International Business Transactions and Taxation: Practical Guidance and Framework for Executives (Management for Professionals) 3031392396, 9783031392399

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Management for Professionals

Manuel C. Solbach

International Business Transactions and Taxation Practical Guidance and Framework for Executives

Management for Professionals

The Springer series “Management for Professionals” comprises high-level business and management books for executives, MBA students, and practice-oriented business researchers. The topics cover all themes relevant to businesses and the business ecosystem. The authors are experienced business professionals and renowned professors who combine scientific backgrounds, best practices, and entrepreneurial vision to provide powerful insights into achieving business excellence. The Series is SCOPUS-indexed.

Manuel C. Solbach

International Business Transactions and Taxation Practical Guidance and Framework for Executives

Manuel C. Solbach Wachenheim an der Weinstrasse, Germany

ISSN 2192-8096     ISSN 2192-810X (electronic) Management for Professionals ISBN 978-3-031-39239-9    ISBN 978-3-031-39240-5 (eBook) https://doi.org/10.1007/978-3-031-39240-5 © The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 This work is subject to copyright. All rights are solely and exclusively licensed by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors, and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, expressed or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. This Springer imprint is published by the registered company Springer Nature Switzerland AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland Paper in this product is recyclable.

To my wife Claudia, and our children Victoria, Saskia, and Frederik.

Foreword

The international community enforces new regulations in its intention to get to tax justice. One of the instruments OECD is encouraging to implement on national level in this field is the Base Erosion Profit Shifting (BEPS) Initiative. In its core, BEPS targets to a fair distribution of tax revenues to countries according to their level of value contribution. One aspect addresses the different types of international business transactions such as direct (export to third parties) business, merchandize business, and agency business. What sounds like a simple and meaningful concept with high ambitions, it is not that simple to execute. Where is what share of total value created? Who, meaning employees and thereby taxable entities create the value? How do you create awareness about this topic on national or even company level? Do individual employees always understand, which taxable entity they represent in the international value creation process? Do companies do enough in order to protect their people and themselves from infringement of tax laws? What about the increasing risks of double or even multiple taxation on a corporate or individual income tax level? Does everybody know how to play by the rules? As always with newly endorsed governmental regulations companies react in different ways and on different timelines. Big international and stock listed players most probably choose to move early and comprehensively in response of their investors to avoid any legal risk. It is clear that not only multinational enterprises and any other company with international business is affected, but it must be expected that also smaller companies will sooner or later appear on the radar of local tax authorities in light of increasing transparency through digitalization and the ever-increasing hunger of many governments for tax revenues. This book details out a pragmatic and “easy to digest” guidance to better understand and cope with the future compliant set up of any “International Business Transactions” by offering a wholistic, managerial view across the company’s value creation. One important focus area is to enhance sensitivity of management to radar for “tax-traps” especially in the international sales process, which can lead to significant legal and financial damage. Therefore, this book is recommended as guideline for practitioners and decision takers in any international business, specifically at the customer interface. It is based on long-term and in-depth knowledge on BEPS

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and vast experience of the author in successfully implementing adequate transactional models in a global leading multinational conglomerate. With BEPS being implemented across the globe, may globalization have seen its peak with the major powers China and the USA focusing on their home economies to become self-sustaining and Europe still looking for their position in this global game? And how do all three players deal with world’s challenges of reducing CO2 emissions, comply with climate targets, fair distribution of wealth, and any kind of forced migration? We do not have all the answers. But what we know is, that international trade will always be there, and so will be the desire of governments to maximize tax income. Heidelberg, Germany 28 June 2023

Dr. Markus S. Kramer

Preface

Developments on the taxation of enterprises operating internationally have been boosted by the OECD initiative on Base Erosion and Profit Shifting (“BEPS”) and have contributed to an increasing internal attention to tax compliance in the commercial activities especially of large enterprises, resulting in different routes of action. Major German companies have taken these developments as a starting point for the transformation of its international business transactions into a streamlined and globally standardized framework. Experiences and learnings of such a transformation project have been extracted from the specific content and form the foundation for the book “International Business Transactions and Taxation.” In today’s global economy, the role of multinational enterprises (MNEs) has increased dramatically since the mid-nineties. Governments need to and will continue to ensure that the taxable profits of MNEs are not artificially shifted out of their jurisdiction – and that the tax base reported by MNEs in their country reflects the economic activity undertaken therein. The OECD Transfer Pricing Guidelines already provides guidance on the application of the “arm’s length principle,” which is the international consensus on the valuation of crossborder transactions between associated enterprises.1 The BEPS framework adds to the existing guidelines to restore trust in domestic and international tax systems by ensuring governments act together. The tax value behind BEPS practices is estimated at 100–240 billion USD, which is in the magnitude of 4–10% of the global corporate income tax revenue. These amounts provide enough incentive for tax administrations to put efforts for capturing them not only from the large MNEs but also from small and midsized international players. Taxpayers, on the other hand, need to protect themselves from double taxation and limit the economic risks. While the book originates from an industry (manufacturing/distribution of goods) in a B2B background, the key ideas and concepts however can be transferred to services, finance, insurance, and other industries. Also, the focus is not on the physical flow of goods across borders, but rather on the complete commercial activities including sales efforts, contracts, and finally fiscal streams. The book targets experienced practitioners as well as young professionals with or without formal business education who work internationally and desire to gain a  See also: OECD Transfer Pricing Guidelines, 2022.

