The evolving procurement model

Procurement organisations in the future will look different to how they look today. They will be dealing with new market and supplier challenges that will require additional skills, knowledge, and tools to drive ever-growing savings goals. These challenges will likely change how companies look at procurement as an organisational function and an overall company competence. Therefore, as the procurement function evolves to manage these challenges and drive increasing value to the organisation, tax departments must focus on harnessing this value within their global tax planning.

The financial acumen and business linkages required of a procurement organisation are shifting dramatically. Over the past decade, procurement's purview has evolved from requiring core competencies in strategic sourcing and commodity management to demanding advanced capabilities in risk management, global supply, business outsourcing, and regulatory and tax issues. While procurement organisations have been successful in recent years gaining a seat at the table of their internal business stakeholders, there is always more that can be done to link up with the finance function to bring to bear more innovative operating model, tax, and foreign exchange solutions. The ability of procurement to squeeze the same year-over-year cost savings out of the same categories and suppliers has diminished, and a more creative and comprehensive approach must be considered to engage financial and tax expertise to continue to drive benefits.

Many of today's procurement fundamentals will stand in the years to come: category sourcing, baseline procurement systems, purchasing performance, and knowledge management. But the purchasing organisation of the future will need more. An important part of this will be the necessary collaboration between the tax and procurement functions in defining the value procurement adds to the overall organisation. Once this value is defined, the tax function will then be tasked with defining how to embed this value in its overall global tax planning.

This article explores both the opportunities and the process for procurement functions, tax departments, and key stakeholders in an organisation (finance, human resources, information technology, legal) to collaborate more closely to capture the full value created from the evolution of the procurement function.

Procurement in the future will encounter expanding risks and extended supply chains. The location of suppliers for both physical and virtual goods and services, as well as the geographic location of internal procurement staff and facilities may have growing and significant total cost and risk implications. Today, when it comes to managing supply chains on a localised basis, such activity is pressuring organisations, even those that are less resource-constrained than most. Tomorrow may bring the need to do this in real time to predict and forecast outcomes, factoring in a range of cost, compliance, transfer price, credit (tax), and related inputs.

Procurement will likely need a new operating approach to enhance localisation (regional enablement) and global support. Decisions regarding centralisation and execution may vary between organisations, but the need to define functional and organisational structure will always remain a part of overall processes, category sourcing, leadership, and execution roles – just as it is today. A good procurement structure not only enables procurement to support internal customers (and their needs) at more defined and localised levels, but also enables insight and action to adjust for balance of trade questions that might arise with customers.

It is imperative that discussions about centralisation versus localisation also include tax, trade, and finance, so key roles and risks are not located in jurisdictions that may give rise to adverse tax implications. Tax, trade, and finance should be included in these discussions at the earliest possible stage so the procurement function and important stakeholders within the organisation understand the opportunities to embed tax efficiency into their operating model.

For example, on a localised basis, a procurement organization might opt to support global marketing with a shared, data-driven infrastructure that supports a macro view of activities all the way down to hyper-local planning. Such a structure would enable a global marketing organisation (potentially centralised in a tax-efficient location) to manage agencies of record (and local teams and local agencies supporting execution) while providing for collaboration on improving measured outcomes across all media planning. But the same company might take a hybrid approach for direct materials categories, such as metal stampings, by centralising vendor management data collection in in a tax-efficient location that supports in-country procurement teams (including supplier quality and development resources). This example illustrates how companies look at categories (marketing and metal stampings) differently, and how tax must do the same. The business requirements will always come first in terms of how best to support the various categories and where activities must take place to drive specific efficiencies. Tax then can put forward its requirements in terms of where certain functions, risks, and assets can be more efficiently located from a global tax planning perspective. The ability of an organisation to match these requirements will determine how effectively it can embed tax planning within its operating model.

