Managing the potential tax fallouts of operational change

17 September 2020
Tom Lickess, Global Head of International Tax Advisory, and Andrew Norris, Director, Indirect Tax Advisory, examine how operational change can create challenges across multiple business functions and why proactive management is key to future success.

Operational change is an everyday part of business – it comes in many guises and happens for a multitude of reasons. While organisations of all sizes make changes to operations on a regular basis, it is particularly prevalent among multi-national corporations and those with an international presence. 

Typically, operational changes are driven by commercial needs and financial/cash requirements. So, the decision to expand into new territories, undertake M&A activity or introduce new products, for example, will bring about change within a business. Significantly, any changes that happen can have a broad impact across the enterprise, such is the interconnected nature of today’s global business operations.

An acquisition, for instance, can lead to HR issues around staffing levels, legal issues around intellectual property and contracts, and, notably, matters that arise around corporate and indirect taxation. 

Take, for example, a standard ABC vanilla US entity, which has half a dozen sales and marketing people in the UK, Germany and Singapore. While they have cost-plus entities in those jurisdictions, they still sell from, distribute from and satisfy their contractual obligations, invoicing and so on from the US. All that the offshore subsidiary offices are doing is facilitating the sales process. 

Now consider that business is booming in the UK, Germany and Singapore, and it’s decided the organisation may more readily achieve greater market share by selling directly out of these three jurisdictions. This seemingly straightforward operational change would involve shifting the point of taxation from the US to the offshore entity, in which case the entirety of the tax supply chain, the delivery model and the number of people offshore changes. 

Generally speaking, operational changes are usually worked through from a commercial perspective and executed over time. It would be natural to assume, therefore, that a business would have proper people, processes and technology in place to manage the type of knock-on effects highlighted above. However, in a surprising number of instances, that isn’t the case.

There can be many reasons for this, but it often comes from business functions operating in silos or from multiple processes operating across different areas of the business as a result of organic growth or by way of acquisition. 

Whatever the causes, the impact of failing to map the true impact of these changes across a wide variety of areas – including tax, legal and people resource – can have long-term consequences, with the bottom line ultimately suffering as a result. 

For instance, in shifting the point of sale in the above example, there are:

  • Amendments to corporate governance potentially required to document the change in business operations
  • Corporate tax transfer pricing considerations, including the need to price and document the new intra-group arrangement
  • Indirect tax considerations – for example, what information should the invoice contain and what is the VAT/GST treatment of the provision of the goods or services?

In our experience, by focussing on mapping the change, and overlaying this with the various tax, legal and HR considerations, organisations are best placed to not only manage change, but also the longer-term resource, financial and reputational risk concerns that arise.

A time of unprecedented change

A potential lack of organisational inter-connectedness clearly presents a distinct set of challenges under normal operating conditions. But as 2020 has demonstrated, we currently live in anything but normal times. During the COVID-19 pandemic, businesses had to act quickly, making decisions at speeds they typically wouldn’t consider. The shift to remote working is one of the most obvious, along with the need to change supply chains in order to contend with international border closures. 

Many, if not all of the operational changes made at the height of the pandemic will have likely triggered a whole range of knock-on issues around HR, contracts and tax, which business will have to manage. But as we emerge from the pandemic, and businesses that were hit hard look to recover, they are likely to have to make further operational changes.

Those changes may be coming because businesses are forced to reassess their operations. For instance, it's possible that some businesses will seek to consolidate vendors in order to reduce costs, whereas others may look to expand vendors but more locally in order to future-proof their operational supply chain. Any changes, however, are going to create even more pressure points.

Take an MNC that chooses to reshore or onshore certain operations to make sure the just-in-time supply chain coming in from offshore isn’t interrupted, for example. What are the transfer pricing implications of this? And what wider international tax, financing and IP issues will fall out of this as well?

As if this isn’t a complex enough landscape, these operational changes need to be carried out not only with a broad view of immediate impacts but also with regard to regulatory or legislative change that will come about as governments seek to recoup the cost of support and stimulus packages implemented to shore up their economies during the pandemic. 

Indeed, we are already seeing tax authorities around the globe being tasked with reviewing the handouts over the past six months for potential fraud. The more lenient approach to tax administration – including compliance and collection activity – will certainly not last.

Removing the COVID ‘lens’

While COVID-19 has unquestionably had a significant, and for many businesses a detrimental effect on operations, it’s important that organisations don’t consider everything through a COVID lens. Prior to the pandemic, Brexit, taxation of the digital economy and the US/China trade war were already leading to businesses considering operational change, particularly when it came to supply chains.

Those factors haven’t gone away. Indeed, we are fast approaching the point at which a deal needs to be struck between the EU and the UK, which will have a direct impact on many businesses. At Vistra, we’re already seeing an increased planning for Brexit, with UK trading entities, for instance, looking to have a foothold in other jurisdictions in mainland Europe.  

What COVID has done, however, is start a process of organisations critically reviewing certain elements of their business – not just operationally but also financially. So, for example, businesses have started to look at cash pooling, allocation of capital, allocation of debt intra-group – and they are looking at alternative financing sources to shore up what they have but also to facilitate opportunities and to hopefully thrive in the ‘new normal’. 

What is critical, however, is that any changes that are made – be they contractual, operational and/or financial – are done so with the understanding of how they will impact other functions across the business. Whatever organisations choose to do to create competitive advantage – be it revisiting supply chains, onshoring, reshoring, entity consolidation, group rationalisation, vendor consolidation – the overlay of the wider implications from a full function perspective, including tax, legal and HR shouldn’t be an afterthought. 

Managing change

In order to make sure that any impacts of operational change aren’t overlooked, businesses can consider a range of steps, that can help create efficiencies, reduce costs, minimise tax leakage and mitigate any other ‘fall-outs’.

  • Ensure that the right people are involved during the appropriate parts of any operational change lifecycle. It is relatively common, for instance, for certain functions, such as tax and finance, to be involved pre-change, but to play a reduced or no further part afterwards. This can lead to important matters slipping through the net – so proper allocation of resource is critical. This may involve bringing in third parties to provide the requisite expertise – not only before any change, but just as importantly following the change, when the organisation is rightly forward-looking, but the post-implementation implications are key in managing risk.
  • Mapping the operational global supply chain, both third-party and intra-group, helps give transparency of operations, meaning that the impacts of any change are more likely to be seen. These supply chains can be overlaid with points of corporate and indirect taxation with a view to knowing the tax cost and risk, and minimising leakage around the globe
  • Constant monitoring of global taxation on a country-by-country basis and active analysis of the implications of any change is particularly important right now as governments look to increase revenues post-pandemic. Understanding the global tax landscape can help reduce the risk of penalties and controversy. And with the introduction of new tax measures and regimes – such as the digital services taxes – only set to complicate matters further, being absolutely up to date has arguably never been more important.

In simple terms, it is critical for businesses to look at where they are, what they are doing, where they are doing it, and to get that down into some sort of roadmap so they know the direction of travel. They then need to overlay that direction of travel in terms of red, amber and green lights. Where are the warning signs and where are the opportunities? Which are the problem countries, and which are the priority countries that they want to expand into, for instance.

In order to thrive, businesses need to create competitive advantage, and this can be done with a focus on operational change and a comprehensive understanding of the side effects of such change. Smart businesses will take the learnings from the COVID-19 pandemic and from previous experience to ensure that nothing slips through the cracks going forward and that they manage change as effectively and efficiently as possible.