How a growing procurement footprint can increase your tax footprint

Long considered a support function for reducing and controlling costs, procurement is now a strategic function for many multinationals.

Procurement functions are more connected to the business than ever before and impact almost every aspect of the organization. These connected procurement functions have already gained a voice in areas such as managing group demand, maintaining supplier relationships, overseeing raw material quality, and strategically sourcing goods and services.

In recent years, there has been an observed marked increase in the involvement of procurement functions in specification optimization, new product development and innovation, often empowering them to promote supplier integration throughout an increasingly connected supply chain.

In the eye of the storm

This evolution of the procurement function has not gone unnoticed by tax authorities, nor by the Organisation for Economic Co-operation and Development (OECD). It should, therefore, come as no surprise that tax authorities are also increasingly challenging the appropriateness of the compensation models (transfer pricing) applied for multinational enterprise (MNE) procurement functions.

Tax authorities are particularly interested in understanding the nature of their activities and the value they deliver. However, and more significantly, the OECD has recently recommended countries expand their permanent establishment (PE) concepts and definitions, and tighten existing PE exemptions. The adoption by countries of these recommendations into their local tax law may result in the creation of new PEs for some existing MNE procurement functions, and the related tax implications will need to be identified, understood and managed.

From corporation tax and value added tax (VAT) registrations and returns, transfer pricing reports, country-by-country reports (CbCR) and master file obligations, to new tax liabilities, individual income tax compliance and social security obligations for business travelers, the compliance and financial burden of these PE developments could be significant for some MNEs.

For those thinking that this is more about being caught in a “storm in a teacup” than being caught in “the eye of the storm,” it is worth noting that the CbCR that MNEs are now obliged to file requires that MNEs specify which of their entities are involved in performing procurement functions. The master file has a special section for the MNE to disclose its supply chain and to provide an overview of the various functions performed across that supply chain, creating increased visibility for tax authorities into the procurement functions of MNEs.

With increased visibility into the function and changes to PE concepts, definitions and exemptions, MNE procurement functions are likely to encounter a heightened level of scrutiny from tax authorities across the world, with consequential increased levels of tax controversy risk.

Ignore the storm at your peril – navigate the winds of change

From a risk perspective, where tax authorities successfully identify PEs that taxpayers have not, this could lead to a significant increase in tax costs, reducing the value delivered by procurement teams. This is arguably a direct consequence of the MNE procurement function’s operating model, including where its people are located, performing their activities and making their decisions.

However, when MNEs proactively consider these new PE developments in the design of their procurement function, the potential exists to sustain the procurement operating model’s effectiveness. It is possible to even enhance the value the procurement function delivers and the tax optimization outcomes the operating model seeks to secure.

Ignoring the new normal may come at a cost: a missed opportunity to increase value and manage risk. MNEs need to evaluate the implications of these changes to ensure their procurement operating models remain operationally effective and tax compliant. Is now the time to review yours?