How Taxation Affects Your Global Sourcing Strategy

Date: January 13, 2015

How Taxation Affects Your Global Sourcing Strategy

Pay Attention to Import Duties and Taxes

Apart from governments taxation is an undeniable and significant part of global sourcing, and it is important to take this into account when planning your sourcing strategy. The import and export of goods outside local markets involves not just the transportation costs, but also the tax liability and compliance with international trade laws.

If you’re a company bent on selling a product to an end-user, one question you should be asking is whether you’d be willing to import a $10 power bank into China in a bulk order of 2,000 items, which can be sold at a 30% mark-up in digital shops. Discounting the import taxes and miscellaneous fees, the profit is attractive, but these factors can’t be overlooked and are inevitable; in fact, taxes can affect the global companies’ location in terms of expansion and sourcing decisions.

In this article, we’re going to explore more on how taxation can affect your decision-making process, whether to outsource products and labor onshore or offshore or practice a hybrid approach in global sourcing.

How global companies see taxes in the sourcing strategy

In a study entitled PWC report on Global Sourcing: Shifting Strategies, where 59 executives from eight global retail and consumer companies participated in the interviews, 46% of them consider tax optimization as part of the global sourcing strategy, while 61% measure their exposure to import duties and environmental and corporate taxes.

Apparently, 48% of them are not very confident that they are dealing with tax compliance correctly or are ignorant about it, yet to a very large extent tax costs are major factors in the buying decisions of these companies. The PWC report shows that most companies did not viewing taxes on a macro perspective.

Wolfgang Kersten wrote in Global Logistics Management: Sustainability, Quality, Risks that in the presence of taxes, a diverse domain is created where a company can find a realized profit in one country, but may have different value because of tax rates. So, it is important for company to pay more attention to the taxation system.

Three frictions based on Porter’s global strategy theory

In the Studies of International Taxes published by the National Bureau of Economic Research, three proposed categories of frictions are needed to understand the contributing factors of taxation.

  • Coupling frictions – these include, but are not limited to, technology constraints, shipment costs, corporate culture and the need to stay near the market
  • Country frictions – these include variables in facilities and infrastructure in each sourcing country, labor force, and political and financial systems as considerations, and proximity to markets
  • Coordination frictions – these include mechanisms such as transfer pricing or key-performance indicators needed to align everything in local planning and implementation. In short, it’s an opportunity cost where companies can use a mechanism related to the next best option without considering the differences in tax benefits.

When developing a digital product, for example, a particular intermediate part is perhaps unstable for transport or needs to pass an environmental test, which can be costly for the company. But what if a low-tax country can produce this intermediate part and they can also efficiently produce the entire digital product, though at a high cost?

As a result the coupling frictions (technology constraints) that are too costly would prevent them from locating any manufacturing company there, even though it’s a low-tax country. There are also coupling restrictions that include government laws to comply with, and companies may find them challenging to meet, such as high import duties.

Overall, just as taxation plays a major role in decision-making, companies, according to Porter’s premise, should decide first whether to concentrate on a few nations in global sourcing or go for diversification throughout many countries. 

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