Business, systems, talent, and tax requirements should all be considered as future operating models are thought through. The risk of not having the full organisation, including tax, involved in the design of a new model is that key value drivers may not be built in at the appropriate time, and it may be too expensive or disruptive to build them in at a later date. This is especially true when the requirements involve the location of key people, altering legal ownership of property flows with respect to transactions, or changes to the systems. It is also expected, when an organisation successfully embeds all these requirements, including tax, in the design of its future procurement operating model that the procurement function will be involved in the eventual defense of the model before the tax authorities. This may be necessary if tax authorities assume that any changes to the model were made purely for tax purposes. It will be up to the procurement business leaders to explain to the tax authorities why they chose to operate in a way that allowed them to increase business efficiencies at the same time they were embedding tax planning into their model.

To achieve these goals, procurement will need to work with finance more closely to truly become responsible for not just how spend is managed, but how it impacts and meets the needs of the business. As with traditional transformation efforts, leadership and stakeholder engagement will remain essential, but with a new aspect of tax/finance-centric collaboration. Such a transition will require a shift in mindset away from price (even on a total costs basis) to also consider consumption, delivery, quantity, and foreign exchange and tax-related impacts.

As procurement migrates to a new model that manages increasing risk and drives greater value in the organisation, tax functions must earn their own seat at the table to help steer the future design so it fits within the company's global tax planning. To achieve this, tax must answer this question: how can the organisation align its evolving procurement model from a tax and finance perspective to capture the potential marginal improvements in a tax-efficient manner?

Typically the design of the new procurement model focuses on leveraging global scale while harmonising and standardising processes to drive efficiencies and cost savings. These efficiencies are further enabled by systems technology and other business process intangibles to remove costly touches from the supply chain through automation. Being close to suppliers is a key element, but there is typically a core group within the procurement function that is tasked with managing the organisation's overall procurement risk while also driving toward savings targets. Many times the business will not focus on the location of this core group, missing a critical opportunity.

Imagine that, instead of critical procurement roles that are involved in setting strategy and managing risk being dispersed on an ad-hoc basis throughout the globe, they are co-located in a procurement operating company (POC) located in a tax-efficient jurisdiction such as Ireland, the Netherlands, Switzerland, or Singapore, providing the following services to the organisation:

• Global, regional, and local procurement strategy;

• Category management;

• Managing global and regional supplier relationships;

• Consolidating buying data to identify savings opportunities;

• Developing negotiating strategies;

• Providing training to the organisation on purchase-to-pay processes; and

• Managing the overall spend of the entire organisation from a direct and indirect perspective.

While this group centrally drives the overall procurement strategy and manages key global suppliers, regional procurement centers of excellence located close to suppliers manage local relationships and are responsible for negotiation and conclusion of procurement contracts with local suppliers. This procurement "hub and spoke" model allows the procurement function to achieve operational efficiencies while also providing the tax and finance functions with the ability to potentially locate a portion of the marginal improvement from the evolving model in locations with either a low statutory tax rate or where the tax authorities negotiate tax rates based on the projected economic footprint of the new organisation.

From a business perspective, the benefits of having these roles co-located can include faster decision-making while also allowing for a single procurement operating model to be chosen that drives standardisation and harmonisation from a process and systems perspective. The standardisation and harmonisation of both processes and systems typically provide significant benefits to the business in terms of reducing touches and opportunity for human error while reducing complexity and making it easier to train new people on the model. Standardisation and harmonisation can also provide benefits when integrating a new acquisition, as the model for aligning the two procurement organisations has already been defined.

These transformations can be extremely expensive to undertake, especially when they involve moving highly compensated roles or modifications to existing systems so companies will pull together a business case comparing the potential group savings the procurement organisation will provide against the one-time costs (systems reconfiguration, people move costs, consultant and attorney fees, etcetera) and the ongoing run-rate (incremental cost or savings of having roles located in new jurisdictions, administrative costs, potential tax-audit defense costs, etcetera) to make a decision. The tax function should be involved in defining the value that can be attributed to the POC and its spokes so an after-tax savings/benefit number can be used in the business case.

