I reported on 16.06.2015 that Deloitte’s 2015 Global Transfer Pricing Country Guide predicted intra-group procurement would be the subject of a coordinated HMRC challenge during 2015.
So I thought it might be useful to do a note on Procurement Operating Companies (POCs).
POCs are now widely used to handle group-wide purchases. There are a number of potential structures but the most common are a central POC hub in a low-tax jurisdiction, e.g. Switzerland or the Netherlands, with local POCs close to their source, e.g. Hong Kong, to manage local arrangements.
Tax Authorities worldwide will be interested in how these companies are rewarded, the transfer pricing methods used and the underlying evidence to support these decisions.
MNE procurement has been evolving, having to adapt to new market and supplier challenges.
In some cases it’s the result of expansion into new markets, in some it’s been prompted by the continuing recession and the need to keep costs down and in others there may have been a one-off window of opportunity after a merger or acquisition.
There are also a number of trends affecting retail and consumer businesses in particular, ranging from the increased risk of supplier failure during the recession, to changes in consumer behaviour and to sustainability.
So, procurement arrangements may now include risk management, global supply chains, business outsourcing, regulatory and tax issues in addition to traditional functions such as strategic sourcing and commodity management.
PwC estimates that “procurement can make a significant contribution to the bottom line – cutting purchase costs by as little as 5% can result in a 50% increase in profit margin.”
The right approach for a particular business will depend on a number of specific factors, including the markets the company operates in, the scope of its activities and the location of both risks and assets.
According to International Tax Review, “an important part of this will be the necessary collaboration between the tax and procurement functions in defining the value procurement adds to the overall organisation.”
The design of a procurement model will aim to combine the advantages of global scale with the efficiencies and cost savings achievable from synchronising and standardising processes, enhanced by automation where possible.
Proximity to suppliers is a key factor, but there may also a need for a centralised function to manage the group’s overall procurement risk and drive the local network toward savings targets.
Therefore a POC, most likely based in a tax-efficient jurisdiction such as Ireland, the Netherlands, Switzerland or Singapore, may be set up to provide the following services to the MNE:
– Global, regional, and local procurement strategy,
– Category management,
– Managing global and regional supplier relationships,
– Consolidating buying data to identify savings opportunities,
– Developing negotiating strategies,
– Providing training to the organisation on purchase-to-pay processes, and
– Managing the overall spend of the MNE from a direct and indirect perspective.
(Source: International Tax Review)
While this central company will drive the overall procurement strategy and manage key global suppliers, regional procurement centres located close to suppliers will manage local relationships and be responsible for negotiation and conclusion of procurement contracts with local suppliers.
There is no one-size-fits-all approach to defining the most appropriate procurement model.
Some organisations look at procurement globally, so that a “hub and spoke” model may make sense. However, others may have a regional or commodity-driven model that allows for a simpler “single central sourcing hub”. On the other hand, if the MNE sources most of its materials from a single country like China it may choose to use more targeted business and tax planning to capture the potential savings
In addition to the location of key roles and the substance required in the procurement operating company, the MNE will also have considered how best to manage legal title flows.
Should the POC buy directly from the suppliers and then sell on to affiliates under a buy/sell model? Should the affiliates purchase directly from the suppliers and pay a commission or service fee to the POC?
In a typical set-up the regional spokes will be compensated on a cost-plus basis for the routine functions they provide, while the POC captures the residual profits from managing the overall group risk.
Other considerations, when deciding on the appropriate procurement model include people impact, tax risk management, base erosion and profit shifting (BEPS), transfer pricing, permanent establishment and indirect taxes.
This means that the transfer pricing studies underpinning the POC model chosen should properly reflect what’s actually happening on the ground.
Many of these issues will depend on the substance and value provided by the roles filled by the POC. From a transfer pricing perspective, it will be necessary to show that the POC generates significant value to the group through its activities and risk management capabilities. The question that arises is how much can the POC keep of those savings and how much will it have to share with other members of the group.
The OECD, in its Revised Discussion Draft on the Transfer Pricing Aspects of Intangibles issued July 2013, framed this particular issue as follows:
If important group synergies exist and can be attributed to deliberate concerted group actions, the benefits of such synergies should generally be shared by members of the group in proportion to their contribution to the creation of the synergy. For example, where members of the group take deliberate concerted actions to consolidate purchasing activities to take advantage of economies of scale resulting from high volume purchasing, the benefits of those large scale purchasing synergies, after an appropriate reward to the party coordinating the purchasing activities, should typically be shared by the members of the group in proportion to their purchase volumes
So, from an OECD perspective, simple aggregation of purchases that lead to volume discounts is not an activity that entitles the POC to claim a significant portion of these discounts. Such activities would provide the POC only with a routine return for its logistical functions.
For the POC to drive significant value and receive non-routine returns, it must be demonstrable that the POC develops, controls, and helps implement strategic sourcing solutions that lead to cost savings/profits beyond those that would be associated with higher volumes alone.
But, as far as tax is concerned, the key, as always, is that the tax structure should reflect the actual substance of the business and the level of transfer pricing is a key consideration here.
International Tax review
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