Deloitte Tax identifies three tax risks to consider when managing your supply chain

This article, prepared by Deloitte Tax, identifies international tax implications when restructuring your organisation’s supply chain activities. For additional information contact Louise Vosloo (Lead Director –  International Tax) at lvosloo@deloitte.co.za or Janien Jonker (Senior Tax Consultant) at jjonker@deloitte.co.za.

“The best supply chains aren’t just fast and cost-effective. They are also agile and adaptable, and they ensure that all their companies’ interests stay aligned.”

(Hau L. Lee, US Professor of Operations, Information and Technology in Harvard Business Review, Oct. 2004)

Three tax risks to consider when managing your supply chain

Supply Chain Management (SCM) aims at fulfilling customer demands through the most efficient use of resources, which includes distribution capacity, inventory and labour. Merely locating the assets and risks of one’s supply chain in a favourable tax jurisdiction is not sufficient. The functions, together with the people, must be located in the chosen jurisdiction to manage these particular assets and risks. It is essential that the systems and processes, implemented and applied, support these functions in order to create a sustainable tax benefit.

Local tax authorities will attempt to defend their tax base at all costs. This may result in the local tax authorities seeking substantial taxable capital gains and/or transfer pricing adjustments when restructuring actions (which reduce the ultimate tax they would have received) are implemented.

Therefore, careful planning and documentation substantiating the reasons why certain steps were taken, are essential to ensure most tax risks are mitigated. Transfer pricing documentation also forms an important part of the documentation required. In the absence thereof, a substantial amount of time and resources may need to be set aside in the event that adverse assessments have to be defended.

The following are a few tax risks to consider with regard to supply chain management:

Low tax jurisdictions

It is interesting to note that whenever a South African group is considering a restructure of its current operations, Mauritius is almost always the first “low-tax” jurisdiction to be considered, and justifiably so. Mauritius has a wide treaty network and a low tax rate, and it provides relief for capital gains tax when shares are sold.

However, it is common knowledge that whenever a “low-tax” jurisdiction (e.g. Guernsey, Mauritius, Isle of Man) is part of a company’s group structure, it is frowned upon by SARS. This is no surprise, as there is most likely no other reason to have an entity in such a location, other than for the provided tax benefits.

Therefore, even though a favourable tax jurisdiction can be chosen, it asks for something in return – substance.

This could be illustrated as follows:

Company Z, a South Africa tax resident, sets up an entity (Company Y) in the Netherlands, to optimise its supply chain management by utilising the tax benefits provided for. The following activities should, inter alia, be executed by Company Y to ensure it has sufficient substance in the Netherlands:

• No strategic or policy decisions regarding business operations should be taken by Company Z.
• All board meetings should take place in the Netherlands.
• Staff must be suitably qualified and provided with suitable equipment, such as telephones and computers.
• Decisions should not merely be “rubber-stamped”, as though already taken by Company Z.

The substance and risk are components that impact significantly on the amount of profits that may be attributed to the company in the supply chain, in this instance Company Y. In addition, in the event that the decisions pertaining to the day-to-day operations of Company Y are taken by Company Z, SARS could determine that Company Y is being “effectively managed” from South Africa, and subject it to South African tax on its worldwide income.

Double taxation agreements (“DTAs”)

A country with a wide treaty network is an important consideration.

In terms of supply chain management, the two primary articles of any DTA to watch out for are the articles dealing with permanent establishments and business profits.

Even if an entity is set up in a favourable tax jurisdiction, it should be careful about not carrying out any activities in South Africa that could result in the creation of a permanent establishment in South Africa.

This could be illustrated as follows:

Company X is set up in the Netherlands, but contracts are negotiated and signed on its behalf by a person in South Africa. This would result in the creation of a permanent establishment for South African tax purposes for Company X in terms of the DTA entered into between South Africa and the Netherlands.

In light of the above permanent establishment creation in South Africa, the particular DTA further determines that the profits attributable to the permanent establishment would be subject to South African tax, thus possibly negating any tax benefits that may have otherwise been generated.

Controlled foreign company (CFC) considerations

Our CFC legislation currently acts as an anti-avoidance provision by imputing the income of a foreign company and subjecting such income to tax in the hands of its South African shareholders.

It contains the so-called “diversionary-rules”, and Silke on International Tax at paragraph 3.6.2.2. states the following in respect thereof:

These rules, which are essentially provisions targeted at tax avoidance, are aimed at deterring South African taxpayers from entering into transactions aimed at shifting income that otherwise would have been taxable in South Africa, out of the South African tax net and into a taxing regime that is more beneficial.

The diversionary rules need to be reviewed when goods are sold and services rendered to South African residents who are connected parties in relation to the offshore entity.

Conclusion

When restructuring one’s current supply chain activities, it is important to consider the international tax implications, as set out above. One cannot implement new supply chain functions by only considering the physical execution thereof.

We recommend that you thoroughly research, consider and apply possible solutions to suit your company’s unique operations, which can result in potential tax savings.

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Filed under: Finance, Risk Management, Taxation, anti-avoidance provision, capital gains tax, CFC, Controlled foreign company, Deloitte, Deloitte Tax, diversionary-rules, Double taxation agreements, DTA, international tax, international tax implications, low tax jurisdictions, low tax rate, Mauritius, SARS, Silke, South Africa, supply chain, tax, tax authorities, tax jurisdiction, taxable capital gains, Taxation, taxing regime, taxpayers, transfer pricing adjustments, treaty network, wide treaty network