Cross-border Tax Talks

welcome to cross-border tax talks where we discuss the latest trends in international taxation from u.s tax reform to the oecd's latest developments i'm doug mcconey pwc's u.s international tech services leader you can follow me on twitter at exporter tax on this week's episode of cross-border tax talks i'm excited to be joined by alex velasco alex is an international tax partner in pwc's washington national tax services practice and the leader of our value chain transformation practice alex welcome back to the podcast thanks for having me doug it's good to be back so alex what i wanted to start with before we dive into the number of things that we're seeing from an operational perspective and the tax implications related to just really major disruptions around the globe is start with the term value chain there may be a number of our listeners non-tax folks or frankly even tax professionals i i was always mystified kind of earlier in my career kind of what is a value chain and we hear a lot about the supply chain i want to talk a little bit about demand chain but how would you define what the what the value chain is or what a value chain is great question doug um a value chain is um a collection of capabilities that allows you know a company a business enterprise to make money and that's really the simple definition um an example of a value chain for a products company for example would be something that begins with you know market insights goes into the r d you know innovation process makes its way into the supply chain you know the the system that decides the balancing of supply and demand you know has the product manufactured or sourced you know moving it to the to the markets and ultimately selling uh it in the markets and then that sort of circle of life repeats itself so that's an example of a value chain for a products company you know and then of course there could be a similar example in the services business you know something that begins with um understanding you know clients demand to you know designing developing solutions capabilities tools models and then deploying um professionals to actually render services so those are examples of the value chain it's the way our clients make money i i love that that's a great definition one of the things alex you know that was always perplexing to me was that i think sometimes the term supply chain and value chain are used interchangeably and i mean maybe it's the tax nerd in me but i'm like well that's i that's not technically correct right the way the way at least i think about the value chain is that it's beyond just the supply piece it's all the ways that a company makes an end to end point yep it's the end to end and the supply chain is is really the beginning of that and particularly um in in a product type industry the demand chain is also very important right and so that's the way i tend to think of things as far as the overall value chain but we have the supply chain which is how does a product get initiated and then ultimately to market right and then the the demand chain is like okay once that that supply once we've gotten that product uh as close to the customer as we can how do we then take that next step to get it to the customer from the marketer from the sales person or or whatever and then there are a variety of different intangibles if you will and things that are important to both the supply chain and the demand chain that drive how a any particular entity or company can make money exactly i think uh like one useful example how management consultants refer to these things as using words innovate plan make source deliver and sell right think that's your value chain okay and then as doug you just said there are valuable capabilities within each of those elements of the value chain you know they could be intangibles they could be you know valuable services functions etc and supply chain is just a small piece of that supply chain is typically something that kind of lives between you know planning uh sourcing making and moving inventory i mean that is supply chain and there is a lot more to that to the end-to-end value chain of a business right and and then the other thing to take this back to cross-border tax talks and the tax side is that there are tax implications to every single aspect of of the value chain right from initiating the idea and coming up with the the concept of a product or a service how it gets made right and is there any magic and and how our materials source that ultimately get into the product and then how does a company get the product from manufacturing to sales or to the sales and distribution cycle and then is there any magic as as part of the distribution cycle and so every time anything crosses a border it has tax implications and then anytime you know there's there's a movement of anything there's then transfer pricing implications right as far as insofar as when you're dealing with related parties how do we make sure that each respective cog in the wheel is appropriately compensated and really the way i think of value chain transformation is really the the combinat from a tax perspective is the combination of that you know operations the tax consequences which each with each of those pieces of the puzzle and then from a transfer pricing perspective it plays a really really important role as well right on doug doug and you know the the what you're illustrating here is no two companies i like we're really just talking about unique dna that every company has you know when somebody says just give me the playbook you know like what are the things i should be doing just think about all the intricacies you just highlighted you know all those elements are unique to every company not too alike you know there's some themes but uh you really need to be very attuned to the way our clients operate in order to provide meaningful advice absolutely and and there has been a lot of disruption in in 2020 um i think there's a lot of a hope for for a vaccine and an economic recovery shortly thereafter as that gets distributed but you know a lot of big changes not just as a result of covet 19 um but obviously the economic impact and then even before covet 19 and this seems like an eternity ago um you know the changes to trade policy from a u.s perspective and just a whole lot of change for for for taxpayers to deal with that that impact their value chain and so wanted to go through a a few of the things that that we've seen happen in 2020 and that you know the thinking about the prospective for 2021 and what i wanted to start with alex is supply chain disruption there have been a number of macroeconomic factors geopolitical factors we think about you know china's involvement with hong kong we think about trade policy a lot of these that we've covered um on the cross-border tax talks what have you seen uh both from how countries are reacting and how companies are reacting with respect to the the disruption in the in the supply chain and it's everybody and then i'll already spoil the follow-up question is everybody moving all their manufacturing back to the us but we we can work our way to that yeah sure like what a year it's been um it's just absolutely crazy um and the the supply chain executives you know the guys and gals that run uh the supply chains of our clients are really in the hot seat uh we've seen a ton of just highly disrupted supply chains for a variety of reasons you know some of them you've you've just mentioned you know obviously the the trade and tariffs were already a big source of disruption um as companies were reacting to potentially significant new costs in the system trying to figure out how to deal with that the um the pandemic just brought elements of the the global logistics supply chain to a standstill and just because how global everything has become and how integrated supply chains have become uh an interruption in one element just brought to their knees entire supply chains of clients we have numerous examples where you know maybe the factories you know able to produce and china is a great example that china recovered fairly quickly from you know covet pandemic and reopen the factories but the the ocean freight was disrupted or the warehouses in europe went down right and so that just really brings down the entire system to its knees um so all those factors are very much in play uh there's a number of these kind of shorter term events that happened or are happening and uh these shorter term events are really causing companies to rethink whether they have the right models you know capabilities for the long run i mean what this is really highlighting is some of the the the themes that doug you just mentioned like are we is our supply chain too stretched you know is our source of you know raw material or production too far from the markets that we serve or are we too reliant on one particular country of