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wholistic perspective and understanding of the transactional concepts and its implications on the company’s freedom to operate, particularly with regard to the customer interface. The aim is to inspire the readers to think beyond the context of their own (often functionally dominated) experience, transfer the content of the book to their business situations, and initiate a critical reflection in their work environment to sensitize for compliance and thus reduction of commercially induced tax-risk. Not intended as a handbook, an umbrella is formed that will help to connect functional dots and facilitate detailed discussions in a contextual framework. Wachenheim an der Weinstrasse, Germany

Dr. Manuel C. Solbach

Acknowledgments

This book is the result of the firm conviction  to capture and further  built on the results of the intensive work of a great project team consisting of many experts all highly recognized in their fields. I had the honor to work with these experts in course of a major global transformation project on international business transactions. One of the main insights is that our key challenge was not so much access to the depth of the functional expertise. It was much more bringing the details and uncertainties into one consistent and jointly accepted picture as the basis for decisions and action: “International Business Transactions and Taxation” provides a managerial view to the topic including some functional details, but especially highlighting risk-imposed restrictions and laying out the options for compliant business transactions in the globalized world. Representing all team members and many other contributors to the project, I thank Dirk Hopmann, Christoph Ruppert, Dr. Klaus-Peter Krause, Schahin Schafiyha, Monika Bechtel, Andrea Hördt, Dr. Andreas Teiche, and Corinne Schlösser-Rinkel, for their intellectual stimulation and inspiration, passion, dedication, commitment, and loyalty to the project: especially the professionalism during our intense “rollercoaster” in the initial phase of the project when creating the consistent framework is highly respected and well-remembered. Special thanks go to Mirjam and Dr. Lothar Ende for their hospitality: I gratefully accepted the standing offer to stay in their cottage in the spectacular landscape of the alps multiple times to work on the book. The whole project would not have been possible without the uncompromised backing of my wife Claudia for the past decades and particularly her support for the book project. Most importantly and besides successfully pursuing an own career, you always ensured a memorable family-life. Thank you! Wachenheim an der Weinstrasse Germany/Hirschegg Austria 3 August 2023

Dr. Manuel C. Solbach

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About the Book

The book provides a comprehensive overview of choices to structure crossborder commercial activities with focus to the specific role and tasks of the functions within a company – and the way the results come together in one transaction. The basic options for transactional models are introduced and analyzed, particularly to what extent they trigger a tax risk to the enterprise. This is reviewed with the intention to create insight and thereby focus discussions within the organization to meaningful choices for action in this matter. In market-driven management with its commandment for customer-centricity today, most individuals and organizations are focused on the immediate market success closing the deal with the customer. The “backoffice” for conducting the transactions quite often is neglected, little known or left to operational transactional specialists. A key element in international business transactions for compliance is the distinct awareness of the role of commercial resources as agent, crossborder agent, or full representative of the seller. This differentiation will become the one underlying theme of the book. The first chapter will start with the background and reason (“Why”) by introducing the reader to the international tax environment, exploring the cornerstones of tax regulations, and building the connect between international taxation and the transactional model implemented. As transactional models typically have developed with the company and are part of the established routines, any change requires a strong trigger either in value creation or forced from outside. The OECD initiative of 2015 is such a trigger and changed the level of attention with regard to the taxation of international business transactions: “Permanent Establishments” (PE) are the risk at the horizon if international business transactions if not conducted in line with laws and regulations by all functions involved. While a PE can be officially maintained and managed, also a change in the transactional model is possible. The key elements and functions affected by such a change are introduced. In the second chapter, business strategy is explored with a focus on the market and distribution strategy which is then linked to the choice of transactional model. Markets are understood as industries, geographies, or socioeconomical segments and form the base for any transaction: strategy and transactional model need to be aligned. Furthermore, triggers for permanent establishments as one root cause for double taxation risks are reviewed in detail. The probability of such a trigger for a

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About the Book

permanent establishment must be considered in the choice of the transactional model to be implemented (“What?”). The three following chapters address the transactional models specifically and their implications to doing business across borders (“How”): Direct Business, Merchandize Business, and Agency Business. Each chapter is structured equally, starting with a general definition of the Transactional Model including variations of it to give a flavor of the complexity which is found in practice. This part is followed by a detailed discussion of the functional consideration for implementation. Particularly, the commercial functions will be reviewed, followed by the supporting functions Legal, Finances, Tax, Regulatory and Trade Control, Supply Chain Management, IT and Master Data, HR and Leadership. Each chapter closes with a synopsis of the implications for the vendor and the customer as well as a general conclusion. The final chapter summarizes key perspectives for choosing und running a specific transactional model. The need for switching the transactional model is discussed in a separate section, including potential triggers and directions for switching. Besides a synopsis of what needs to be done, an outline for the project setup for a successful transformation is provided. The chapter closes with Ten Commandments as key takeaways for the practitioner responsible for international commercial activities. The appendix offers a summary of the prominent but still not widely known case of Bosch Italy which stands as a monumental warning sign. It is showing how wrongdoing and especially repeated wrongdoing might destroy significantly more shareholder value to the company than the respective action with all its good intentions it initially creates. Based on practical experience, one potential challenge for a market practitioner diving into the topic will be to leave the market-focused perspective and embrace the more formal, legal entity-based view to follow the conclusions step-by-step. However, based on increased awareness and insight, the guidelines be easier to accept and so-called formalities to avoid damage to the company to be implemented – even if it is against the temptation to sell more and conclude a deal.

