Management control:

Benefits of tax
effective supply
chain restructuring

Todays executives in multinational companies tend to carefully consider business

and tax implications when (re)organizing their supply chain. Improvements in

technology increased information availability and enhanced the potential for

long-distance management. As a result, the landscape for structuring international

supply chains and operations has changed significantly: often, production and sales

are transformed into separate subcontractors for a (regionally) centralized principal

organization. This enables multinationals to capture business efficiencies and to

explore a more tax effective structure. The Organisation for Economic Co-operation

and Development (OECD) advises authorities to allow for business restructuring

with envisaged tax savings only when it is considered commercially rational.

32 MCA: februari 2011, nummer 1

 Centralization to
capture business
efficiencies, while
exploring a more
Saskia Kersemaekers and Bert Pist: In
this article we argue that tax effective supply chain tax efficient
restructurings result in both (corporate) tax and
business benefits. Indirect tax is not measured.
Our empirical findings confirm only one of our
structure
two hypotheses: Within the first two years upon
restructuring there are significant corporate tax
benefits, however there is no significant evidence There are several terminologies used for tax
of business benefits. This may be explained by effective supply chain restructuring. Authors refer
the argument that it takes a longer time to realize to a tax effective supply chain (Oster, 2009), a tax
the envisaged commercial benefits while the efficient supply chain (Banker, 2009) or to a tax
restructuring costs are accounted for directly. As aligned supply chain (Irving et al, 2005; Lange et
a conclusion, we would like to state that the tax al, 2007; Rawlings, 2009). Lee Oster (2009) defined
benefits directly provide a positive net contribution tax-effective supply chain restructuring as the
to profit, and that business benefits may need a restructuring process of integrating tax planning
longer payback time than two years. into the overall management of a companys supply
chain, factoring in where to locate functions and
Introduction assets of the business, centralized management
Over the past decades, a large number of multi- and control over the risks, and which entity will
national companies restructured their supply legally and economically assume the risks. We
chain to increase business and tax efficiencies. A thus consider that tax effective structures are
recent study found that while most organizations combining tax efficiencies or benefits and business
were focusing on cost cutting, only 46% of benefits.
financial executives saw real integration between The restructuring trends raise important
purchasing and finance processes, ignoring the issues for companies and governments: When
opportunities that supply chain management does tax-effectiveness becomes tax avoidance?
can bring to their organization (Cotton, 2009). In Tax avoidance can be seen as the use of corporate
the tax effective supply chain restructurings, it is tax shelters without having any economic
the objective to combine these kinds of business substance or business purpose. Normal business
improvement opportunities with tax advantages. decisions, such as the financing structure, are
Tax effective supply chain restructuring primarily motivated by an underlying business
requires an integrated approach of supply chain purpose; however they also have (secondary) tax
management, tax management and financial consequences. The Organisation for Economic
management and is typically considered complex. Co-operation and Development (OECD) argues
that it is commercially rational for multinational
Literature companies to restructure their business operations
Despite the abundant academic research on in order to obtain tax savings, as long as the
strategic management of global supply chains and following three elements are considered (OECD,
transfer pricing, there has been limited academic 2009).
research on how supply chain decisions affect First, in the restructuring of the business
the tax results in combination with the (non-tax operations the functions, assets and/or risks
related) financial performance of companies. need to be effectively transferred. This implies
Historically tax has been seen as an inescapable that the assumption of an increased risk must
environmental factor that can be influenced be compensated by an increase in the expected
through financing decisions (i.e. changes in capital return. Second, appropriate transfer prices need
structure), as described by Modigliani and Miller to make the restructuring at arms length for
(1958). Nowadays, with increased globalization and each individual group member. The arms length
technologic improvement, companies continue to principle as defined by the OECD in art. 9 of
optimize their supply chains while taking various its Model Tax Convention (2005) is based on a
location-related factors into account, including comparison of the conditions of controlled and
corporate tax. uncontrolled transactions. This means for example

MCA: februari 2011, nummer 1 33

Figure 1. Conceptual model of benefits of
restructuring Business benefits
(Higher EBIT to Net Revenue ratio)
+/-
Business case for
restructuring to a
low-taxation country
+
Tax benefits
(Lower Corporate Tax to EBITDA)

Designs vary by responsibility for some of the following tasks:

purchases, research & development, planning,

the extent to production and distribution planning, stock

management, logistic planning, marketing strategy

which activities development, sales, treasury, intellectual property

(IP) management financial and administrative

and risks are functions (Clerc, 2010; Morris, 2008, Frick et al,
2005).