It's important to note that there is no one-size-fits-all approach to defining the correct tax-aligned procurement model. While some organisations look at procurement globally, so that a "hub and spoke" model may make sense, other organisations may have a regional or commodity-driven model that allows for a simpler "singe central sourcing hub" approach. Additionally, some organisations may source most of their materials from a single country like China and therefore choose to use more targeted business and tax planning to capture the savings. In all these cases, procurement and key stakeholders must first drive how the business can most efficiently deliver value and grow over time. The role of tax is to share with the business the opportunities to align the model from a tax perspective (POC-type model, single central sourcing hub, country sourcing hub, etcetera) by explaining the tax requirements the business would need to live within so that both the tax and business benefits would be sustainable over the long term. The business – both procurement and key stakeholders – then decides whether it can live within the tax requirements. It is only when the business and tax are aligned that a truly sustainable tax-aligned procurement model can be implemented to drive sustainable tax and nontax benefits.

In addition to the location of key roles and the substance required in the POC, a critical part of the discussions between tax and procurement will include how best to manage legal title flows. Should the POC buy directly from the suppliers and then sell on to affiliates under a buy/sell model? Or should the affiliates purchase directly from the suppliers and pay a commission or service fee to the POC? From an economic perspective, the remuneration attributable to the POC may be similar under either approach as that value is driven by the functions, risks, and assets the POC manages. However, the title flows will affect the tax requirements analysis when it comes to managing permanent establishment concerns (who is binding whom) and indirect tax and customs issues.

Regardless of how the legal title flows operate, the POC will have to compensate the regional centres of excellence or spokes for their functions, risks, and assets. Typically, the regional spokes would be compensated on a cost-plus basis for the routine functions they are providing, while the POC captures the residual from managing the overall group risk.

As an alternative to the buy/sell or commission model, it is also possible to contemplate a hybrid buy/sell/service model whereby the POC and its spokes negotiate global pricing and rebates with suppliers. Under this model, the local affiliates purchase goods directly from the suppliers and retain the value of the group buying power through lower supplier prices. Under this option, the POC may be remunerated for its services by retaining a portion of the rebates it collects from the suppliers if the group achieves its volume goals.

The chosen procurement model, whether it is buy/sell, commission, rebate, or another version, will depend primarily on the following considerations that should be defined during an initial opportunity/feasibility analysis phase involving key stakeholders to ensure the organisation does not move down an unsustainable path:

• Business transformation: How is the procurement function evolving and can it operate within the tax requirements? For any tax benefits to be sustainable, the business must be able to live with the model, so business sign-off before implementation is critical.

• ERP enablement: Can the systems technology support the model in a cost-efficient manner? Harmonising and standardising processes will reduce costs and enable the POC to effectively manage the procurement function globally.

• People impact: Can the appropriate people move to the POC and spoke locations, and is the cost of these moves manageable? Locating highly compensated employees in expensive locations such as Singapore or Switzerland can be a show stopper, so identify these costs up front.

• Tax risk management: Are the tax risks from migrating to and operating under the model manageable?

• Base erosion and profit shifting (BEPS): With the current focus on BEPS by the G20, the OECD, and many governments, there is increased interest in the concept of companies paying their "fair share" of tax. The OECD BEPS action plan essentially requires that tax planning must be married with how the business chooses to operate, so that the substance of the business matches the location where the profits accrue. From an operational perspective, that means business must choose to operate in a manner, and from locations, that drive sustainable tax savings. In other words, locating the appropriate level of substance in the POC is a critical first step to managing ongoing tax risk.