Contents

1

Introduction����������������������������������������������������������������������������������������������    1

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International Taxation and Transactional Models��������������������������������    5 OECD Triggers Attention to Transactional Models����������������������������������    5 First Approach to Transactional Models����������������������������������������������������    8 The “Phantom” of Permanent Establishments������������������������������������������   11 Managing a Permanent Establishment������������������������������������������������������   14 Changing Transactional Models����������������������������������������������������������������   15

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 Business Strategy and Transactional Models����������������������������������������   19 Market-Driven Business Strategy��������������������������������������������������������������   19 Synthesis: Triggers for Permanent Establishments������������������������������������   24 Permanent Establishments and Physical Distribution����������������������������   25 Permanent Establishments and Customer Acquisition��������������������������   25 Risk-Balanced Choice of Transactional Models����������������������������������������   27

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Direct Business ����������������������������������������������������������������������������������������   31 Definition ��������������������������������������������������������������������������������������������������   31 Basic Model ������������������������������������������������������������������������������������������   32 Variations of the Basic Direct Business Transactions����������������������������   33 Functional Considerations for Implementation ����������������������������������������   38 Business Management: Marketing and Sales����������������������������������������   38 Legal������������������������������������������������������������������������������������������������������   44 Finance and Taxes����������������������������������������������������������������������������������   45 Regulatory and Trade Control����������������������������������������������������������������   50 Supply Chain Management��������������������������������������������������������������������   51 IT and Master Data��������������������������������������������������������������������������������   52 HR and Leadership��������������������������������������������������������������������������������   53 Summary of Implications for Vendor and Customer ��������������������������������   54

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Merchandize Business�����������������������������������������������������������������������������   57 Definition ��������������������������������������������������������������������������������������������������   57 Basic Model ������������������������������������������������������������������������������������������   58 Variations of the Basic Merchandize Business Transactions����������������   59 Functional Considerations for Implementation ����������������������������������������   64

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Contents

Business Management: Marketing and Sales����������������������������������������   64 Legal������������������������������������������������������������������������������������������������������   68 Finance and Taxes����������������������������������������������������������������������������������   70 Regulatory and Trade Control����������������������������������������������������������������   79 Supply Chain Management��������������������������������������������������������������������   81 IT and Master Data��������������������������������������������������������������������������������   83 HR and Leadership��������������������������������������������������������������������������������   83 Summary of Implications for Vendor and Customer ��������������������������������   84 6

Agency Business ��������������������������������������������������������������������������������������   87 Definition ��������������������������������������������������������������������������������������������������   88 Basic Model: Internal Agents – Addressed by OECD BEPS����������������   88 Basic Model: External Agents ��������������������������������������������������������������   90 Variations of the Basic Agency Business Transactions��������������������������   92 Functional Considerations for Implementation ����������������������������������������   97 Business Management: Marketing and Sales����������������������������������������   98 HR and Leadership��������������������������������������������������������������������������������  100 Corporate Taxes at Principal and Agent������������������������������������������������  104 Remaining Functions Operate as in Direct Business����������������������������  104 Summary of Implications for Vendor and Customer ��������������������������������  108

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Conclusion������������������������������������������������������������������������������������������������  111 Choosing and Running Transactional Models ������������������������������������������  112 Switching Transactional Models����������������������������������������������������������������  114 Ten Commandments: Key Takeaways ������������������������������������������������������  119

Appendix: The Bosch Case������������������������������������������������������������������������������  121 Glossary������������������������������������������������������������������������������������������������������������  125 References and Further Reading��������������������������������������������������������������������  129

About the Author

Dr. Manuel C. Solbach is a business consultant, transformation manager, and author based in the Rhein-Main area in Germany. He is an experienced leader of transformation projects with indepth knowledge in the pharmaceutical and chemical industry. With over 25 years of international experience at leading players, he has built his track record focusing on customer value while maximizing internal efficiencies. His marketing and sales background is driven by the mindset that long-lasting relationships create mutual value for buyers and sellers. At a leading European chemical conglomerate, he co-lead a major transformation project which had a fundamental impact on the international business transactions of nearly all business units and legal entities of the company. In this book, he shares his insights, reviews learnings, and distills principles for the sector and the wider industry, which could be used as guiding principles in other transformation programs. Dr. Solbach studied Business Economics with focus on Strategy and Organization in Minneapolis, Minnesota (USA) and at the University of St. Gallen, Switzerland, where he also earned his PhD degree in Controlling. He has been teaching at the University of Applied Sciences Ludwigshafen for several years and is engaged as Corporate Assessor in the MBA program at the University of St. Gallen. Today he delivers transformation programs for clients in the B2B industry with focus on value creation through strategy, organizational leadership, and commercial impact.

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Abbreviations

B2B, B-t-B B2C, B-t-C BU CoC CtC DB DTA ERP Fx GDP ICTP MB MLI MNC, MNE OECD P/A PE SLA UN VAT VCLT

Business-to-Business Business-to-Customer Business Unit Cost of Capital Customer-to-Clear, Client-to-Clear Direct Business Double Taxation Agreement Enterprise Resource Planning (System) Foreign exchange, foreign currency Gross Domestic Product Intercompany Transfer Pricing Merchandize Business Multilateral Instrument Multinational Company, Multinational Enterprise Organization for Economic Cooperation and Development Principal-Agent Business Permanent Establishment Service Level Agreement United Nations Value-Added Tax Vienna Convention on the Law of Treaties

