The Tax Efficient Supply Chain
By Giles Sutton
It has been said that the ability to learn faster than your competi- to a split in supply chain methodologies within organizations for
tors is the only truly sustainable competitive advantage. And that’s volatile and nonvolatile goods.
just what those companies that learn to apply tax planning best
practices to their supply chain structure are finding out. The thought processes and technologies required to optimize a
given enterprise’s supply chain have also changed. Increasingly,
For several years purchasing executives, particularly in the retail companies are developing tighter relationships with their suppli-
industry, have been trying to squeeze every conceivable dollar ers, including the sharing of information once thought of as being
out of the supply chain. They have focused on process improve- “sensitive.” There has also been an enhanced reliance on technol-
ments such as total quality management, just in time (JIT), and ogy hardware and software. Two further complexities arising in
Six Sigma. In addition, they have poured significant investments the early part of the 21st century are cross ownership integration
into information systems and, more recently, vendor partnering. and the internationalization of the supply chain. From an opera-
However, one of the single biggest costs of managing a supply tional perspective, this has resulted in new thinking and greater
chain has often gone unaddressed: tax. contractual flexibility regarding commercial relationships.
The reason for this disconnect is that, unlike procurement profes- In an environment where supply chains are trying to respond to the
sionals and information technology (IT) professionals who work pressures of maximizing technology, thinking outside the limits of
on the operational side of the business (i.e. in profit centers), tax economic ownership and extending beyond international boundar-
professionals have typically limited their discussions to a compa- ies, a tax focus has been glaringly absent.
ny’s financial group (a cost center).
Where is Tax Planning Applicable?
Typically, corporate tax professionals are measured on a “no Tax planning applies to both the steps in the supply chain
surprises” basis and are seldom looked to for innovations. Instead, (supplier, distribution function, retail channels and customer deliv-
they are encouraged to mitigate tax “overhead” costs. Often, from ery) and to processes that drive successful supply chain manage-
a strategic perspective, no news is goods news from the tax depart- ment (procurement, electronic data interchange (EDI), merchandis-
ment. Commonly, this has led to a disconnect between pragmatic ing, finance, branding and asset management). Further, it applies to
operational logistical planning and the most sustainable form of above-the-line and below-the-line taxes. (Above-the-line generally
tax planning — functional-based tax planning. refers to taxes that impact operating income above the line labeled
as “Net Income Before Income Taxes.” Above-the-line costs are
What Are Supply Chains Trying to Accomplish? expenses that are used to compute net operating income before
Supply chain design is unique to each industry, and the measure- income taxes. They include operational taxes such as sales and use
ment of supply chain effectiveness can be based on several differ- taxes, property taxes, franchise and license taxes and excise taxes.
ent metrics, such as the percent of perfect orders, cost/margin or Below-the-line taxes impact income-based taxes.)
other asset-based measurements. Regardless of the metrics used,
the end result must be to satisfy customers while managing costs. Tax issues permeate every aspect of identifying, acquiring, import-
ing, transporting, distributing and selling goods. Tax planning can
In most circumstances, managing costs (i.e. reducing retail costs) impact almost every aspect of the supply chain. As such, one of the
equates with customer satisfaction, but in almost every circum- few ways a company can benchmark its operational tax profile is to
stance cost is at least a component of customer satisfaction. As a look at the economic efficiency of its supply chain.
result there has been an intense focus on cost reduction.
Further, unless a holistic approach is adopted, supply-chain-related
Supply chain managers are trying to respond to the increased tax savings will often be left on the table. Below is a discussion of
velocity through supply chains in response to accelerated changes some of the areas, by function, where savings might lie.
in fashion, technology and volume. In some cases this has lead
From a tax perspective, ownership of the transaction (i.e. the ability There are many tax implications, including:
to determine the amount, subject matter and jurisdiction) of taxa- • The property tax implications of the capitaliza-
tion is the single most crucial function to own. Ownership of this tion of site selection and store design costs; and
function will allow the taxpayer, not its vendors, to determine the • The state income tax implications of valuing and
subject matter of the transaction (services, intangible or tangible properly sourcing the services associated with the merchandising
personal property), the value of each component (if it is a bundled and marketing functions.
transaction) and the appropriate jurisdiction to impose tax. This
is critically important because each of these factors determine the Finance
level of tax the company will pay. Specifically: The structure of a company’s internal financing can also impact its
• In many states, intangible assets are not subject overall tax profile.
to property tax. As such, warranty cost included in and capitalized • The capital structure of a legal entity can often
on as a part of certain asset purchases will unnecessarily increase a impact its franchise tax profile.
company’s property tax base; • Efficient internal leveraging can, in some juris-
• In several states, software electronically down- dictions, serve to reduce an operation’s state income taxes.
loaded is not subject to sales tax. The ability to facilitate this type
of delivery to the ultimate end-user may determine whether or not Customer Relationship Management (CRM)
the software is subject to sales tax; Increasingly, companies are seeking to manage the data collected
• Many companies often disconnect vendor from a myriad of contact points with customers. Contact points
volume or contract inducement payments from the purchase of include data gathered in surveys, interactions with customer ser-
the underlying tangible personal property. As such, they overstate vice representatives, orders placed online, dealings with warranty
income, sales or property tax values of such assets; personnel and the usage of coupons. This information is critical
• The ability to value the importance of this func- to companies because it tells them, from a customer perspective,
tion within the organization and charge related entities for its the relevance of their products or services in the marketplace, the
services may produce a more state income tax-efficient profile. effectiveness of their marketing efforts and the efficiency of their
• Planning pertaining to the importations of goods delivery system. The tax implications of building the infrastructure
can often lead to a reduction in the customs and duties paid.. to compile and store this data include:
• In situations with rapid vendor turnover, it’s • Due to the extremely high value of customer
important to manage the related escheat (unclaimed property) data, there are state income tax implications as to where CRM data
exposure. is stored and maintained.