origin or one particular manufacturing site and if that thing goes down our whole business goes down with it or you know are we too vulnerable to the the sort of cross-border trade war between you know us and china which is capturing or you know causing collateral damage and number of other you know global markets all those things are very much in play and then um doug as you mentioned uh it's interesting your question about um disruption and the impact on the on supply chains um it really is helpful to think of the the change in disruption you know first from a perspective of you know governments um there are certain things that are really changing you know from the government standpoint there are certain things happening that are changing companies you know response and then there are certain things that are you know happening that are changing people's behaviors and we have to think about all those you know elements and how they affect the the company's tax costs yeah and and each one of those changes has a tax consequence right and so one of the things that's been interesting to me alex and you certainly spend a lot more time in the space is just how long these uh these supply chains are and and maybe that's not the right term because i guess the supply chain itself can be relatively short but these are things that have been put in over decades and to be able to change something like where a company has relied heavily let's say on southeast asia for their manufacturing to try to then move that manufacturing to another similarly costed you know maybe it's closer so central america or mexico or another alternative those are massive changes right and now we can deal with it as tax advisors and like we can understand what the tax consequences are but it's been surprising to me how how long that that that takes i guess to be able to effectuate those those changes and then you know the the tax policy and tax policies in various jurisdictions continues to change so so dramatically and so so quickly too that you know how do companies kind of manage the well we know we're going to want to change the supply chain from a longer term basis and then how do we try to manage those tax costs given the uncertain environment yeah it's really interesting there's a lot there it's a very loaded question um you know the one thing doug that's interesting um and like you have been doing this for for a long time um i really i'm trying to like remember i don't think i've ever seen a company that would have made a decision to establish you know a manufacturing site or some you know massive you know footprint investment in the particular place because of taxes i mean it just really doesn't happen despite you know some of the publicity or despite you know somewhat of a popular belief there's so much more goes into these fundamental kind of network planning decisions it's things like cost structure it's things like access to qualified labor it's things like access to uh production capabilities at the right scale it's things like lead times and reliability it's you know environmental and regulatory considerations like those are the things that motivate companies to organize their business footprint in a particular manner you know of course there is you know tax cost there is income tax cost and then there is indirect tax cost you know customs and that for example uh and those are part of the equation but they are like way down the list um and this is the reason uh doug you write these decisions have you know a very long lead time uh and there's a lot of consequences to changing the course on how you organize your supply chain you know your operating footprint um we certainly seeing some trends i mean the trends that are discernible i think companies are concerned about um overall reliance on china mainland as you know the the primary only source of supply for critical components or critical inputs we definitely see companies wanting to diversify um both in terms of potentially having backup countries of origin as well as just kind of disintegrating their uh supply chain so not being as vertically integrated in one country but perhaps you know still producing certain critical inputs in china as an example but then setting up you know um assembly or integration location locations elsewhere maybe closer to the the market um there's definitely a trend to kind of nearshore not quite necessarily always unsure but at least near shore some capabilities a big reason for that uh is um the uh there's a lot of pressure to shorten the lead times um and a lot of us as consumers have grown to expect that you can you know very quickly have something customized made shipped and delivered to your door so in response to that companies are certainly looking at you know neoshoring certain activities closer to the key markets um that's the reason why for example uh north america has been beneficial not just the us but you know mexico and canada i've been beneficiaries of some of these trends so the the short answer doug i think these are definitely long lead time decisions there are definitely trends that are discernible but what many don't realize um china of today is not the china of you know yesterday or you know five years ago ten years ago um it's a it's a massive economy with uh tremendous you know capabilities and resources not just in the supply chain side but also in the demand side it's just a huge uh and quickly growing market for goods and services um and there are things that are existing in that country on a scale that is just unimaginable and really really difficult to compete so i think we will continue to see our companies heavily invested in china both as a supply point as well as a market for their you know goods and services but we are going to see some of these other trends you know in terms of um additional operating locations you know uh reassuring of certain activities closer to the key markets uh and building in redundancies yeah and your point alex which really resonated is that you're right tax is just one piece of the equation and i think sometimes it's viewed as like the the primary reason that certain companies look to go offshore for their manufacturing and and there have been obviously a number of significant tax policy changes to to influence these decisions but it's not really tax policy that it's going to make that decision generally speaking to onshore offshore now as we think about some of the tax changes over the course of the last year um with respect to supply chains specifically the whirlpool case uh was has i think shaken a lot of us uh and caused us to question our historic interpretation of the the branch rules we had a podcast dedicated to that but i think that has certainly caused a lot of us to think and rethink what are the the u.s tax implications of some of these foreign supply chains we've seen a number of changes outside the the us particularly in europe um the anti-tax avoidance directive for example and their treatment of various types of payments as we think about global supply chain i think about the proposed rule in mexico um with respect to some of the changes about how they tax employees for their services companies so all of these really play a role none typically will will absolutely drive the business to to make that decision but a lot of big changes from a tax perspective we've seen this year if you want to comment on that uh sure um there's a tremendous amount of change in disruption and all these different elements that you're highlighting um maybe just to to think of um a couple of these as examples so from the countries you know the government's perspective we definitely see huge focus on um increasing um you know tax collections countries are faced with deficits as a result of dealing with pandemic countries were already um recognizing that they not collecting as much revenue as they would like to see with respect to the sales in their particular markets so the one thing we're seeing is just a tremendous um incremental focused attention scrutiny from countries all around the world on increasing their uh tax revenue tax collections and they're doing it in a variety of ways they're increasing their headline tax rates um they are making more challenging to claim you know deductions reductions to the tax base they are changing their trade you know rules and regulations there are uh tweaking their um currency exchange controls this basically this whole theme of kind of incremental tax cost and continuing economic nationalism so that's one thing that we clearly are seeing um the other thing we're seeing is just tremendous additional visibility that governments all around the world have into the affairs of cross-border businesses i mean just become a new reality we now have country by country reporting we now have um automated access to tax filings as they're being made and uh data analytics being used by governments