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Introduction

Business transactions are the base of every economic action. The way a society agrees to do business influences setup and prosperity of its economy. In the simplest and ancient way, a business transaction takes place between a seller and a buyer at the same time at the same place, typically by exchanging goods or services against each other or against money by providing a receipt thereof. This ancient, original desire of mankind for (international) trade has been codified in the ancient Code of Hammurabi more than 3500 years ago already.1 Business transactions today are intimately linked to business strategy, more specifically to the distribution strategy, which has become increasingly international, especially after World War II. Markets are globalized for a broader set of people in many regards: goods, services, travel, and vacation. World Bank figures document this in the increase in the export of goods and services from around 2 trillion in 1970 to around 24 trillion USD (constant 2015 USD) with increasing pace from the 1990s on and drawbacks following the economic crisis in the 2009 and the effects of the COVID-19 pandemic in 2020 (see Fig. 1.1). This development is equally  reflected in the export of goods and services as share the global GDP, which has been globally rising from around 13% in 1970 to 29% in 2021, showing the same drawbacks in 2009 and 2020 while being overall more volatile through the addition of the GDP development as denominator. The figures  – and especially the fast recovery in 2010 and 2021  – show how entangled global economy has become over the past 50 years. This status is very likely to persist on a high level for the next decade(s) even despite the current crises on almost all continents which fuel the insight for more autarky in the production of critical goods and technologies especially, but not only in Europe (Fig. 1.2).

 K.V. Nagarajan: The Code of Hammurabi, 2011.

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© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 M. C. Solbach, International Business Transactions and Taxation, Management for Professionals, https://doi.org/10.1007/978-3-031-39240-5_1

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22 20 18 16 14 12 10 8 6 4 2 0 1970

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Fig. 1.1  Export of goods and services in constant USD (2015). (World Bank https://data.worldbank.org/indicator/NE.EXP.GNFS.KD, 7. November 2022) %

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Fig. 1.2  Export of goods and services as share of GDP. (World Bank https://data.worldbank.org/ indicator/NE.EXP.GNFS.ZS, 7. November 2022)

In today’s economy, especially B2B transactions tend to be more sophisticated resulting from the choices of the vendors’ distribution (and customers’ sourcing) strategies: Buyer and seller may not be at the same location, even in different countries. Timing between transfer of goods or services and transfer of money (or equivalent) might deviate. Negotiations and the resulting contract may be agreed upon between parties in one country, and fulfillment of the contract might be in one or

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several other countries by other parties than the contracting parties, which they have formal or legal control over. Continuing this train of thought in separating the components of each transaction, one can easily end up with a complicated and often even complex network of parties in even only one transaction. In such a setup, transparency is at risk: for own managers and employees on the one hand and for authorities on the other hand. Especially, governments and tax administrations have been increasingly concerned with the effects of globalization in conjunction with the allocation of earnings of large corporations to low-tax countries. Business transactions are therefore closely related to taxation and thus tax justice or tax fairness. The choice of the transactional models determines how profits of international business transactions are allocated between the geographies and legislations involved. As a consequence, transactional models therefore determine the share of profit that will be taxed by the respective legislations.  Tax justice in general, and even more tax justice on an international level, can be judged from several points of view: consistency with international and national (tax) laws, economic development of countries and regions, industry- and business-­ wise and most importantly regarding a shared vision of global society: They are nothing more or less than a reflection of our global ethics and morale. Recent trends of migration clearly reflect where people see a prosperous future for themselves – and where not. So, “fair taxation” needs to be a compromise reflecting the holistic consideration of different interests. The OECD/G20 BEPS Project addressed these issues and developed fifteen actions published in 2015 “to equip governments with domestic and international rules and instruments to address tax avoidance, ensuring that profits are taxed where economic activities generating the profits are performed and where value is created.”2 As a result, international business transactions receive the attention of today’s globalized economy in a perspective that goes beyond quality, cost, product performance, and supply chain matters: The marketing and sales process becomes closely linked to the management of tax risk of companies operating internationally. Consequently, increased awareness for tax compliance in the implementation of commercial activities and high sensitivity to potential “tax-traps” is a must not only for the tax department, but especially for the international commercial manager today.

2   OECD (2022) BEPS Actions, https://www.oecd.org/tax/beps/beps-actions/. Accessed 27 Dec 2022.

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International Taxation and Transactional Models

Transactional models established in each specific company typically have developed with the company, the business, and their customers. Any desire for designing or changing them typically is rather low unless a benefit for the vendor or the customer arises. As a result, business practitioners and most commercially oriented business education normally do not spend too much time on them. The OECD initiative of 2015 changed that level of attention with regard to the taxation triggered by International Business Transactions: Definitions of “permanent establishments” (PE) have been revised and increase the risk of tax incompliance if international business transactions were not conducted in line with laws and regulations by all functions involved. Having identified such an imminent tax risk, company can pursue two routes: managing the permanent establishment or changing the transactional model. This Chapter explores the cornerstones of tax regulations and builds the connection between international taxation and the transactional model implemented.

OECD Triggers Attention to Transactional Models By the end of 2015, OECD endorsed by the G20 has issued a guideline called “BEPS” (“Base Erosion and Profit Shifting”).1 This guideline adds a new dimension driven by an increasing digital presence and its  value creation in the economy. Therefore it was initially intended to address the specific tax challenges of the digital economy. Main target is to ensure a continued fair tax base of a company for each country where value creation takes place by fighting the erosion of the tax base by the shifts of profits between countries within multinational enterprises (MNE).  See also OECD (2015) Guideline on Base Erosion and Profit Shifting, https://www.oecd.org/tax/ beps/, 2022-Jan-17. 1

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 M. C. Solbach, International Business Transactions and Taxation, Management for Professionals, https://doi.org/10.1007/978-3-031-39240-5_2

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OECD estimates the damage to  all countries and their  governments globally at about 100–240 billion USD in lost tax revenue annually.2 The BEPS document has been signed by 141 states and encourages, beyond the actual signees, OECD and non-OECD members to reflect this guideline ultimately into local law. Since then, the MLI as “vehicle” for fast implementation has been signed by 100 member states by November 10, 2022, plus three countries with the intention to sign (see Fig. 2.1).3 The graph displays jurisdictions’ participation in the convention of the MLI, differentiating between “in force” (the convention is in force in the jurisdiction), “Ratified / accepted/approved” (the jurisdiction has ratified, accepted or approved and deposited the convention at the OECD) or “signed” (the convention has been signed by the jurisdiction, domestic legal formalities still to apply for ratification). Furthermore, jurisdictions that “expressed interest to sign” are covered.