centralized Centralization of these functions needs to be

based on a clear business case in line with the
OECD guidelines. Typically, the business case is
calculated for business and tax (corporate tax,
value added tax, customs and transfer pricing)
that a company has to treat its external suppliers benefits over a period of 10 years, in which most
similar to its inter-company suppliers. Third, restructuring costs are accounted for in the initial
the company needs to take into consideration years upon restructuring. The operational benefits
all available realistic options, and will only enter typically come from real savings (e.g. headcount
into a transaction if they see no alternative that is reduction) and cost avoidance.
clearly more attractive.
Methodology
Predominant designs of tax-effective In this article, we argue that business restruc-
supply chain restructuring turings with the principal office in low-taxation
In a tax-effective supply chain structure, produc- countries may obtain business benefits and tax
tion and sales are transformed into separate benefits. The hypotheses are the following:
subcontractors for (regionally) centralized
management. This centralized principal structure H1: Restructuring requires additional resources at
enables multinationals to capture business first but eventually results in business benefits,
efficiencies, while exploring a more tax efficient measured by a higher ratio of earnings before
structure. The designs for tax-effective supply interest and tax (EBIT) to Net Revenue.
chains vary by the extent to which activities and
risks are centralized (Rao, 2008). Manufacturing H2: The business restructuring provides tax
and sales activities typically stay at the local benefits to the company, measured by a lower
sites, while a principal is located in a low income corporate tax to earnings before interest, tax,
taxation country (Rawlings, 2009). depreciation and amortization (EBITDA) ratio.
When risks are moved from the manufacturer
and/or sales company to the principal, the In our research we examined 17 companies
principal should be compensated. Through the before and after restructuring. The companies
legal design and/or service level agreements were selected from 190 companies registered as
(SLAs), the manufacturer may transfer the risks principal office at the Development Economic
related to e.g. raw materials, market demand, and Western Switzerland (DEWS), Fribourg
warehousing to the principal (Rawlings, 2009). Development Agency or at the Vaud Economic
The sales company may transfer risks such as bad Development Agency. The following inclusion
debt risk, foreign exchange risk, and finished goods criteria were used:
inventory obsolescence to the principal. ~~registered and transferred between 1998 and
A tax effective principal typically assumes 2007 (source: Confederation Switzerland);

34 MCA: februari 2011, nummer 1

 Tax benefits are
~~data series available through OneSource or from
published annual reports; evident directly
~~classified as going concern;
~~companies that were structurally loss-mak- upon
ing when transferring to Switzerland were
eliminated from the sample, because the purpose
for moving to Switzerland does not correspond
restructuring
with a tax-effective supply chain restructuring.

It was assumed that when companies have been direction for the relation between the business
registered and transferred to Switzerland, a low- restructuring and the business benefit. This is
taxation area, the companies had embarked on because the costs of restructuring may outweigh
a tax-effective restructuring. This was validated the envisaged business benefits from the
by checking the business purpose with which the restructuring particularly during the first years.
principal had registered with the Confederation Therefore a 2-tailed paired t-test was performed.
Switzerland. The year of transfer to Switzerland ~~The second hypothesis on the Tax to
was considered year 0. The two years before the EBITDA ratio assumes a positive relation
transfer and the two years after the transfer were between the business restructuring and tax
analyzed using student t-test statistics (Mc Clave, benefits. We already predicted the direction
2003). Due to limited availability of data, it was not of the relationship, so we tested for 1-tailed
possible to examine for all companies the data for a significance. The assumption is that the
longer period of time. However, we did extend the population of differences between before and
pre and post averages to three years where possible after restructuring is approximately normally
to incorporate the data available as comparison. distributed.
The following factors were examined:
~~EBIT to Net Revenue ratio: This ratio examines Findings
the relation between the operating profit before The study compares for a sample of 17 companies
interest and tax and the net revenues. The the average ratios in the years before restructuring
reason for examining the EBIT is that it reflects (PRE) with the years after restructuring (POST).
the cost of goods sold (COGS) and the selling, The study focuses on the 2-year averages (PRE
general and administrative expenses (SG&A). and POST). For a few companies the data of the
The restructuring may also have resulted in third year is not available and 2-year averages are
depreciation changes, for example if assets included instead in the 3-year averages. Therefore
are added to establish a shared service center. the 3-year averages function just as a reference.
Therefore this is taken into account when
examining the business benefits. Business benefits
~~Tax to EBITDA ratio: Income taxes are To analyze the business benefits, we performed
compared with the operating income before a 2-tailed paired t-test on the average ratios. The
depreciation and amortization. The EBITDA mean values for the PRE and POST show that the
used in this ratio is different from the first ratio ratio of EBIT to Net Revenue is lower POST than
(EBIT to Net Revenue) in order to avoid influence PRE, implying that restructuring has a negative
from financing decisions and depreciation impact on the business performance in the first
schedules that do not necessary correspond with two years. For the ratio of EBIT to Net Revenue,
fiscal depreciation. The study first determined there is a 95% certainty (p = 0.047) that this null
the pre and after ratios per company and then hypothesis (there is a relation between PRE and
examined for the group of companies whether POST) has to be confirmed and that the relation
there was a significant difference in pre and after has a negative direction. This negative relation
situation. In this way, the research captured the confirms that business restructuring will require
changes resulting from the restructuring. additional resources in the first years upon
~~The first hypothesis does not presume a restructuring.