to automatically crunch that data and you know throughout red flags which then you know trigger exams you know audit activity we're seeing um we're seeing great examples where taxing authorities both between countries and authorities within countries responsible for different tax matters talk to one another and compare notes you know it's for example become very common to see you know vat authorities talking to income tax authorities and trying to come up with kind of integrated audits uh same thing from the payroll tax perspective a lot of information exchange so if we just pause there what we're really seeing is a picture where there's a lot of scrutiny attention focus on increasing international businesses um enabled by great access to data uh information visibility and just a broad array of tools that governments have whether it's you know laws that exist or some of the things that have been proposed you know we're seeing companies just using kind of grabbing those and using that toolbox um to try to increase their uh collection of their share of the the company's profits so so that's that's one trend you know again from the from the government's perspective um and then doug from the you know as we just talked about from the company's perspective just rethinking um rethinking parts of the uh business as we just talked about in response to these various disruptions uh all of that is really causing fresh look at you know are we are we still operating efficiently is the operating model so the collection of you know entity structure transaction flows into company economic allocations of income and costs all of that is what we call operating model is it fit for purpose that's been a topic du jour in all kinds of meetings happening at the c-suite uh and on down that's been a big big focus a lot of disruption and just fundamental questions about revisiting uh operating models yeah so let's go to that because i think that's been a number a big theme the one thing i want one point i wanted to add on kind of the list of various weapons if you will that we're seeing various territories and governments uses the digital service taxes i think you alluded to that but wanted to make sure that we mentioned that that's been another one that has then had a domino effect of impacting trade policy and and and everything else that i know a number of uh our listeners have been have been impacted by so let's move then to what has definitely been a theme that i was probably sometime coming after a very strong economy and then probably induced by covet 19 is the the desire to take costs out of the system right and and simplify and so i think you know across a variety of industries including the the one including our own right it's been a fundamental change i mean as like you i traveled five days a week you know before before march and have been firmly planted in this chair for you know ever since so companies are really looking at you know how they do business how they deal with their clients how they deal with their customers what are some of the trends that you've seen with respect to simplification or fit for growth as we call it um or or cost takeout and how is that impacting uh companies and tax profiles yeah there's a lot of deferred deferred sort of maintenance unaddressed opportunities that have accumulated at a lot of our clients a lot of cross-border businesses um a lot of these like we mentioned this concept of an operating model right which is just a collection of you know entity structure you know transactional flows contracting arrangements you know trans pricing policy and so forth those those models have been put in place many many years ago in the world that looked very different than the world as look as we as we know it now um there's a lot of opportunity in simplifying those models and we actually saw in this year in 2020 um many global businesses taking an opportunity of a crisis to go and do some housekeeping basically try to address those divert maintenance issues and in hopes of emerging kind of leaner more resilient more productive businesses some examples of that so one example we're seeing is companies um harnessing um data analytics and automation to take out complexity and simplify just a lot of very basic data intensive you know processes within their operations um so that's been a huge emphasis a lot of those capabilities are widely available um they uh they can be put in place fairly quickly and they just result in not just the cost takeout but just much much higher efficiency of operating and enabling business transactions to be processed so that's one um the other area of focus have been at um reducing transactional complexity uh that's a huge focus as you as you think about the uh typical multinational enterprise that has a network of you know manufacturing companies it has different maybe supply points that transact with those manufacturers and then it has a network of distributors all around the world you know third parties and their own affiliates you can just imagine the the spaghetti of transactions that that system requires and all those trends that need to be you know maintained priced um there's tax compliance associated with a lot of those cross-border flows you know from income tax or indirect tax perspective there is the the system complexity you know i.t system complexity that's needed to maintain them so there's a huge opportunity as it relates to those transactional models to simplify and we're seeing a lot of interest in appetite for example to setting up models where maybe manufacturers are um just made to refocus on the key things they control which is conversion costs you know labor and overhead a lot of times the sourcing for key categories of spent has already been centralized globally regionally so we're basically seeing more and more for example the so-called toll manufacturing models you know manufacturing as a service that's one example of that we're seeing on the demand side of the business more and more interest in the models where there is a master distributor or a single sales entity maybe transacting with customers like many companies went and asked the question do we really need to have you know 37 affiliates in europe or in a mia region you know booking their own revenue and the answer is not really there's really no compelling commercial or regulatory reason why you must operate that way and so companies using that as an opportunity to ask these tough questions and um and simplify simplify and reduce complexity and cost uh and this has been a big year for that and expect 2021 will continue that trend if anything now um there's a bit of a pure competition you know for these sort of streamlined you know more automated digitally enabled you know simpler operating models um and then doug of course from our standpoint there is tax consequences both as a defensive matter as well as the opportunities associated with all those things yeah and i would be remiss you know if we went through an entire cross-border tax talks where i did mention the term guilty and so what comes to mind as you were talking about particularly taking some of the costs out is we've been and had mike urson a few episodes ago to talk about the new foreign tax credit the final and proposed foreign tax credit rules well stewardship the house stewardship gets allocated for purposes of determining what foreign tax credits company gets for guilty we've spent a lot of time on the the podcast talking about interest expense and stewardship can have a very similar impact on a u.s multinational that is paying a significant amount of foreign tax on their guilty income and yet can still pay u.s tax because of expense apportionment and then stewardship becomes a piece of that and so as companies are thinking about taking costs out right there's a transfer pricing element of okay well what costs for example that remain in the u.s should be charged out and then what's left what's directly allocable what should be apportioned and so you know as as taxpayers are thinking about taking costs out i also think there's a strategic opportunity to think about well how should those costs be allocated what are some of the tax implications even from a foreign tax credit perspective that could be impacted like that and then of course the other tax implications that you mentioned which i think are probably more obvious to our listeners of just like okay where should income be earned what are the key value drivers in intellectual property that that that need to be rewarded and then how do you structure the the distribution chain for example the demand chain to try to manage tax risks and there's also an element to that that i feel like it's it's a little bit like fashion you know it comes in and out of style as far as commission type arrangements and uh you know by buy sell arrangements and part of it is you wait around long enough it's going to be