• Transfer pricing risk: Once tax and procurement have agreed on the right substance to be located in the POC and the appropriate level of remuneration, it is necessary to address remaining transfer pricing issues arising out of the model. Are the centers of excellence and local affiliates being properly remunerated? How should business process intangibles developed by the POC be rewarded? Are the mark-ups, commissions, and/or contribution analyses supportable from a local country perspective? The transfer pricing studies prepared as part of these projects will form the basis of the company's defense in any future disputes with tax authorities, so it will be critical that they tell the story of the procurement function's evolution and explain the commercial rationale behind the transformation. The business also should review and sign off on these studies to confirm they properly reflect what's happening on the ground. This will prove invaluable when the tax authorities interview the business leaders, and their interviews are consistent with the company's transfer pricing studies.

• Exit charges: While undergoing the transformation, have any local affiliates transferred valuable intellectual property or other assets to the POC that require compensation? The intellectual property could be in the form of supplier databases, valuable "in-the-money" contracts, and other assets that allow the POC to drive future value for the organisation. Before transferring such items valuations should be prepared to substantiate the compensation due to the transferor. Alternatively, the transferor could license to the POC the right to use specific rights in their business. In the case of "in-the-money" contracts it may make more economic sense to let the "owner" of the contract earn out the value of the contract instead of transferring to the POC and incur a one-time tax charge.

• Permanent establishment (PE) concerns: Tax authorities may argue that the POC has a taxable presence or PE in their jurisdiction because of the activities of the POC or the local affiliate, if the local affiliate acts in the name of the POC on a regular basis. If a PE is created, the tax authorities will try to attribute profit to the PE, potentially negating the tax advantages of the chosen structure. In most cases, the POC will have a PE in a tax jurisdiction if the POC has a fixed place of business in that jurisdiction from which it carries on its business activities. A fixed place of business could include leasing or owning warehouses where goods are stored; thus, ownership of any property by the POC outside its country of incorporation should be avoided. Additionally, to avoid the creation of a "dependent agency" PE, it will be necessary to determine that no employees of a local affiliate sign contracts in the name of the POC or are deemed to bind the POC through their actions. This can be challenging when the POC operates on a buy/sell basis and employees of a regional center of excellence or local affiliate have responsibility for issuing binding purchase orders (POs) with suppliers. Because these POs will be issued under the name of the POC in a buy/sell model, tax authorities may argue that the local employee issuing the PO creates a PE for the POC. While some income tax treaties exempt preparatory and auxiliary activities, including "purchasing activities", from the definition of a PE, the question arises whether a "purchasing activity" could ever be considered "preparatory or auxiliary" for a POC whose sole purpose is to procure goods. Therefore, many companies that implement a POC buy/sell model choose to implement within their ERP system the ability for the POC to approve all supplier contracts and pricing terms so no PO can be sent to a supplier the POC has not already approved.

• Indirect taxes: Finally, indirect taxation issues such as VAT, GST, customs, and trade issues should be carefully analysed to identify any incremental costs that may arise from the POC stepping into the middle of the organisation's flows. Typically, these issues are manageable when operating in Europe, but significant hurdles can arise in certain countries in Asia as well as throughout Latin America.

Many of the issues listed above will depend on the substance and value provided by the roles filled by the POC. From a transfer pricing perspective, it will be important to show that the POC generates significant value to the group through its activities and risk management capabilities. The question that arises is how much can the POC keep of those savings and how much will it have to share with other members of the group. In many cases this will come down to an economic analysis defining the relative contribution analysis of the POC and the affiliates. While the factors used for the contribution analysis will differ based on the type of procurement activities being centralised (commodities, ingredients, packaging, component parts, finished goods from low-cost countries, etcetera) there are some significant activities that should be compared:

1. The importance of the value and volume of purchases as part of the procurement strategy, the benefits of which may arise passively due to the association with a controlled group vs. a specific POC contribution.

2. The pervasiveness of existing relationships with suppliers prior to POC implementation may also lean toward weighing this as a group vs. POC contribution, or as an intangible that should be acquired and managed by the POC.

3. The development of new global or regional relationships, or driving additional value from existing relationships may be a significant POC contribution.

4. Creating innovative procurement strategies should be a POC contribution.

5. Developing, implementing, and executing the procurement strategies for specific products, markets, and suppliers may generate cost savings that are left in the POC or shared with group members.

