Global supply chain is a tax shell game

For five days running The New York Times has featured articles on the tax avoidance strategies of multinationals. It has been big news in Europe and the United States as companies such as Apple, Pfizer and Medtronic come under scrutiny for using locations like Ireland, Luxembourg and even Britain to minimise corporate taxes.

President Obama is making noises about stopping acquisitions meant to shift headquarters from a high tax location, like the US, to a lower tax location, like the UK – also known as “inversions”. And in Britain earlier this week the Conservative finance minister announced a crackdown on tech companies that evade their corporate tax obligations. Everybody seems to think it’s unfair, but until some very big rule changes come down, it’s really just good business.

The taxman and the union boss

Larry Summers, a former US Treasury Secretary, was quoted this week saying: “A combination of greater economic integration and more income accruing to intangibles like intellectual property, which by nature are hard to locate, does raise profound questions for the future of taxation.”

He is absolutely right, and if anything is underestimating the degree to which this shift has changed global supply chain strategies. Digitisation of economic value is so quickly replacing traditional material measurements like tonnes, bushels and barrels that tax authorities risk getting stuck behind the 21st century version of an impotent picket line. Just like unions, the taxman is learning that holding production assets hostage doesn’t work very well.

Apple, of course, is the ultimate proof point. Its products, which are in theory made by a contract manufacturer but in practice are produced in a deeply vertically integrated manufacturing and distribution network, are the equivalent of a gate fee at an amusement park. All the real economic value happens later when apps, voice and data stream pleasure to the consumer.

The economic value created by the Apple supply chain is in no way comparable to that of, say, a bicycle manufacturer. If we’re talking Schwinn bikes back in 1965, taxation is straightforward. Today, how exactly do you identify where to levy the tax?

The idea economy

It should be no surprise that the most visible targets of tax authorities’ ire are in idea intensive businesses. Pharmaceuticals and life sciences companies feature prominently, as do tech companies like Apple and Google and even brand-heavy companies like Burger King and Starbucks. All depend more on intellectual property embedded in their products than on big machines converting raw materials into basic consumables. As such, the nexus of power and logical place to take a fair tax is hazy at best.

This idea economy is also accelerating. Not only does IP move formlessly around the world in its creation phase, so too increasingly can it be “shipped” as finished product to customers as electrons rather than atoms. Our entire 2015 Leaders Forum theme is dedicated to this third industrial revolution and the business strategies to master the digital supply chain.

Self-provisioning capital equipment or home appliances, smart connected vehicles or buildings and even digital medicine are all realistic money makers in the near future. In the meantime, we’re all learning how to price and buy such digitised products on our smartphones and set-top boxes. The tide will not be reversed.

Supply chain and taxes

Which brings me back to taxes and global trade. In mid-2013 we surveyed 114 supply chain professionals to understand their approach to global trade management and found that, after product cost, the second most important reason to source internationally was tax savings.

Policy and fairness considerations aside, our job in supply chain is to enable the business to win and that means profit. Tax avoidance scores pretty high on our selection criteria for global sourcing locations, and for good reason. The differences between locations can be huge, and the receptivity of local, state and even national authorities to negotiated tax holidays or exemptions has proven amazing.

In fact, if as some commentators worry, tax authorities are in a “race to the bottom” on tax incentives, the worst thing you could do is sit on the sidelines.

I’m reluctant to recommend playing the tax shell game, but for supply chain leaders to do anything else under the rules now in force would be dumb.