Fig. 2.1  OECD BEPS implementation as of November 10, 2022. (See OECD (2022) https:// www.oecd.org/tax/beps/, 2022-Nov-11)

 See OECD (2022) https://www.oecd.org/tax/beps/, Nov-11, 2022.  See OECD BEPS (2022), https://www.oecd.org/tax/beps/beps-mli-signatories-and-parties.pdf (Jan-17, 2022). The vehicle to speed up implementation is called MLI – Multilateral Instrument which marks a document at the OECD to be signed indicating the intention to implement BEPS into national law. It requires the law to be deposited at the OECD upon its national ratification. 2 3

OECD Triggers Attention to Transactional Models

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On the one hand, the BEPS guideline is also an answer to the previous tax competition between countries to boost their own economy.4 In this regard, a set of multinational companies responded to the opportunity and have structured themselves in a way to benefit significantly from it. While incentives for certain industries have been present also in previous decades (e.g., Puerto Rico as a tax haven for US-based pharmaceutical companies in the seventies and following decades), the magnitude of the effect has been significantly increased in the new millennium by the rising giants of the new economy. Driven by digitalization, geography does not matter as much as in other business models. Namely companies with rather “mobile” business models such as Google, Amazon, Meta/Facebook, Apple, and Microsoft (GAMAM) can more easily take advantage of such tax incentives than industrial companies relying on value creation based on structures of steel and brick and mortar. The huge fiscal potential of these few companies only can be estimated by their enterprise value and their outstanding weight in the economy.5 Their importance itself along with the importance of their respective industry for the tax generation for nations is obvious, particularly under the assumption of a further increasing weight of the “new economy” driven by digitalization and “Industry 4.0.” On the other hand, it has also been also well appreciated by several jurisdictions as another tool to repair their fiscal situation to some extent – as done in the years following the financial crisis 2007. While the OECD BEPS guideline overall has been designed to address specific adverse developments of the New Economy, BEPS Article 7 also touches the traditional economy: It refers to the principal–agent model used across national borders as a transactional setup, which scrutinizes the tax base of the goods-receiving country.6

 See Globalisation, capital mobility and tax competition: Theory and evidence for OECD countries, Bretschger, Hettich (2000) and Tax Havens in a World of Competing Countries, John D. Wilson (2014). 5  Combined enterprise value of GAMAM (Google, Amazon, Meta / Facebook, Apple, and Microsoft), June 2022: around 7 trillion USD = 7.000.000.000.000 USD = 7 * 1012 USD compared to around total market capitalization of the S&P 500 of around 30 trillion USD. See Statista https:// w w w. s t a t i s t a . c o m / t o p i c s / 4 2 1 3 / g o o g l e - a p p l e - fa c e b o o k - a m a z o n - a n d - m i c r o s o f t gafam/#dossierKeyfigures, 5. November 2022. 6  See OECD http://www.oecd.org/tax/beps/beps-actions/action7/ (2020-Oct-31; 2022-Jan-17): The BEPS Action Plan called for a review of the definition of a permanent establishment to prevent the use of certain common tax avoidance strategies used to circumvent the former model permanent establishment definition, such as arrangements through which taxpayers replace subsidiaries that traditionally acted as distributors by commissionnaire or agency arrangements, with a resulting shift of profits out of the jurisdiction where the sales took place without a substantive change in the functions performed in that jurisdiction. See: OECD/G20 Base Erosion and Profit Shifting Project: Preventing the Artificial Avoidance of Permanent Establishment Status ACTION 7: 2015 Final Report, https://www.oecd-ilibrary.org/docserver/9789264241220-en.pdf?expire s=1642423060&id=id&accname=guest&checksum=B0B58489E16953A43F496B433D418181, 2022-Jan-17. 4

8

2  International Taxation and Transactional Models

First Approach to Transactional Models OECD BEPS therefore moves crossborder transactional models up on the agenda of multinational enterprises. Over the past decades, shareholder value, strategy, efficiency, and market focus along with innovation and technology have dominated the agenda of the C-level. The organizational and transactional setup of many enterprises has been following the paradigms along those tunes – and so did management education and business practice. Business transactions were deeply buried in the “engine compartment” of the company with little awareness for the specifics and background that come along with the different models. Particularly, this effect becomes true in larger entities with a high degree of specialization of the functions. In the absence of better knowledge or acceptance of advice, organizational or individual decisions can be at risk to be taken against the guidelines of the transactional model being operated under. The result of such action (which typically resides in marketing or sales) is an increased tax risk, which can be significant to the cash flow of the enterprise.7 Consequently, the following chapters will show how different setups of international business transactions create a risk to tax compliance, especially by unconsciously forming permanent establishments. Transactional models are understood as a definition of the contractual relationships that companies do business with each other. The focus will be on transactional models across borders chosen by the vendor. Three key models will be described and analyzed with regard to their implications to business (see Fig. 2.2):