in fashion again but a number of tax opportunities as well as pitfalls as companies are even thinking about you know trying to simplify transactions or just trying to take costs out yeah absolutely doug and you know what what's interesting is we just talked about a lot of moving pieces right just you know companies value chains or complex you know the operating models you know are very complicated there's all these changes happening and companies living that change every day either because they are digitizing or because they're taking costs out because their supply chain is in disarray needs to be modified what's interesting is we see tax authorities taking notice um and um really engaging you know with companies um a lot of times in the context of controversy uh or you know litigation um around how do the companies behave when these sort of business changes took place this is a really important lesson as business changes business evolves those different elements of the value chain of being revisited or modified this would be something that will be looked at by tax authorities around the world uh looking for evidence on you know what were the value drivers you know what do the contracts say how did the companies behave how were the transactions booked who bore the costs uh how did the risk materialize and when it materialized who bore that risk who made the decisions relating to how to deploy you know assets or what to invest in or yeah those are all the things that we we as uh tax practitioners need to be thinking about and uh making sure companies are at least acknowledging as uh important telltales of kind of true you know behaviors within an enterprise because that will get looked at and i think that's a perfect transition to the next topic is that you know as companies have designed their value chains and as we think about trying to do it efficiently from a tax perspective a lot of that is driven based on where people are doing certain activities right so to the extent that we have key you know significant people functions as we often refer to that and key dempy functions in a jurisdiction those jurisdictions generally should be rewarded with a higher share of those profits now the question that we've gotten a lot during this 2020 year with covet 19 is like people can't travel anymore i think there were a lot of us i mean as this is the less of an issue in our business but i'm based out of dc i live in st louis um all that's in the united states just to remind people but like in europe you know people can live across borders regularly and and you know we see that all the time and uh and and you know with as ubiquitous as airline travel is has has been pre-covered um what are you seeing with respect because i know we've gotten a lot of questions of like well are we creating pe risk are we fundamentally putting at risk our whole strategy and value chain because you know these executives or significant people functions are not taking place in the territory and i think we've even seen some countries that are giving some relief for pe but you know how how are you thinking about that as a challenge and for for taxpayers yeah it's a tough one um there's a couple of things going on here one even before the pandemic the ways of working have evolved significantly when all these tax rules were put in place you know we're still dealing with fundamentally global tax system that is very focused on activities of individuals as they perform their duties you know their decision rights their roles responsibilities and their physical whereabouts when they um perform their duties so that's on one hand on the other hand we even before the pandemic are already living in a world where more and more things take place remotely we have a lot of process automation and digital tools that allowed people you know in different hemispheres being very hands-on and involved in making decision-making decisions um we had um already a trend to centralize either regionalize or globalize a lot of key business processes i mean that's something that is continuing and i suspect will continue there is less and less appetite uh by multinational businesses to have you know highly fragmented way of making business decisions there's a lot of desire to streamline those processes and you know uh those decision makers might be in uh different parts of the globe all getting together virtually you know enabled by technology and making key decisions as committees as groups of individuals so all those things going on and just think about the it's truly a dilemma you know definition of a dilemma is something that does not have a solution you know unlike a problem that has a solution dilemma doesn't you just need to manage it um so this is a great example of dilemma that most of our clients are facing how do we reconcile these commercial realities with the way that the tax rules are written and the way tax authorities are trying to enforce them and then of course the pandemic came um the the relief um and i know doug you and your guests have talked about this before that the relief relating to the pandemic is very short-term and it's very limited um i think companies would be mistaking to get a lot of comfort from that relief um tax authorities you know for the reasons that we said earlier are very motivated by enforcement in um you know tax revenue collection so that that relief is not really the magic of um it's really just about i think number one um just understanding the commercial reality what are the key most economically significant decisions that are important in the context of each of the elements of the value chain of our business that's the first question you know really understanding that the second question is now that we understand those key decision points how those decisions made are they made by individuals are they made by groups of individuals you know a lot of times there's more than one individual in involved in making those decisions just understanding and just documenting getting our heads around that dynamic uh and then finally designing a you know a a tax operating model um in a way that accommodates that like the one thing uh i've learned a long time ago and i always tell you know my team is um we don't say no to business i mean the business wants to operate the way it wants to operate our job is to kind of figure it out figure out the right solution and then you know make sure they're making informed decisions but we we have no illusion that we can you know say no to companies that wanting to operate a particular way so i think i think we just need to all get accustomed to um just this this complexity fluidity and the way uh people operate um we're probably gonna see some of these trends remain even even after pandemic um we're gonna see i think executives travel less we're going to see them attending more meetings remotely um we're going to see more global governance models where decisions are truly made at the global level by this sort of virtual communities of expertise you know um and we just need to find a way to and there's a lot of tax tools and you know trends pricing tools available to manage that but um there's no simple answer it's just this dynamic that we need to engage with companies and help them manage absolutely and i think that you would also agree that we're also going to see revenue authorities across the globe continuing to be more aggressive and just the nature of this kind of global operating model puts pressure on permanent establishment and similar other type of and just general transfer pricing risk and it's just something that i think we're all going to have to deal with so a a great way to end things alex thank you very much for for joining the the podcast thanks for having me doug so thanks for tuning in to this week's episode of cross-border tax talks thank you alex velasco pwc's value chain transformation leader and partner in our washington national tech services office for joining me on today's podcast i'm doug mcconey pwc's international tax services leader stay tuned in two weeks for another exciting edition of the cross-border tax talks podcast this podcast is brought to you by pwc all rights reserved pwc refers to the u.s member firm or one of its subsidiaries or affiliates and may sometimes refer to the pwc network each member firm is a separate legal entity please see www.pwc.com structure for further details this podcast is for general information purposes only and should not be used as a substitute for consultation with professional advisors

