Navigating the New Global Tax Landscape
The global tax landscape is changing faster than in any other period in history.
A plethora of evolving U.S. and global rules will affect multinational manufacturers. Global tax reform, the Biden administration’s proposed changes to U.S. international tax provisions, and ongoing shifts in trade policy will have significant implications for many manufacturers’ total tax liability and businesses.
Even manufacturers that do not have operations outside the U.S. or sell to customers abroad are inherently part of a global supply chain and may experience the downstream effects of these new rules
Navigating Tariffs
Although tariffs do not dominate news headlines as much as they did in years past, significant tariffs remain on many goods between the U.S. and most of its major trading partners, especially China. While the U.S. has made some progress in striking deals with close trading partners to eliminate normal duties, such as the United States-Mexico-Canada Agreement (USMCA), which replaces NAFTA, the Section 301 China tariffs and others may be around for a longer period.
The road ahead is full of uncertainty and will require manufacturers to monitor developing rules closely and proactively plan to effectively navigate new tax changes. The 2022 BDO Manufacturing CFO Outlook Survey polled 100 manufacturing CFOs to determine how they will react to the significant tax shifts on the horizon. Fifty-five percent of these respondents reported they have operations outside of the U.S.
Some manufacturers’ tariff mitigation plans for the next 12 months are overly ambitious. Nearly half (49%) of manufacturers say they will pursue tariff engineering. Tariff engineering is a term used to refer to altering the physical composition of an item to change its tariff code classification to one that attracts a lower duty rate. For example, tariff engineering could involve adding a plastic upper to a shoe that looks like leather instead of real leather. However, tariff engineering may not produce the savings they seek. Redesigning a product is a time - and resource – intensive process, and the savings that the lower duty rate provides may not be sufficient for manufacturers to recoup their investment for several years, by which time the original tariff rate may have changed in the country of import.
The impacts of the pandemic and other disruptions, including container shortages and shipping delays, should motivate nearly all companies to rethink their geographic footprint and sourcing strategy to improve supply chain agility, resilience and customer service levels. When planning geographical supply chain shifts, it’s important that manufacturers calculate their new duty rate if they switch sourcing to a different country. They should also make sure they thoroughly investigate and understand the customs rules for “substantial transformation” in determining the country of origin before making any decision to move production or sourcing from, e.g., China, to avoid the Section 301 tariffs. Historically, U.S. Customs has ruled against many importers since 2018, which moved production to countries like Mexico or Taiwan – only to find out that, for customs purposes, the country of origin was still China and the import was still subject to the 25% (or 7.5%, depending on the tariff classification code) duty.
Preparing For Global Tax Reform
Global tax reform is the result of several trends including globalization, digitization, the rise of new digital business models and calls to develop a fairer tax system within an accepted global framework. It represents a foundational change in taxation rights around the world and the largest adjustment to the global tax system in more than 100 years.
In October 2021, the OECD announced that 137 countries have reached agreement on the OECD’s two-pillar framework for global taxation, with a phased implementation approach planned for 2023 and 2024. U.S.-based multinational manufacturers should start to understand the impact of global tax reform on their business and develop a plan for how to best respond.
Companies’ plans and contingencies in response to global tax reform may be unwarranted, as many manufacturers will not qualify for either pillar of the framework. Their current plans would also likely cost more than the return on investment they would reap in lowering their total tax liability.
None of the surveyed manufacturers will meet the EUR 20 billion gross revenue qualifications for Pillar One, although some manufacturers may qualify for Pillar Two, which requires a company to have global gross revenue above EUR 750 million. While U.S. manufacturers that are in scope for either pillar may see their total tax liability increase, the investment needed to change their service delivery model would likely outweigh any savings they might receive. They should instead start with an analysis to understand the impact of global tax reform before making any operational changes.
BDO Insight
As we enter 2022, tariff mitigation is a top priority for manufacturers, but many overestimate the scale of change it requires. There are simpler strategies available to manufacturers for mitigating tariffs that they aren’t currently considering. For example, manufacturers can simply review their tariff codes to determine if they are correctly applying them to their imports. If they find they have been incorrectly classifying an item, they are eligible for immediate savings, and depending on the country in which they operate, retroactive refunds as well.
Manufacturers should also consider cost unbundling to lower their duty rate, which involves reducing the declared value of imported items. The customs value declared on imported items represents the taxable base on which duties and import taxes are calculated, so lowering the declared customs value will reduce a manufacturer’s tariff liability. However, manufacturers should note that customs valuation rules and transfer pricing rules are inversely correlated – as one increases, the other decreases. It’s important that manufacturers address these two areas in tandem when managing their total tax liability in order to optimize their position.
When it comes to global tax reform, manufacturers should similarly hold off making significant changes to their businesses. They should instead create scenario plans to determine the outcomes for the parts of their business that are subject to Pillar One or Pillar Two. Manufacturers should also monitor implementation of the framework by individual countries, as that will determine the degree to which the framework will affect their business. For example, if the U.S. stalls or fails to pass legislation to adopt the framework, it could influence the framework’s adoption elsewhere in the world.
Effectively navigating global tax reform — if it is enacted in the U.S. and globally — requires adopting a total tax mindset, which is a holistic approach to tax strategy. It is an understanding of and visibility into the sum of all the taxes a business owes at any point in time, not only at the international level, but also at the U.S. federal, state and local levels. Operating with a total tax mindset will enable manufacturers to make smarter business decisions than if they reacted to every new tax change individually. Every business decision has tax implications, and manufacturers that take this approach will be well-positioned to navigate the changes ahead.
Methodology
BDO’s 2022 Manufacturing CFO Outlook Survey polled 100 manufacturing industry CFOs with revenues ranging from $250 million to $3 billion in October 2021. The survey was conducted by Rabin Research Company, an independent marketing research firm, using Op4G’s panel of executives.