Fig. 2.2  General models for international business transactions

 See Appendix: “The Bosch Case” resulting in payment of Bosch to the Italian government of ~320 Mio. EUR. 7

First Approach to Transactional Models

• • • •

9

Direct Business Agency Business or Principal–Agent model (a variation of the Direct Business model) Merchandize Business

While the direct business model only involves vendor and customer (“direct”), the principal–agent and merchandize business model conceptually involve a third party in the role of agents and merchants respectively. The focus of the analysis shall be vendor-owned, vendor-controlled, or vendor-dependent agents and merchants, as these are explicitly defined in OECD BEPS Article 7 as a cause for permanent establishments. The other side of the relationship are models or setups chosen by a customer on the purchasing or supply chain side (purchasing or supply chain hubs as, e.g., established and continuously developed by Henkel in the Netherlands and Singapore opened in 2015/2016 or P&G in Geneva already in the 1990s).8 The motivation to establish hubs (as in the case of direct business model or principal–agent model) may be driven by different needs on both sides of the transaction. Quite often tax optimization is a strong motivator: allocating the generation of profits to legal entities based in lower-tax countries within the network of the enterprise. Historically, this may not have been the only concern. Large businesses along with limited or overly complex and thus expensive IT capacities or simply the centralization of control are equally important reasons for the existence of centralized transactional hubs today: • Control In a setting where any transaction is run through one single Enterprise Resource Planning system (ERP) that controls all incoming orders, prices, credit notes, inventories, and finally reporting to the most detailed level, the owner of this ERP is under final, present, and forward-looking control. Only under the direct business and principal–agent model, this  can be the principal  – and only in exceptional cases, but never as a standard the agent (= subsidiary). • Large Business Plus Limited IT Especially in large businesses with many business units, articles, products, or similar, a compromise needed to be found at times when IT even in the late 1990s was not as powerful as today. Timely full P&L reporting was only possible on an aggregate level of a subsidiary or a limited subset of BUs of a country – at the price of control and efficiency, as typically systems were not integrated. Alternatively, more detailed reporting was using even more time and resources, still at the price of very limited – and only hindsight – control. Centralizing all orders in one or few ERPs in hubs therefore was a very pragmatic answer to satisfy the increasing need for fast and detailed reporting along with control by creating transparency on transactions and inventories.

 See Mario Brück (2015), Henkel Life (2015) and FAZ.net (2016).

8

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2  International Taxation and Transactional Models

Vendor

Customer

Negotiation

Sales

Purchasing

Contract (fiscal / legal)

Invoicing Party: commercial transfer of ownership of goods

Buying Party: commercial receipt of goods / Sold-to

Goods

Manufacturing / Warehousing: physical transfer of goods

Plant / Warehouse: Physical Receipt of goods/ Ship-to

Legend:

Country 1

Country 2

Fig. 2.3  Elements of a generic crossborder transactional model

Many companies, especially in Europe, had chosen to operate under a principal– agent model internationally. As a result of OECD BEPS Article 7, they need to consider their transactional model to ensure future tax compliance. Three key dimensions form the cornerstones for the business transaction on both, the vendor’s and customer’s side (see Fig. 2.3) and need to be considered for setup and changes in business transactions: • Negotiation: who negotiates, who concludes, and who signs the deal – at which location, in which country? • Contract: which legal entity of each side enters the contract of the transaction, including the resulting obligations? • Goods: who sends and who receives the goods at the vendor’s and the customer’s side? This book synthesizes the basis for the different transactional models focusing on the following perspectives: • Industry (manufacturing/distribution of goods) in a B2B context rather than services, finance, insurance, etc. • Fiscal streams in combination with the flow of goods across a national border rather than solely product flows. • Entities within the legal or factual control of the enterprise (subsidiaries, dependent third parties).

The “Phantom” of Permanent Establishments

11

For simplification, the illustration of the transactional models will be primarily focused on one-business-unit companies acting consistently as a whole in different legislations.9

The “Phantom” of Permanent Establishments The choice of a suitable transactional model ensures a successful implementation of the marketing strategy in an effective and efficient approach to market. The output of a successful marketing strategy is  – for most enterprises  – shareholder value, resulting from current or future cash flows. While typical business measures for investors consider the pre-tax position, taxes are a reality that makes significant inroads into a company’s cash flow to (or better: from) the bank account. Needless to say that double taxation is to be avoided by all means. The idea of a permanent establishment as we know it today originates some 175 years ago. It is construct that gives the right to a jurisdiction to rise income or value-­ added tax.10 The OECD Model Tax Convention defines three basic types of permanent establishments (1–3), while the UN Model Tax Convention adds a fourth:11 1 . Fixed Place of Business PE (article 5 (1), e.g., manufacturing location). 2. Construction or Project PE, as a subset of the Fixed Place of Business PE (article 5 (3), e.g., construction of large projects such as power plants, bridges, and airports by foreign companies). 3. Agency PE, established by the actions of a dependent agent (article 5 (5–6), such as a legal entity or employees thereof acting as sales agents of a subsidiary of a foreign principal). 4. Service PE, specifically addressing taxation to the realities of developing countries.12  Enterprises with a setup of several business units might be able to defend an approach that differentiates specific transactional models per country for each business unit. While from a management perspective, such a setup principally can be run with some effort, the acceptance of such approach tax wise is with the authorities of the respective legislation. 10  According to Wikipedia, the concept of PE emerged in the German Empire as early as 1845, culminating with the German Double Taxation Act of 1909. Initially, the objective was to prevent double taxation between Prussian municipalities. In 1889, the first bilateral tax treaty, including the concept of PE, was concluded between the Austro-Hungarian Empire and Prussia, marking the first time the concept was used in international tax law. Even in 1928, the League of Nations developed a model to tackle crossborder double taxation and to counter tax evasion. Since then, an extensive network of bilateral tax treaties was gradually established, particularly through the influence of the OECD Model Tax Convention. See UN: Wikipedia: Permanent Establishment, https:// en.wikipedia.org/wiki/Permanent_establishment, 25. October 2019; UN Model Tax Convention (2011). 11   OECD (2014): Model Tax Convention on Income and Capital; UN: UN Model Tax Convention (2011). 12  In light of digitalization and more fragmented business structures, some countries such as Saudi Arabia have undertaken efforts to extend the concept even to a virtual service PE. 9