MCA: februari 2011, nummer 1 35

Table 1. EBIT to Net Revenues

Transfer to Year 3 Year 2 Year 1 Year 0 Year -1 Year -2 Year -3

Switzerland

Hasbro 1998 0,07 -0,03 0,08 0,1 0,07 0,11 0,1

Edwards Lifesciences 2000 0,12 0,07 0,03 -0,29 0,13 0,1 0
Starbucks Coffee Trading Company 2001 0,11 0,1 0,1 0,11 0,1 0,09 0,08
Invacare International 2002 0,05 0,08 0,09 0,09 0,06 0,1
Autodesk 1998 0,15 0 0,18 0,12 0,12 0,24 0,18
General Mills International 2003 0,17 0,2 0,18 0,18 0,14 0,22 0,21
Cardinal Health Switzerland 2003 0,02 0,02 0,04 0,04 0,04 0,03 0,03
Cisco Systems International 2005 0,24 0,25 0,25 0,3 0,29 0,26 0,15
Eaton Industries Manufacturing 2005 0,08 0,09 0,08 0,09 0,09 0,07 0,07
Kyphon Medtronic 2006 0,18 0,21 0,29 0,28 0,25 0,31 0,31
Nissan International 2006 -0,03 0,07 0,06 0,08 0,09 0,1 0,1
Parker Hannifin Europe 2006 0,07 0,11 0,11 0,1 0,09 0,07 0,05
Vale International 2006 0,32 0,42 0,4 0,4 0,31 0,29
Yahoo! 2007 0,06 0 0,1 0,15 0,21 0,19
Comet 2003 0,1 0,06 0,03 0,1 -0,03
Lufthansa Systems 2000 0,13 -0,03 0,12 0,08 0,12 0,1
Actuate 2001 -0,02 -0,24 -0,04 0,07 0,07

Sources: Confederation Suisse (http://www.zefix.ch ), OneSource database and Annual Reports from corporate websites

Table 2. Income taxes to EBITDA

Transfer to Year 3 Year 2 Year 1 Year 0 Year -1 Year -2 Year -3

Switzerland
1998 0,08 -0,17 0,13 0,19 0,13 0
Hasbro
Edwards Lifesciences 2000 0,07 0 0,01 0,09 0 0
Starbucks Coffee Trading Company 2001 0,23 0,22 0,21 0,22 0,16 0,2 0,2
Invacare International 2002 0,22 0,29 0,31 0,3 0,25 0,33
Autodesk 1998 0,15 0,06 0,19 0,18 0,16 0,24 0,19
General Mills International 2003 0,27 0,33 0,26 0,24 0,2 0,29 0,31
Cardinal Health Switzerland 2003 0,3 0,3 0,3 0,31 0,3 0,29 0,31
Cisco Systems International 2005 0,21 0,22 0,27 0,29 0,29 0,29 0,3
Eaton Industries Manufacturing 2005 0,06 0,08 0,07 0,19 0,19 0,24 0,3
Kyphon Medtronic 2006 0 0,12 0,14 0,13 0,17 0,21 0,22
Nissan International 2006 0 0,3 0,25 0,27 0,28 0,25 0,25
Parker Hannifin Europe 2006 0 0,26 0,27 0,27 0,25 0,26 0,26
Vale International 2006 0,02 0,22 0,15 0,15 0,15 0,12
Yahoo! 2007 0,12 0,14 0,18 0,24 0,43 0,38
Comet 2003 -0,06 -0,02 -0,01 -0,03 0,3
Lufthansa Systems 2000 0,06 -0,14 0,2 0,17 0,23 0,16
Actuate 2001 0,18 0,03 0,1 0,09 0,04