6. The ability to gather, access, and perform analytics on procurement data is typically a POC contribution.

7. The ability to represent global markets to propose and negotiate the strategy should lean toward the POC.

8. Developing a negotiating strategy and framework for new terms and conditions may be a shared contribution.

9. Negotiations with suppliers and concluding contracts will depend on who is tasked with these responsibilities and will need to factor in analysis regarding dependent agency permanent establishment concerns.

10. Ownership and control of existing IP and data processing systems, and how these will be employed and supported on a go-forward basis should be established if an organisation is migrating to a POC model.

11. The value of new IP and data processing systems should inure to the POC if it is responsible for developing and funding the new capabilities.

12. Managing regulatory issues is typically a POC activity, but may be shared with local affiliates responsible for day-to-day compliance.

Relevant factors, as mentioned above and the comparative weighting between the POC and the group will be determined by company-specific facts and circumstances. However, the factors listed provide an overview of the considerations to be used when an organisation is defining its future procurement model to gauge the level of potential savings that may be earned by the POC. Obviously, the greater the contribution made by the POC the greater the value that can be attributed to its functions, risks, and assets. It is of course necessary to weigh the value of the factors in relation to one another to arrive at an overall contribution percentage between the POC and the group. The exercise is not finished until the level of savings is defined, which may vary over the life of the organisation. The OECD, in its Revised Discussion Draft on the Transfer Pricing Aspects of Intangibles issued July 2013, framed this particular issue as follows:

If important group synergies exist and can be attributed to deliberate concerted group actions, the benefits of such synergies should generally be shared by members of the group in proportion to their contribution to the creation of the synergy. For example, where members of the group take deliberate concerted actions to consolidate purchasing activities to take advantage of economies of scale resulting from high volume purchasing, the benefits of those large scale purchasing synergies, after an appropriate reward to the party coordinating the purchasing activities, should typically be shared by the members of the group in proportion to their purchase volumes

Similarly, U.S. Treas. Reg. Sec. 1.482-9(l)(3)(v) maintains that, "A controlled taxpayer generally will not be considered to obtain a benefit where that benefit results from the controlled taxpayer's status as a member of a controlled group".

US Treas. Reg. §1.482-9(l)(5) provides five examples that illustrate the implications of this concept. Importantly, from both an OECD and US transfer pricing perspective, simple aggregation of purchases that lead to volume discounts is not an activity that entitles the POC to claim a significant portion of these discounts. Such activities would provide the POC only with a routine return for its logistical functions.

For the POC to drive significant value and receive nonroutine returns, it must be demonstrable that the POC develops, controls, and helps implement strategic sourcing solutions that lead to cost savings/profits beyond those that would be associated with higher volumes alone. The POC should have similar control over the business process intangibles, systems, platforms, and data analytics that underlie these strategies. Finally, it may be necessary to buy in to preexisting IP or long-term vendor relationships that are leveraged by the POC in its day-to-day activities.

The OECD's focus on the issues discussed above is recognition of the fact that the market demands that multinationals increase the value arising from their procurement function in a tax-efficient manner. It is up to tax departments to sit down with their supply chain and procurement leadership to make sure tax has a seat at the table as long-term procurement design decisions are made.

Biography
		Michael Gilson Deloitte Tax LLP 111 S. Wacker Drive Chicago, IL 60606 Tel: +1 312 486 3240 Email: mgilson@deloitte.com Over the last 17 years Michael has helped many clients in the manufacturing, consumer products, and services industries realign their value chain (marketing, sales, supply chain, procurement, manufacturing, quality) in both Europe and Asia by designing and implementing business model optimisation (BMO) methodologies involving the creation of tax efficient structures utilising principal or central entrepreneur companies located in Switzerland, Ireland, Singapore and other jurisdictions. These tax efficient structures typically involve the conversion of local sales companies into limited risk distributors and buy-sell manufacturing companies into toll or contract manufacturers operating under the direction of the European or Asian principal company. Many of these projects involved analysing the tax efficiency of locations to hold the company's intellectual property (IP) and structuring the transfer of such IP.

