement function; whether the procurement company will cover only direct or also indirect procurement; the proportion of the addressable spend and the tax rate differential.

Implementation Considerations

Like every change in an operating model, the implementation of a procurement company in a low-tax jurisdiction may require a major change within a business. In order to make it successful, companies should pay particular attention to the following when choosing a location:

1. Ability to do business from the location: e.g., commercial suitability, local infrastructure, attractiveness for expats transferring from other company locations, as well as regulatory and legal framework
2. Costs and incentives: real estate, employment, communications, grants and establishment aid, environmental rules and regulations
3. Pedigree: where have other companies established tax-efficient procurement companies, what is best in class in general and for specific sectors, what is the impact of a specific location on the corporate brand?
4. Substance: what level of substance is required for organizational and fiscal purposes, is this level of substance compatible with local country operations?
5. Tax: structure and levels of corporate tax and personal tax, strength of tax treaty network, capital taxes, anticipated changes in tax law

Conclusion

Recent years have seen a significant centralization of POMs. Increasingly, companies are maximizing the value of the POM by locating key value-added functions in tax-efficient jurisdictions. Implementing a procurement company in this manner (i.e., to achieve the added benefits from tax-efficiency) may require a significant amount of business change, but if done effectively, experience suggests that this structure can generate significant incremental savings that every procurement organization should explore given the potential impact on the overall return on investment to the company.