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2  International Taxation and Transactional Models

In focus here is the agency PE, which is closely related to business transactions of industrial companies. The activities of a dependent agent (i.e., under significant influence or control of the principal) may result in a PE for the principal. The legal entity, employees, or even others under the control of the principal may be considered dependent agent by the tax authorities of the agent country. However, a legal entity is not automatically considered an agent solely by the fact of ownership by the principal; it requires corresponding activities, e.g., in sales to form or extend a tax base in that country. Activities of an independent agent are generally not attributed to the principal and thus do not result in a PE of the principal.13 Agency business therefore still can be the transactional model of choice if criteria for dependency of the agent are not met. The criteria of the Fixed Place of Business PE are to be considered further if a Fixed Place of Business (owned or rented) forms a cornerstone in the enterprises’ distribution strategy and thus – beyond the model for the business transaction chosen – can be the trigger for a PE. The determination if a PE exists generally starts with a Fixed Place of Business. The commentary to the OECD Model Tax Convention indicates that the definition of a Fixed Place of Business consists of three key components:14 • Fixed defines the place of business to a specific geographic point along associated with permanence to the taxpayer. • Place of business defines facilities used by an enterprise for carrying out its business at the free disposal of the enterprise. In a simplified way, this can be translated as “having the key” to a building or site. For example, the regular use of a customer’s premises does not generally constitute a place of business. • Business of the enterprise must be carried on wholly or partly at the fixed place. Specifically, this includes as per the OECD Model Tax Convention the following, notwithstanding the requirements as listed above to be met: • Branch. • Warehouse (in general, but with further limitations, see section “Permanent establishments and physical distribution”). • Factory. • Mine or any other place of extraction of natural resources. • Place of management.

 “Independent” needs to be carefully analyzed: For example, an agent working exclusively or to the majority for the principal is at significant risk to be considered dependent, even if not owned by the principal. 14  OECD (2014): Model Tax Convention on Income and Capital. Commentary 4–7 to Article 5. 13

The “Phantom” of Permanent Establishments

13

In addition to this list, there are also places that are specifically excluded from the definition of permanent establishment under certain conditions referring to activities conducted at these places: • Ancillary or preparatory activities. • Use of a storage facility solely for delivery of goods to customers: • the exception explicitly excludes any repacking, modification, labeling, or similar. • Maintenance of a stock of goods owned by the enterprise solely for purposes of processing by another specific enterprise (e.g., tolling, consignment stock). • Purchasing or information-gathering activities. The criteria of what constitutes a PE within the scope of a specific treaty between countries depend on the perspective a country chooses regarding these terms. While this sounds easy, the implications for multinational enterprises are dramatic: If a jurisdiction places a different meaning or interpretation on the criteria leading to the conclusion that a permanent establishment exists, the dispute arising from this could only be solved in negotiations for a mutual agreement with the respective state.15 As a result, any guidance given by the OECD, advisors, or tax departments can only be indicative. It is important to highlight therefore at this point that the criteria that determine a permanent establishment are more closely and specifically defined in Double Taxation Agreements (DTA) between states. Those can (wholly or in parts with regard to specific topics) either be based on a broader, standardized treaty as provided by the OECD, or bilaterally be negotiated.16 International (or crossborder) business transactions by nature raise the interest of at least two tax authorities. It is their obligation to ensure the collection of taxes for their state to its best interest. Consequently, an appropriate tax base needs to be ensured. On the other side, multinational enterprises define this tax base in each of the two countries by the setup of their crossborder business transactions. This means an ongoing tax risk in both countries, as each country could potentially always try to argue that the tax base is too low. The criteria above determine whether a permanent establishment exists and whether a jurisdiction could refer to it. They thereby also set the framework for the transactional model with its guidelines and rules to comply with.

 The Vienna Convention on the Law of Treaties defines in Article 3 that no one is entitled to claim rights under a particular treaty unless otherwise authorized by the contracting state. 16  An important element of democratic jurisdiction here is the fact that typically a government will negotiate the DTA, a parliament or similar structure, however, will need to ratify it to transfer the DTA into local law. The MLI just “leap-frogs” the bilateral negotiation of the modification of the DTA and thus speeds up the process with regard to the international alignment only. 15

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2  International Taxation and Transactional Models

But there are choices: A transactional model suitable for the company can be established and operated. These choices might require structures and processes to be designed and potentially adjusted accordingly.