welcome to cross-border tax talks where we discuss the latest trends in international taxation from u.s tax reform to the oecd&#39;s latest developments i&#39;m doug mcconey pwc&#39;s u.s international tech services leader you can follow me on twitter at exporter tax on this week&#39;s episode of cross-border tax talks i&#39;m excited to be joined by alex velasco alex is an international tax partner in pwc&#39;s washington national tax services practice and the leader of our value chain transformation practice alex welcome back to the podcast thanks for having me doug it&#39;s good to be back so alex what i wanted to start with before we dive into the number of things that we&#39;re seeing from an operational perspective and the tax implications related to just really major disruptions around the globe is start with the term value chain there may be a number of our listeners non-tax folks or frankly even tax professionals i i was always mystified kind of earlier in my career kind of what is a value chain and we hear a lot about the supply chain i want to talk a little bit about demand chain but how would you define what the what the value chain is or what a value chain is great question doug um a value chain is um a collection of capabilities that allows you know a company a business enterprise to make money and that&#39;s really the simple definition um an example of a value chain for a products company for example would be something that begins with you know market insights goes into the r d you know innovation process makes its way into the supply chain you know the the system that decides the balancing of supply and demand you know has the product manufactured or sourced you know moving it to the to the markets and ultimately selling uh it in the markets and then that sort of circle of life repeats itself so that&#39;s an example of a value chain for a products company you know and then of course there could be a similar example in the services business you know something that begins with um understanding you know clients demand to you know designing developing solutions capabilities tools models and then deploying um professionals to actually render services so those are examples of the value chain it&#39;s the way our clients make money i i love that that&#39;s a great definition one of the things alex you know that was always perplexing to me was that i think sometimes the term supply chain and value chain are used interchangeably and i mean maybe it&#39;s the tax nerd in me but i&#39;m like well that&#39;s i that&#39;s not technically correct right the way the way at least i think about the value chain is that it&#39;s beyond just the supply piece it&#39;s all the ways that a company makes an end to end point yep it&#39;s the end to end and the supply chain is is really the beginning of that and particularly um in in a product type industry the demand chain is also very important right and so that&#39;s the way i tend to think of things as far as the overall value chain but we have the supply chain which is how does a product get initiated and then ultimately to market right and then the the demand chain is like okay once that that supply once we&#39;ve gotten that product uh as close to the customer as we can how do we then take that next step to get it to the customer from the marketer from the sales person or or whatever and then there are a variety of different intangibles if you will and things that are important to both the supply chain and the demand chain that drive how a any particular entity or company can make money exactly i think uh like one useful example how management consultants refer to these things as using words innovate plan make source deliver and sell right think that&#39;s your value chain okay and then as doug you just said there are valuable capabilities within each of those elements of the value chain you know they could be intangibles they could be you know valuable services functions etc and supply chain is just a small piece of that supply chain is typically something that kind of lives between you know planning uh sourcing making and moving inventory i mean that is supply chain and there is a lot more to that to the end-to-end value chain of a business right and and then the other thing to take this back to cross-border tax talks and the tax side is that there are tax implications to every single aspect of of the value chain right from initiating the idea and coming up with the the concept of a product or a service how it gets made right and is there any magic and and how our materials source that ultimately get into the product and then how does a company get the product from manufacturing to sales or to the sales and distribution cycle and then is there any magic as as part of the distribution cycle and so every time anything crosses a border it has tax implications and then anytime you know there&#39;s there&#39;s a movement of anything there&#39;s then transfer pricing implications right as far as insofar as when you&#39;re dealing with related parties how do we make sure that each respective cog in the wheel is appropriately compensated and really the way i think of value chain transformation is really the the combinat from a tax perspective is the combination of that you know operations the tax consequences which each with each of those pieces of the puzzle and then from a transfer pricing perspective it plays a really really important role as well right on doug doug and you know the the what you&#39;re illustrating here is no two companies i like we&#39;re really just talking about unique dna that every company has you know when somebody says just give me the playbook you know like what are the things i should be doing just think about all the intricacies you just highlighted you know all those elements are unique to every company not too alike you know there&#39;s some themes but uh you really need to be very attuned to the way our clients operate in order to provide meaningful advice absolutely and and there has been a lot of disruption in in 2020 um i think there&#39;s a lot of a hope for for a vaccine and an economic recovery shortly thereafter as that gets distributed but you know a lot of big changes not just as a result of covet 19 um but obviously the economic impact and then even before covet 19 and this seems like an eternity ago um you know the changes to trade policy from a u.s perspective and just a whole lot of change for for for taxpayers to deal with that that impact their value chain and so wanted to go through a a few of the things that that we&#39;ve seen happen in 2020 and that you know the thinking about the prospective for 2021 and what i wanted to start with alex is supply chain disruption there have been a number of macroeconomic factors geopolitical factors we think about you know china&#39;s involvement with hong kong we think about trade policy a lot of these that we&#39;ve covered um on the cross-border tax talks what have you seen uh both from how countries are reacting and how companies are reacting with respect to the the disruption in the in the supply chain and it&#39;s everybody and then i&#39;ll already spoil the follow-up question is everybody moving all their manufacturing back to the us but we we can work our way to that yeah sure like what a year it&#39;s been um it&#39;s just absolutely crazy um and the the supply chain executives you know the guys and gals that run uh the supply chains of our clients are really in the hot seat uh we&#39;ve seen a ton of just highly disrupted supply chains for a variety of reasons you know some of them you&#39;ve you&#39;ve just mentioned you know obviously the the trade and tariffs were already a big source of disruption um as companies were reacting to potentially significant new costs in the system trying to figure out how to deal with that the um the pandemic just brought elements of the the global logistics supply chain to a standstill and just because how global everything has become and how integrated supply chains have become uh an interruption in one element just brought to their knees entire supply chains of clients we have numerous examples where you know maybe the factories you know able to produce and china is a great example that china recovered fairly quickly from you know covet pandemic and reopen the factories but the the ocean freight was disrupted or the warehouses in europe went down right and so that just really brings down the entire system to its knees um so all those factors are very much in play uh there&#39;s a number of these kind of shorter term events that happened or are happening and uh these shorter term events are really causing companies to rethink whether they have the right models you know capabilities for the long run i mean what this is really highlighting is some of the the the themes that doug you just mentioned like are we is our supply chain too stretched you know is our source of you know raw material or production too far from the markets that we serve or are we too reliant on one particular country of origin or one particular manufacturing site and if that thing goes down our whole business goes down with it or you know are we too vulnerable to the the sort of cross-border trade war between you know us and china which is capturing or