The long dominance of the traditional centralised business operating model with a single global or regional hub location may be about to end. The continued move to digital operations, the onward march of online sales channels, the rise in state-imposed trade barriers, and the talent constraints brought about by Covid-19 are among the many reasons why businesses are reconsidering their operating models. There is also the need to increase supply chain resilience.
A multihub model can help build supply chain resilience and protect against tax risk
The centralised model has prevailed for so long because it offers big advantages. It reduces the duplication of effort and functions, and enables organisations to take advantage of incentives offered by jurisdictions seeking to attract global investment. Ireland has been particularly successful in this regard over the past two decades.
Now, however, the efficacy of the centralised model is being challenged by the ongoing OECD base erosion and profit shifting (BEPS) process. Among its aims has been the reduction in the centralised model’s tax advantages by focusing on transparency, substance and coherence. The result has been an increase in the cost and complexity of tax compliance for globalised organisations employing the centralised model. This, in turn, is driving them to locate their activity in larger economies.
The BEPS pillar 1 project will provide for a new means of attributing profit, while its pillar 2 project introduces a global minimum effective tax rate. Should both initiatives be fully actioned, they will further erode the tax advantages enjoyed by the centralised model.
A loose definition of a multihub model is that rather than employing a single, centralised structure, it locates high-value business functions in multiple countries. The multihub benefits include increased agility, the ability to tap into wider and deeper talent pools in different jurisdictions, closer proximity to customers, and a greater facility to customise goods and services to meet specific needs.
Furthermore, by adopting a fully distributed tax operating model to reflect the business operating model and spreading income in a more decentralised manner, an organisation may be better able to deal with future tax risk.
Indeed, from a tax and talent point of view, organisations may find themselves having to deploy a more significant number of people, functions and assets in certain countries to meet the economic substance requirements arising from BEPS. The multihub model lends itself to such actions.
Supply chain resilience
The fragility of highly complex global supply chains was exposed during the Covid-19 pandemic. Traditional just-in-time production models simply ground to a halt, resulting in global shortages of everything, from cars to kiwi fruit. The response has been to increase supply chain resilience by nearshoring or onshoring.
However, as organisations seek to reshape their supply chains, they must also be aware of the tax consequences, be it corporate tax, indirect tax, etc, as they shift substance across jurisdictions.
Moves by governments around the world to increase trade regulation is another factor driving decentralisation. For example, the UK’s exit from the EU has added a new layer of complexity to trade with that country, and companies may decide they need to establish an in-market UK presence.
At another level, regulations curbing the activities of overseas companies in certain markets may result in them having to establish operations with real substance in those territories that are deemed to be of sufficient value.
Latte isn’t just a milky coffee drink, it is also the acronym for local, authentic, traceable, transparent and ethical consumer products. Increasing demand for ethically sound goods is accelerating the drive to nearshoring and onshoring, and consequently the move to a multihub, decentralised business model.
It is not enough just to apply a label to a product to make it appeal to consumers who have ESG (environmental, social, governance) concerns. Businesses will also need to have the right people located in-market to customise products to meet local needs and preferences.
The efficacy of the centralised model is being challenged by the BEPS process
The fear of inadvertently increasing the effective tax rate paid has been one of the main obstacles to businesses adopting the decentralised model. However, the BEPS process will all but eliminate the potential cost difference, while the increased focus on the taxation of income from intangibles on the part of a number of major economies is further reducing the perceived tax advantages of the centralised model.
There are also concerns that the administration of a decentralised model may be more complex than traditional models, but arrangements can be put in place to eliminate that complexity.
That said, any organisation considering a switch to a decentralised model should carry out a thorough cost-benefit analysis and business risk assessment to ensure the benefits outweigh any potential increases in cost and complexity. While the model may not suit every organisation, and is more important in some industries than others, it is clear that many global businesses would benefit from the move.
The switch to a multihub model can help organisations build supply chain resilience while also protecting against future tax risk by enabling them to spread their income in a more decentralised manner. There are no predetermined rules for the adoption of a fully distributed tax operating model. Based on their individual needs, organisations need to make a choice about how many hubs they should have, what functions should be dispersed, and where they should be based.