Most businesses have been feeling the impact of supply chain disruptions on their operations and their ability to meet customer demand. But many of them have not evaluated its impact on their taxes, one of the major influences on a company’s bottom line.
Supply chain management affects tax planning strategies in several ways. Covid-19 demonstrated the importance of supply chain diversification; sourcing materials and goods from new suppliers and geographies, however, will have an immediate and direct impact on the company’s tax obligations. The taxation rules and available benefits in each state, country and locality should be carefully considered to ensure both compliance and optimal tax efficiency.
Multinational companies face transfer pricing challenges, as comparability and benchmarking data from normal times may need additional review with enhanced studies using longer timeframes. Reference data from previous adverse events may be helpful. Companies may benefit from reviewing their transfer pricing documentation process and intercompany agreements to find synergies in improving cost efficiency, conducting risk assessments, and maintaining reliable analysis and documentation of tax compliance in the event of tax audits.
Indirect taxes, including value-added tax and goods and services tax, are also affected by a modified supply chain because they are driven by the place of supply. Diversifying supply chains domestically requires businesses to consider whether their business activity creates physical presence or exceeds certain other state thresholds that establish a connection with the tax jurisdiction and impose sales and use tax, income tax or other reporting requirements. When making changes to domestic links in the supply chain, it is essential to perform nexus studies to determine state tax obligations.
Apart from pandemic-related supply chain issues, businesses have sustainability issues to consider when creating a tax-efficient supply chain. Many jurisdictions offer credits and rebates, among other tax incentives, for integrating sustainability into their supply chains. Business owners should ensure they are taking advantage of all applicable tax benefits and consistently considering new ways to make their link in the supply chain more sustainable.
At the same time, many jurisdictions are imposing penalties for supply chain practices that negatively affect the environment. Avoiding these penalties will require a significant investment of resources but may open additional tax incentive opportunities, particularly in the area of research and development credits.
Companies facing inflationary pressure and higher prices because of supply chain disruptions and higher freight costs may want to consider adopting the last-in, first-out inventory (LIFO) valuation method. Under LIFO, the most recently purchased inventory items are deducted first in computing taxable income, thus absorbing higher prices in the cost of goods sold and reducing taxable income for the current year. It is an income and tax deferral mechanism that can produce current tax savings that will reverse when prices decline and older lower-cost layers are removed from inventory.
Capital assets must be placed in service by the end of the year to take advantage of tax deductions, such as bonus depreciation and the Section 179 deduction under current U.S. tax law. Continuing supply chain disruption could threaten a business’s ability to take advantage of these tax benefits if the business cannot acquire machinery, equipment or components and place them into service by year’s end. 2022 is the final year for 100% bonus depreciation before it phases out with a 20% reduction each year from 2023 until 0% in 2027. Business owners may want to accelerate capital expenditures and review their procurement timeline for orders – both international and domestic components.
It is more important than ever for organizational tax departments to work closely with business operations and purchase officers to establish supply chain resilience, security, transparency and tax efficiency throughout the supply chain.
Shashi Singal, CPA, MSA, CA is a Partner at Grassi Advisors & Accountants and brings over 20 years of diversified tax and accounting experience to the firm. Her expertise lies in review of tax returns, research projects, tax planning and projections, international tax planning and compliance and assisting with mergers, acquisitions and corporate re-structuring. She can be reached at [email protected].