you know causing collateral damage and number of other you know global markets all those things are very much in play and then um doug as you mentioned uh it&#39;s interesting your question about um disruption and the impact on the on supply chains um it really is helpful to think of the the change in disruption you know first from a perspective of you know governments um there are certain things that are really changing you know from the government standpoint there are certain things happening that are changing companies you know response and then there are certain things that are you know happening that are changing people&#39;s behaviors and we have to think about all those you know elements and how they affect the the company&#39;s tax costs yeah and and each one of those changes has a tax consequence right and so one of the things that&#39;s been interesting to me alex and you certainly spend a lot more time in the space is just how long these uh these supply chains are and and maybe that&#39;s not the right term because i guess the supply chain itself can be relatively short but these are things that have been put in over decades and to be able to change something like where a company has relied heavily let&#39;s say on southeast asia for their manufacturing to try to then move that manufacturing to another similarly costed you know maybe it&#39;s closer so central america or mexico or another alternative those are massive changes right and now we can deal with it as tax advisors and like we can understand what the tax consequences are but it&#39;s been surprising to me how how long that that that takes i guess to be able to effectuate those those changes and then you know the the tax policy and tax policies in various jurisdictions continues to change so so dramatically and so so quickly too that you know how do companies kind of manage the well we know we&#39;re going to want to change the supply chain from a longer term basis and then how do we try to manage those tax costs given the uncertain environment yeah it&#39;s really interesting there&#39;s a lot there it&#39;s a very loaded question um you know the one thing doug that&#39;s interesting um and like you have been doing this for for a long time um i really i&#39;m trying to like remember i don&#39;t think i&#39;ve ever seen a company that would have made a decision to establish you know a manufacturing site or some you know massive you know footprint investment in the particular place because of taxes i mean it just really doesn&#39;t happen despite you know some of the publicity or despite you know somewhat of a popular belief there&#39;s so much more goes into these fundamental kind of network planning decisions it&#39;s things like cost structure it&#39;s things like access to qualified labor it&#39;s things like access to uh production capabilities at the right scale it&#39;s things like lead times and reliability it&#39;s you know environmental and regulatory considerations like those are the things that motivate companies to organize their business footprint in a particular manner you know of course there is you know tax cost there is income tax cost and then there is indirect tax cost you know customs and that for example uh and those are part of the equation but they are like way down the list um and this is the reason uh doug you write these decisions have you know a very long lead time uh and there&#39;s a lot of consequences to changing the course on how you organize your supply chain you know your operating footprint um we certainly seeing some trends i mean the trends that are discernible i think companies are concerned about um overall reliance on china mainland as you know the the primary only source of supply for critical components or critical inputs we definitely see companies wanting to diversify um both in terms of potentially having backup countries of origin as well as just kind of disintegrating their uh supply chain so not being as vertically integrated in one country but perhaps you know still producing certain critical inputs in china as an example but then setting up you know um assembly or integration location locations elsewhere maybe closer to the the market um there&#39;s definitely a trend to kind of nearshore not quite necessarily always unsure but at least near shore some capabilities a big reason for that uh is um the uh there&#39;s a lot of pressure to shorten the lead times um and a lot of us as consumers have grown to expect that you can you know very quickly have something customized made shipped and delivered to your door so in response to that companies are certainly looking at you know neoshoring certain activities closer to the key markets um that&#39;s the reason why for example uh north america has been beneficial not just the us but you know mexico and canada i&#39;ve been beneficiaries of some of these trends so the the short answer doug i think these are definitely long lead time decisions there are definitely trends that are discernible but what many don&#39;t realize um china of today is not the china of you know yesterday or you know five years ago ten years ago um it&#39;s a it&#39;s a massive economy with uh tremendous you know capabilities and resources not just in the supply chain side but also in the demand side it&#39;s just a huge uh and quickly growing market for goods and services um and there are things that are existing in that country on a scale that is just unimaginable and really really difficult to compete so i think we will continue to see our companies heavily invested in china both as a supply point as well as a market for their you know goods and services but we are going to see some of these other trends you know in terms of um additional operating locations you know uh reassuring of certain activities closer to the key markets uh and building in redundancies yeah and your point alex which really resonated is that you&#39;re right tax is just one piece of the equation and i think sometimes it&#39;s viewed as like the the primary reason that certain companies look to go offshore for their manufacturing and and there have been obviously a number of significant tax policy changes to to influence these decisions but it&#39;s not really tax policy that it&#39;s going to make that decision generally speaking to onshore offshore now as we think about some of the tax changes over the course of the last year um with respect to supply chains specifically the whirlpool case uh was has i think shaken a lot of us uh and caused us to question our historic interpretation of the the branch rules we had a podcast dedicated to that but i think that has certainly caused a lot of us to think and rethink what are the the u.s tax implications of some of these foreign supply chains we&#39;ve seen a number of changes outside the the us particularly in europe um the anti-tax avoidance directive for example and their treatment of various types of payments as we think about global supply chain i think about the proposed rule in mexico um with respect to some of the changes about how they tax employees for their services companies so all of these really play a role none typically will will absolutely drive the business to to make that decision but a lot of big changes from a tax perspective we&#39;ve seen this year if you want to comment on that uh sure um there&#39;s a tremendous amount of change in disruption and all these different elements that you&#39;re highlighting um maybe just to to think of um a couple of these as examples so from the countries you know the government&#39;s perspective we definitely see huge focus on um increasing um you know tax collections countries are faced with deficits as a result of dealing with pandemic countries were already um recognizing that they not collecting as much revenue as they would like to see with respect to the sales in their particular markets so the one thing we&#39;re seeing is just a tremendous um incremental focused attention scrutiny from countries all around the world on increasing their uh tax revenue tax collections and they&#39;re doing it in a variety of ways they&#39;re increasing their headline tax rates um they are making more challenging to claim you know deductions reductions to the tax base they are changing their trade you know rules and regulations there are uh tweaking their um currency exchange controls this basically this whole theme of kind of incremental tax cost and continuing economic nationalism so that&#39;s one thing that we clearly are seeing um the other thing we&#39;re seeing is just tremendous additional visibility that governments all around the world have into the affairs of cross-border businesses i mean just become a new reality we now have country by country reporting we now have um automated access to tax filings as they&#39;re being made and uh data analytics being used by governments to automatically crunch that data and you know