Sources: Confederation Suisse (http://www.zefix.ch ), OneSource database and Annual Reports from corporate websites

36 MCA: februari 2011, nummer 1

Companies are randomly divided within the sample.

well-advised to ~~Some principals may be structured in a country

to centralize the profits, while paying at the

track the same time royalties to an entity in an other

country with an even lower taxation climate

envisaged (i.e. Bermudas). This would decrease the profits

captured in the Swiss principals. This study

benefits examined the consolidated corporate data and

therefore it has not become a confounding
factor.
~~Financing structure of the company: Modigliani
and Miller (1958) showed that financing
Tax benefits structure can have a significant influence on
The relation between restructuring and tax the income taxes paid by a company. Due to a
benefits is considered to be positive, thus small sample size (N=17), no further sub-group
restructuring resulting in a lower ratio of income analysis was performed.
taxes to EBITDA. Therefore a 1-tailed paired ~~Size of the company: Tax-effective restructuring
t-test was performed. As shown in table 2, there is more interesting for large companies. We
is a positive relation between restructuring and therefore removed the (2) companies under US
income tax deduction. A significant relation was $ 1 billion revenues.
observed using data of the two years before and
after restructuring (p = 0.018). An even stronger Some clear limitations have been identified that
relationship was seen between the ratio of income complicate the interpretation of this study. First,
tax to EBITDA (p = 0.0025) for the 3-year averages. the sample of companies was relatively small;
This confirms our hypothesis for tax benefits. because companies moved in different years,
many years of data needed to be available to
Discussion and conclusion make a comparison between before and after
The study addressed several confounding factors in restructuring, resulting in a smaller selection.
the following way: Second, it would have been preferable to monitor
~~Influence of economic situation on the ratios: the companies over a longer period of time,
Because each of the companies had their own particularly to explore the business benefits.
transfer date, the influence of the economic Third, it should be noted that the business
context is not likely to be a confounding factor benefits could also have been influenced by other
since we expect that external time-specific confounding factors that were not identified or
effects, such as economic recessions and booms, controlled for in this research. Fourth, the scope
will be evened out as a function of sample size. of the restructuring was regional for several of
The company data is taken for the two years the companies, while the investigated results were
before and two years after the transfer (between global.
1998 and 2007). Time-specific factors that did Some alternative explanations for the above
not last the 15 years covered by the sample were findings are:
sampled out. Furthermore ratios minimized the ~~During the selected timeframe (1995-2010),
impact of revenue fluctuations. there may have been a worldwide tendency to
~~Scale and scope: Sometimes a company has optimize cost structures as a result of increased
multiple principals. When only a small part globalization and enhanced long-distance
of the company is moved, the impact on the communication (e.g. shared service centers).
consolidated corporate results may be less than Similarly, the globalization may have also
when moving a larger part. The impact also resulted that companies increasingly revised tax
depends on the scope of the processes that are structures.
transferred to the principal and the chosen ~~Tax rates worldwide may have become lower for
restructuring design. It is assumed that the multinational companies during the selected
various restructuring models will have been timeframe.

MCA: februari 2011, nummer 1 37

In conclusion, the research implies that it takes ~~ Irving, D., G. Kilponen, R. Markarian, and M. Klitgaard. 2005.
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materialize. This corresponds with other types of Review, April 1.
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well-advised to develop a detailed project plan in Economic Review, 48 no. 3, June, pp. 261-97.
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benefits. 2008. The Tablet, KPMGs views on Supply Chain Management in the
Pharmaceutical Industry, November, http://www.docstoc.com/
Suggestions for further research docs/20175389/KPMGs-views-on-Supply-Chain-Management-and.
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made. Further research on the long-term (i.e. 4-8 on Income and on Capital, July 15, pp. 1-19 http://www.oecd.org/
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in the envisaged business benefits. This could also ness Restructurings, 19 September 2008-19 February 2009,
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the principal against its initial business case. cle-page/article/how-to-benefit-when-the-supply-chain-meets-tax/
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of the performance has under- or over-delivered ~~ Rawlings, C. 2009. Mixing Oil with Water or Mixing Gin with
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customs, subsidies, corporate tax, withholding tax,
transfer pricing etc). This requires a more detailed
and specific dataset, which would have less noise Drs. S.P. Kersemaekers RC is Manager at Ernst & Young Advisory
from external factors such as the performance of and is based in Geneva.
other business units that are not included in the
restructuring. Prof.dr. E. Pist is professor Strategic Management at the
University of Amsterdam and Chief Executive Officer at Royal Ga-
zelle in Dieren.

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38 MCA: februari 2011, nummer 1