Further, owning the tax-determination piece of a transaction allows • The ability to license and protect intellectual
companies to reduce the exposure created by mis-compliance. property associated with the brand, such as copyrights, patents,
trademarks and trade names, will often impact the jurisdiction of
Brand Management income taxation.;
For many companies, brand management is “the” essential value • Property tax implications as to where CRM soft-
driver of the organization. The ability to control the “look and ware is capitalized.
feel” of the customer experience is essential to maintaining the • Since CRM is a communication-intensive func-
company’s position within the marketplace. The tax implications tion, a review of the excise tax amounts on telecommunications
of branding include: charges may lead to certain excise tax refunds.
• The determination within the supply chain of
when goods are “branded” and therefore where the value is added. Distribution and Asset Management
This, in part, determines the situs of taxability and the value of the In an era of just-in-time replenishment, distribution is a critical
goods for income and property tax purposes. function. Efficient management of distribution center (DC) func-
• The ability to license and protect intellectual tions and of the related transportation and merchandise handling
property associated with the brand, such as copyrights, patents, equipment is a key component of creating a cost-efficient supply
trademarks and trade names, will often impact the jurisdiction of chain. There are significant tax impacts on these functions as well,
income taxation.; for example:
• The ability to attach the value of certain intel- • Paying attention to the actual assets employed
lectual property may impact the customs and duties charges on the and special purpose designs of facilities can impact the amount of
importation of products. property taxes paid.
• The situs of where such intellectual property is • For those jurisdictions imposing property taxes
held will impact the tax costs of dispositions when a business unit, on inventory, employing the proper valuation methodology can
and its related intellectual property, is sold. reduce the holding cost of such assets.
• In certain jurisdictions there exist sales tax
Merchandising and Marketing exemptions for transportation equipment used in inter-state
The merchandising function determines what merchandise is commerce.
carried and where such merchandise is displayed. Often, it also • Improper capitalization of cost, such as duplica-
determines the overall store layout or design. These are critical tive site selection costs or the improper characterization of costs as
factors in retail operations, as convenience and functionality are real property as opposed to personal property, can impact property
essential in retaining customers in today’s fast-paced society. tax assessments.
• Often, distribution activities, if not segregated of the key factors required to achieve this result are discussed
into separate legal entities, can cause a company to expose its below.
major profit centers to unnecessary multi-state income taxation.
• Taking advantage of negotiating with, and Inter-departmental Coordination
sourcing of Internet sales to, local jurisdictions (cities/counties) To effectively manage a supply chain from a tax perspective,
can reduce the cost acquiring internal use assets. certain departments must coordinate their efforts. Tax planning is
• A failure to closely examine inventory han- most effective when tax planners know in advance what operat-
dling operations can lead to an overcapitalization of such costs for ing functions plan to do (purchase assets, restructure operations
federal and state income tax purposes. or locate facilities), before they do it. In particular, procurement
and distribution operations as well as information technology (IT)
Retail should vet prospective planning, purchases and changes in opera-
Tax also impacts the cost of running retail operations. Certain tions with a company’s tax department. Further, reaching out to the
characteristics make operating retail operations susceptible to tax tax department and encouraging them to focus on reducing operat-
inefficiency, including: ing costs can often produce significant results.
• The high turn over in employees can lead to
escheat (unclaimed property) exposure. Holistic Approach
• The employee-intensive nature of retail can Each supply chain has a unique structure. A detailed understand-
lead to process-based payroll tax incompliance and, perhaps, the ing of the operational elements of the supply chain is essential to
payment of unnecessary payroll taxes. effective and sustainable tax planning. Further, within tax, a multi-
• Inefficiently designed gift card programs can disciplinary approach is required to identify a broad range of
often cause unnecessary escheatment of funds. potential efficiencies (property, sales and use, franchise, excise,
• Certain operational structures may reduce the state, and federal income tax).
use tax cost of producing and distributing advertising inserts.
• State income tax planning pertaining to vendor Supply chains are not static structures. In fact, the structure of
payments negotiated for retail display allowances, cooperative supply chains is constantly changing, as are the products they
advertising, volume discounts and exclusive carry arrangements convey. The need for agility in the structure of supply chains leads
may lead to significant savings. to ongoing opportunities for tax efficiency or inefficiency, depend-
• Potential state income tax savings may be ing upon whether the organization has an operationally focused
obtained based on international sales and distribution assets. tax function. Significant investments in technology and processes
• Review of sales tax systems should be reviewed in an attempt to create a competitive advantage can be squandered
to reduce the costs of mis-compliance. if tax is ignored.
Key Factors in Creating a Competitive Advantage About the Author: Giles Sutton, J.D., LL.M. is a Partner in the
A competitive advantage exists for those companies that look State and Local Tax practice of Grant Thornton LLP in the firm’s
beyond tax compliance and towards tax self determination. Some National Tax Office in Washington, DC. Giles.Sutton@gt.com.
Electronically reprinted with permission from Supply & Demand Chain Executive online article • www.sdcexec.com