Biography
		John Wells Deloitte Tax LLP 2200 Ross Avenue, Suite 1600 Dallas, TX 75201 US Tel: +1 214 840 7558 Email: johnwells@deloitte.com John Wells is the mid-America leader of Deloitte's US transfer pricing practice and the US energy sector leader. He is experienced in managing large projects involving quantitative analysis in the areas of transfer pricing and intangible valuation. Although his primary focus has been on the energy sector, Wells has provided services to clients across the industry spectrum, including Fortune 500 companies in chemicals, engineering, manufacturing, retail, software, and telecommunications. Before joining Deloitte, Wells was the lead economist for the global energy and national resources sector of another big four firm, and an economic adviser to the Kuwait government. Wells was also a professor at Auburn University, where he taught PhD-level courses in time-series analysis, macroeconomics, and international finance. He has numerous publications and was a referee for the American Economic Review, Economic Inquiry, and other journals. Wells was awarded a National Science Foundation grant for his work on the effects of political events on financial markets.

Biography
		Andrew Feinberg Deloitte Tax LLP 1111 S. Wacker Drive Chicago, IL 60606 Tel: +1 561 310 4109 Email: anfeinberg@deloitte.com Andrew provides cost reduction and cash generation consulting services within Deloitte Consulting's Strategy and Operations practice, with a specific focus on supply chain management and sourcing & procurement. Andrew has over 19 years of experience in consulting and operational roles. He has significant leadership experience in industry as the head of a procurement organisation, and as an operational and strategy consultant on client engagements. Andrew specialises in working with global supply chain and procurement professionals to formulate strategy and organisational design, execute rapid diagnostics, and lead strategic sourcing, logistics, supply chain strategy and planning engagements.

Biography
		Andrew Newman Partner Deloitte Tax LLP Tel: +1 312 486 9846 Email: acnewman@deloitte.com Andrew Newman is a tax partner specialising in international tax matters for multinational companies (MNCs). With more than 30 years of experience, he serves multinational clients in a variety of industries, including manufacturing, services, specialty chemicals, fast-moving consumer goods, food processing, and distribution and franchising. Mr. Newman is the Co-Global Leader of the Business Model Optimisation (BMO) service offering. In this role, Mr. Newman is heavily involved in working with MNCs in optimising their supply chains and operating models and the tax benefits that can flow from such business transformations. This has included the design and implementation of principal and intellectual property company structures for Europe and Asia. BMO focuses on creating value though business transformation. Mr. Newman has performed numerous global strategic tax reviews for MNCs to focus on reducing their worldwide effective tax rates. In addition, he has been instrumental in pioneering a new approach to managing the effective tax rate of a global company while optimising its utilisation and repatriation of offshore cash. He has successfully implemented this Global ST2EPS methodology for many U.S.-based multinational companies. In a highly regarded international survey on tax advisors, Mr. Newman recently was recognised as one of the leading international tax service professionals in the central region of the United States. The study, conducted by the International Tax Review, gathers and assesses feedback on accounting and law firm tax advisers from 2,000 in-house tax experts and chief financial officers at major companies and financial institutions throughout North America. Mr. Newman is also listed as one of the 2010 World's Leading Tax Advisor's. Mr. Newman has published several articles on international tax matters in such magasines as The Tax Executive, Investment USA, and The International Tax Management Journal. Mr. Newman is a co-author of the BNA Portfolio on the Allocation and Apportionment of Deductions. He has spoken on international tax matters to various tax groups, including The Chicago Tax Club, the Tax Executives Institute, CITE, the International Fiscal Association, and the National Chamber Foundation. Mr. Newman is a member of the International Fiscal Association, the American Institute of Certified Public Accountants, and the Illinois CPA Society.