throughout red flags which then you know trigger exams you know audit activity we&#39;re seeing um we&#39;re seeing great examples where taxing authorities both between countries and authorities within countries responsible for different tax matters talk to one another and compare notes you know it&#39;s for example become very common to see you know vat authorities talking to income tax authorities and trying to come up with kind of integrated audits uh same thing from the payroll tax perspective a lot of information exchange so if we just pause there what we&#39;re really seeing is a picture where there&#39;s a lot of scrutiny attention focus on increasing international businesses um enabled by great access to data uh information visibility and just a broad array of tools that governments have whether it&#39;s you know laws that exist or some of the things that have been proposed you know we&#39;re seeing companies just using kind of grabbing those and using that toolbox um to try to increase their uh collection of their share of the the company&#39;s profits so so that&#39;s that&#39;s one trend you know again from the from the government&#39;s perspective um and then doug from the you know as we just talked about from the company&#39;s perspective just rethinking um rethinking parts of the uh business as we just talked about in response to these various disruptions uh all of that is really causing fresh look at you know are we are we still operating efficiently is the operating model so the collection of you know entity structure transaction flows into company economic allocations of income and costs all of that is what we call operating model is it fit for purpose that&#39;s been a topic du jour in all kinds of meetings happening at the c-suite uh and on down that&#39;s been a big big focus a lot of disruption and just fundamental questions about revisiting uh operating models yeah so let&#39;s go to that because i think that&#39;s been a number a big theme the one thing i want one point i wanted to add on kind of the list of various weapons if you will that we&#39;re seeing various territories and governments uses the digital service taxes i think you alluded to that but wanted to make sure that we mentioned that that&#39;s been another one that has then had a domino effect of impacting trade policy and and and everything else that i know a number of uh our listeners have been have been impacted by so let&#39;s move then to what has definitely been a theme that i was probably sometime coming after a very strong economy and then probably induced by covet 19 is the the desire to take costs out of the system right and and simplify and so i think you know across a variety of industries including the the one including our own right it&#39;s been a fundamental change i mean as like you i traveled five days a week you know before before march and have been firmly planted in this chair for you know ever since so companies are really looking at you know how they do business how they deal with their clients how they deal with their customers what are some of the trends that you&#39;ve seen with respect to simplification or fit for growth as we call it um or or cost takeout and how is that impacting uh companies and tax profiles yeah there&#39;s a lot of deferred deferred sort of maintenance unaddressed opportunities that have accumulated at a lot of our clients a lot of cross-border businesses um a lot of these like we mentioned this concept of an operating model right which is just a collection of you know entity structure you know transactional flows contracting arrangements you know trans pricing policy and so forth those those models have been put in place many many years ago in the world that looked very different than the world as look as we as we know it now um there&#39;s a lot of opportunity in simplifying those models and we actually saw in this year in 2020 um many global businesses taking an opportunity of a crisis to go and do some housekeeping basically try to address those divert maintenance issues and in hopes of emerging kind of leaner more resilient more productive businesses some examples of that so one example we&#39;re seeing is companies um harnessing um data analytics and automation to take out complexity and simplify just a lot of very basic data intensive you know processes within their operations um so that&#39;s been a huge emphasis a lot of those capabilities are widely available um they uh they can be put in place fairly quickly and they just result in not just the cost takeout but just much much higher efficiency of operating and enabling business transactions to be processed so that&#39;s one um the other area of focus have been at um reducing transactional complexity uh that&#39;s a huge focus as you as you think about the uh typical multinational enterprise that has a network of you know manufacturing companies it has different maybe supply points that transact with those manufacturers and then it has a network of distributors all around the world you know third parties and their own affiliates you can just imagine the the spaghetti of transactions that that system requires and all those trends that need to be you know maintained priced um there&#39;s tax compliance associated with a lot of those cross-border flows you know from income tax or indirect tax perspective there is the the system complexity you know i.t system complexity that&#39;s needed to maintain them so there&#39;s a huge opportunity as it relates to those transactional models to simplify and we&#39;re seeing a lot of interest in appetite for example to setting up models where maybe manufacturers are um just made to refocus on the key things they control which is conversion costs you know labor and overhead a lot of times the sourcing for key categories of spent has already been centralized globally regionally so we&#39;re basically seeing more and more for example the so-called toll manufacturing models you know manufacturing as a service that&#39;s one example of that we&#39;re seeing on the demand side of the business more and more interest in the models where there is a master distributor or a single sales entity maybe transacting with customers like many companies went and asked the question do we really need to have you know 37 affiliates in europe or in a mia region you know booking their own revenue and the answer is not really there&#39;s really no compelling commercial or regulatory reason why you must operate that way and so companies using that as an opportunity to ask these tough questions and um and simplify simplify and reduce complexity and cost uh and this has been a big year for that and expect 2021 will continue that trend if anything now um there&#39;s a bit of a pure competition you know for these sort of streamlined you know more automated digitally enabled you know simpler operating models um and then doug of course from our standpoint there is tax consequences both as a defensive matter as well as the opportunities associated with all those things yeah and i would be remiss you know if we went through an entire cross-border tax talks where i did mention the term guilty and so what comes to mind as you were talking about particularly taking some of the costs out is we&#39;ve been and had mike urson a few episodes ago to talk about the new foreign tax credit the final and proposed foreign tax credit rules well stewardship the house stewardship gets allocated for purposes of determining what foreign tax credits company gets for guilty we&#39;ve spent a lot of time on the the podcast talking about interest expense and stewardship can have a very similar impact on a u.s multinational that is paying a significant amount of foreign tax on their guilty income and yet can still pay u.s tax because of expense apportionment and then stewardship becomes a piece of that and so as companies are thinking about taking costs out right there&#39;s a transfer pricing element of okay well what costs for example that remain in the u.s should be charged out and then what&#39;s left what&#39;s directly allocable what should be apportioned and so you know as as taxpayers are thinking about taking costs out i also think there&#39;s a strategic opportunity to think about well how should those costs be allocated what are some of the tax implications even from a foreign tax credit perspective that could be impacted like that and then of course the other tax implications that you mentioned which i think are probably more obvious to our listeners of just like okay where should income be earned what are the key value drivers in intellectual property that that that need to be rewarded and then how do you structure the the distribution chain for example the demand chain to try to manage tax risks and there&#39;s also an element to that that i feel like it&#39;s it&#39;s a little bit like fashion you know it comes in and out of style as far as