Many multinational groups, particularly those operating in the digital economy, have made use of global supply chain structures as a way to manage their cross border operations, as well as to minimize their global effective tax rates. Global supply/value chain considerations are important for multinationals because their global profits are often driven by specific value drivers. Careful planning of these value drivers are essential to their survival and profitability.
The same is also true for businesses of IT entrepreneurs. A thorough understanding of the value drivers not only assists IT entrepreneurs to protect and enhance the values of their businesses, but a proper structuring can lead to significant cost savings without the risks associated with hiding or under reporting of income.
Although certain aspects of the tax planning structures adopted by multinationals such as Google and Amazon were considered too “aggressive” by tax administrations and other public interest organizations, much of the core practices (and their advantages) remain popular and viable. A simplified idea of the sorts of supply chain structures that continues to be popular is illustrated in Figure 1.
In this structure, the IT entrepreneurs would set up a company in another location (preferably a location such as Singapore, balancing commercial, cost as well as tax considerations). This company, also known as the principal, owns most of the important assets; performs the key functions and bears the significant risks of the IT entrepreneurs’ business. To the extent that these assets, functions and risks were with the IT entrepreneurs initially, they would have to be transferred to the principal company at market price. The IT entrepreneurs remain as shareholders/owners of the company but the company will run the business – it will also contract with the clients and carries out the business directly.
When a customer deals with the IT entrepreneurs that adopt this type of supply chain structure, contracts are entered into directly with the principal company, which also assumes the significant risks associated with this transaction. The principal company may contract also with the suppliers for support or other services it needs. As a result, when structured properly, the principal company earns most of the associated entrepreneurial profits, less any expenses for support and other services.
A tax optimum supply chain structure such as the one illustrated in Figure 1 relies on the internationally accepted standards (based on the arm’s length principle) where profits are attributed to group entities based on assets used, functions performed and risks assumed. As such, if key assets, functions and risks are centralized in a low tax environment, then profits related to the value chain would also follow, thereby reducing the overall effective tax rate of the business.
Such a centralization strategy has many commercial benefits, such as synergies, efficiency, better risk management, as well as the associated tax benefits. Although tax saving is one of the reasons for centralization, IT entrepreneurs that choose to do so often would also improve their pre-tax earnings as this approach allows them to lower costs through synergies and improved efficiency. Risks can be better managed through a central location by people who specialized in such functions. For these reasons, a tax effective supply chain structure has been popular and will remain so in the foreseeable future globally.
Singapore and Supply/Value Chain Structures
For IT entrepreneurs worldwide, Singapore is an interesting location for principal company in their global business. It offers not only a strategic location for access to the world market, modern and latest technology as well as the related IT infrastructure, it also offer skilled workforce who are able to manage the IT business for the entrepreneurs and provide related services that the IT entrepreneurs may need.
Figure 2 provides an example of how IT entrepreneurs based in the US or Australia make use of a supply chain structure with Singapore as the central principal company location.
What are the tax and associated benefits?
The IT entrepreneurs will carry out their business under this centralized structure using a principal company and a holding company, which are separate legal entities, based in Singapore. Carrying out IT businesses through such a structure instead of running the business and taking on the full risks personally has the effect of separating, and limiting, the legal liabilities of the IT entrepreneurs from those of the business (which will now be borne by the companies).
Further, the holding company is an investment vehicle that is separate from the principal company. This separation provides a range of legal, regulatory and commercial benefits for the IT entrepreneurs, particularly in anticipation of future expansion, sales or re-organization.
The structure also offers a range of tax benefits. Profits of the principal company would not be taxed in Singapore unless they are received in Singapore. These profits will also not be taxed in the home countries unless the IT entrepreneurs receive dividends from the Singaporean companies. Furthermore, the principal company would not be taxable in the countries where the customers are located. For example, a principal company that operates websites through which its customers can transact online does not have a taxable presence in the countries of the customers.
In terms of accessing the benefits of their success, this structure also offers IT entrepreneurs a range of flexible options. The IT entrepreneurs will be paid for the services they provide to the principal company and dividends may be distributed to them in their capacity as shareholders with minimal tax liability in Singapore (although such income would be taxable in their home countries). In addition, the holding company is able to sell shares in the principal company (and the IT business it operates) without any capital gains tax in Singapore.
Technical tax considerations
The effectiveness of this structure from a tax perspective depends to an extent on the taxation rules in the home countries. A properly structured company in Singapore with its own management and control would ensure that the company could not be treated as a resident of the home country. This is an important consideration particularly for IT entrepreneurs based in Australia, where a company that is incorporated in Singapore can still be considered an Australian company if the management and control of that company remains with the IT entrepreneurs in Australia. This issue is less relevant for IT entrepreneurs in the US, since a Singaporean incorporated company will not be considered a US resident under US tax rules.
In addition, an anti-avoidance rule, known as the controlled foreign company (CFC) rules in the countries of the IT entrepreneurs may seek to tax the profits in the Singaporean holding company and principal company before these Singaporean companies distribute their dividends to the IT entrepreneurs. This aspect has to be managed by relying on the exceptions that are provided for in CFC rules in the IT entrepreneurs’ home countries. For IT entrepreneurs in the US and Australia, income of the principal company would qualify for an exemption under the CFC rules in those countries as it earns income from active business.
Singapore taxes the income earned from the contracts with customers when the income is repatriated to Singapore. A certain amount would have to be repatriated to meet the operational costs of the Singaporean company – this amount, less any tax deductible expenses, would be taxable in Singapore.
Where existing assets, functions and risks were transferred from other locations (for example, from the IT entrepreneurs) to the Singaporean company, such transfers may be subject to tax. This usually dictates that the transferor would have to be compensated for the transfers in the same way that a third party would be compensated. The compensation would likely be taxable in the countries where the transferor is located. As a result of this consideration, it is often useful to anticipate the true value of the assets being transferred, and executing the transfer well before the anticipated growth.
All the support and other services that are performed by the service providers (including the IT entrepreneurs in their capacity as service providers, if any) for the principal company would have to be paid for based on the market price for such services. These fees are taxable to the service providers and are deductible against the profits of the principal company.
Withholding tax liability may arise from the service fees paid by the principal company to any non-Singaporean service providers. This withholding tax liability would need to be managed by relying on the tax treaties entered into by Singapore and the countries in which the service providers are located. When service fees are paid to the IT entrepreneurs in Australia, these fees would not be subject to withholding taxes in Singapore under the tax treaties. However, there is currently no tax treaty between the US and Singapore – to the extent that service fees are paid to US service providers, Singapore may impose a withholding tax on such service fees. Notably, however, no withholding tax is applicable if the service is performed wholly outside Singapore.
There is a risk that the principal company may become taxable in the countries in which the customers are located if it is found to have a taxable presence, known technically as a permanent establishment (PE), in those countries. When that is the case, profits that are attributable to the PE would become taxable in those countries. The PE risk of the principal company would have to be managed using the large network of Singaporean tax treaties, in order to secure the tax benefits of this centralized supply chain structure.
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