commission type arrangements and uh you know by buy sell arrangements and part of it is you wait around long enough it&#39;s going to be in fashion again but a number of tax opportunities as well as pitfalls as companies are even thinking about you know trying to simplify transactions or just trying to take costs out yeah absolutely doug and you know what what&#39;s interesting is we just talked about a lot of moving pieces right just you know companies value chains or complex you know the operating models you know are very complicated there&#39;s all these changes happening and companies living that change every day either because they are digitizing or because they&#39;re taking costs out because their supply chain is in disarray needs to be modified what&#39;s interesting is we see tax authorities taking notice um and um really engaging you know with companies um a lot of times in the context of controversy uh or you know litigation um around how do the companies behave when these sort of business changes took place this is a really important lesson as business changes business evolves those different elements of the value chain of being revisited or modified this would be something that will be looked at by tax authorities around the world uh looking for evidence on you know what were the value drivers you know what do the contracts say how did the companies behave how were the transactions booked who bore the costs uh how did the risk materialize and when it materialized who bore that risk who made the decisions relating to how to deploy you know assets or what to invest in or yeah those are all the things that we we as uh tax practitioners need to be thinking about and uh making sure companies are at least acknowledging as uh important telltales of kind of true you know behaviors within an enterprise because that will get looked at and i think that&#39;s a perfect transition to the next topic is that you know as companies have designed their value chains and as we think about trying to do it efficiently from a tax perspective a lot of that is driven based on where people are doing certain activities right so to the extent that we have key you know significant people functions as we often refer to that and key dempy functions in a jurisdiction those jurisdictions generally should be rewarded with a higher share of those profits now the question that we&#39;ve gotten a lot during this 2020 year with covet 19 is like people can&#39;t travel anymore i think there were a lot of us i mean as this is the less of an issue in our business but i&#39;m based out of dc i live in st louis um all that&#39;s in the united states just to remind people but like in europe you know people can live across borders regularly and and you know we see that all the time and uh and and you know with as ubiquitous as airline travel is has has been pre-covered um what are you seeing with respect because i know we&#39;ve gotten a lot of questions of like well are we creating pe risk are we fundamentally putting at risk our whole strategy and value chain because you know these executives or significant people functions are not taking place in the territory and i think we&#39;ve even seen some countries that are giving some relief for pe but you know how how are you thinking about that as a challenge and for for taxpayers yeah it&#39;s a tough one um there&#39;s a couple of things going on here one even before the pandemic the ways of working have evolved significantly when all these tax rules were put in place you know we&#39;re still dealing with fundamentally global tax system that is very focused on activities of individuals as they perform their duties you know their decision rights their roles responsibilities and their physical whereabouts when they um perform their duties so that&#39;s on one hand on the other hand we even before the pandemic are already living in a world where more and more things take place remotely we have a lot of process automation and digital tools that allowed people you know in different hemispheres being very hands-on and involved in making decision-making decisions um we had um already a trend to centralize either regionalize or globalize a lot of key business processes i mean that&#39;s something that is continuing and i suspect will continue there is less and less appetite uh by multinational businesses to have you know highly fragmented way of making business decisions there&#39;s a lot of desire to streamline those processes and you know uh those decision makers might be in uh different parts of the globe all getting together virtually you know enabled by technology and making key decisions as committees as groups of individuals so all those things going on and just think about the it&#39;s truly a dilemma you know definition of a dilemma is something that does not have a solution you know unlike a problem that has a solution dilemma doesn&#39;t you just need to manage it um so this is a great example of dilemma that most of our clients are facing how do we reconcile these commercial realities with the way that the tax rules are written and the way tax authorities are trying to enforce them and then of course the pandemic came um the the relief um and i know doug you and your guests have talked about this before that the relief relating to the pandemic is very short-term and it&#39;s very limited um i think companies would be mistaking to get a lot of comfort from that relief um tax authorities you know for the reasons that we said earlier are very motivated by enforcement in um you know tax revenue collection so that that relief is not really the magic of um it&#39;s really just about i think number one um just understanding the commercial reality what are the key most economically significant decisions that are important in the context of each of the elements of the value chain of our business that&#39;s the first question you know really understanding that the second question is now that we understand those key decision points how those decisions made are they made by individuals are they made by groups of individuals you know a lot of times there&#39;s more than one individual in involved in making those decisions just understanding and just documenting getting our heads around that dynamic uh and then finally designing a you know a a tax operating model um in a way that accommodates that like the one thing uh i&#39;ve learned a long time ago and i always tell you know my team is um we don&#39;t say no to business i mean the business wants to operate the way it wants to operate our job is to kind of figure it out figure out the right solution and then you know make sure they&#39;re making informed decisions but we we have no illusion that we can you know say no to companies that wanting to operate a particular way so i think i think we just need to all get accustomed to um just this this complexity fluidity and the way uh people operate um we&#39;re probably gonna see some of these trends remain even even after pandemic um we&#39;re gonna see i think executives travel less we&#39;re going to see them attending more meetings remotely um we&#39;re going to see more global governance models where decisions are truly made at the global level by this sort of virtual communities of expertise you know um and we just need to find a way to and there&#39;s a lot of tax tools and you know trends pricing tools available to manage that but um there&#39;s no simple answer it&#39;s just this dynamic that we need to engage with companies and help them manage absolutely and i think that you would also agree that we&#39;re also going to see revenue authorities across the globe continuing to be more aggressive and just the nature of this kind of global operating model puts pressure on permanent establishment and similar other type of and just general transfer pricing risk and it&#39;s just something that i think we&#39;re all going to have to deal with so a a great way to end things alex thank you very much for for joining the the podcast thanks for having me doug so thanks for tuning in to this week&#39;s episode of cross-border tax talks thank you alex velasco pwc&#39;s value chain transformation leader and partner in our washington national tech services office for joining me on today&#39;s podcast i&#39;m doug mcconey pwc&#39;s international tax services leader stay tuned in two weeks for another exciting edition of the cross-border tax talks podcast this podcast is brought to you by pwc all rights reserved pwc refers to the u.s member firm or one of its subsidiaries or affiliates and may sometimes refer to the pwc network each member firm is a separate legal entity please see www.pwc.com structure for further details this podcast is for general information purposes only and should not be used as a substitute for consultation with professional advisors

Transcript for:Cross-border Tax Talks

Transcript for:
Cross-border Tax Talks