Managing a Permanent Establishment A subsidiary of an enterprise in the form of legal entity in another country typically becomes taxable with their income and other taxes, depending on the country of business. A permanent establishment, however, can appear in two shapes, which are more difficult to grasp: as a legal entity, a part thereof or even as a fully virtual construct defined by the tax authorities of the country. At this point, it is important to highlight that the PE in the context of this book is always a permanent establishment of a foreign legal entity in a specific country.17 A permanent establishment can be formed in two ways: either the tax authorities determine the existence, or the foreign legal entity declares a PE to the authorities. In both cases, the tax base for the country will be determined, independently of whether earnings have already been taxed in another country. Double taxation can only be avoided if a Double Taxation Agreement (DTA) specifies to rules of claiming back in the home country of the foreign legal entity. Clearly, a permanent establishment can be managed and thus be controlled if declared proactively. In some cases, declaring and managing a PE might be the preferred choice over other structural options. In that case, it needs to be considered that it affects two parties: • The foreign legal entity (or virtual construct) becoming taxable in the country of business. • The employees of the foreign legal entity becoming taxable with their income from the first day of presence in the country of business. Company’s interest with regard to double taxation topics and the reclaim of taxes can be managed with additional, but depending on size and infrastructure reasonable effort, even if not very convenient. On the employee side, the situation has a much deeper impact: Effectively, employees as business travelers of the foreign legal entity to the respective countries of business will need to pay taxes for the days of their presence in the country of business, which might be two or even more legislations: in their home country by definition of the local tax laws based on residence and employment contract, as well as in each country of business where a PE exists. In practice, this means that employees might be left with no or very little monthly income along with the burden of  Conceptually a PE could also be formed within one country depending on the tax system defining the authority to tax to geographic areas, e.g., in the United States of America with regard to Fderal and State Taxes on income, VAT, or other. This is more typical for federal, decentralized than for centralized nations. 17

Changing Transactional Models

15

filing income tax declarations in each country of their activity for claiming back taxes paid in excess based on the down payments or  – if existing  – the respective DTA: Needless to state that beyond the monthly cash situation, there is significant burden and cost associated with the filing of these returns and some potentially reluctance to disclose the personal financial situation broadly in a set of states. How relevant is this in practice, would anyone be affected? Yes, this situation would apply to anyone in management, marketing, or sales in a capacity with crossborder responsibilities and associated business travel, if a PE exists or is considered by the respective state to exist. It potentially also affects engineers or other employees in a Project PE setup. While the management of a PE initially seems to be an attractive choice for the enterprise, the implications of this decision need to be carefully considered also from an employee’s perspective.

Changing Transactional Models In regular operations, business typically is conducted on an “as-is” basis, being constantly optimized, and assessed for further opportunities and risks to be eliminated. Unavoidably, however, routines form and once practiced are seldomly questioned for consistency with the rules. As a matter of fact, those routines (as the “How?”) become the implicit organizational measure of “right or wrong” (to answer the “What?” or even the “Why?”). In contrast, a disruptive setting questions surface that are typically not brought up during a regular assessment. Frequently, it becomes visible that answers to these questions are not as unified across the organization as previously and implicitly assumed. Changing the transactional model of an enterprise is such a disruptive element. A change in the transactional model means changing the contracting parties of the transaction. This change is much more than just changing the letterhead of the invoicing (or ordering) party: It has implications in several functional backyards – mostly on both sides, vendor and customer. A broad range of functional areas need to be considered and analyzed for the following topics. • Commercial –– Account Managers will represent, act, or communicate for a different contracting party. –– This has an influence on how they can fulfill their role in negotiating, closing, and signing an agreement, potentially also geographically. –– The same might be mirrored on the customer’s side. –– Business might be at risk in some cases where customers operate in Free Trade Zones if a change in the transactional model triggers a disadvantage.

16

2  International Taxation and Transactional Models

• Legal –– Contracts need to be adjusted for the new contracting parties on both sides, the vendor and the customer. –– Different national law will apply. • Finance/Tax –– VAT implications need to be considered, particularly within the European Union. –– Currency (Fx) risk might be created or shift to the other party, along with the need to be newly agreed upon between vendor and customer. –– Financing need might arise on the customer’s side due to VAT effects. –– Financing need for the subsidiary on vendor’s side might change due to changes in payment terms and inventory requirements. –– Financing need for seller needs to be re-evaluated with potential impact on vendor’s consolidated cost of capital (CoC). –– An ICTP system might need to be established. • Regulatory: The legal entities in the commercial chain… –– … need to be equipped with the national rights to buy and sell the products. –– … need to have the permissions to handle the products physically, if required. • Supply Chain Management/Customs: The legal entities in the commercial chain… –– … need to have to permission and capability to import the products. –– … need to carry the import duties and potentially applicable excise taxes. –– … in some cases, even need to have the quotas to import the product. • IT/Master Data –– As contracting parties change, both legal entities of vendor and customer need to adjust their master data for the new contracting party and products associated with it. –– In some industries (automotive, pharmaceutical, food, feed), this might in many legislations already require new customer qualification documents. The specific setup of transactional models between two contracting parties (= often legal entities of conglomerates) alone may involve in one transaction alone up to six legal entities in up to six different countries (see Fig. 2.4) – whereas the flow of goods to/from a different location can even further expand this picture. This is one of the reasons why transparency on this network sometimes is difficult to create  – for employees of the customer and the vendor within the network and for authorities or the interested public outside the network. Not all variations of this picture can be considered in this book. The focus will be on the explanation of the underlying principles. In practice, topics need to be analyzed in each case at hand specifically. Along with the technical aspects, a change in the transactional model has significant impact on processes, the way of working together, the power matrix within the organization, reputation of specific positions  – in one word: company culture. Changing the business model landscape also implies a shift in company culture and

Changing Transactional Models

17

Vendor

Customer

Negotiation

Sales

Purchasing

Contract (fiscal / legal)

Invoicing Party: commercial transfer of ownership of goods

Buying Party: commercial receipt of goods / Sold-to

Goods

Manufacturing / Warehousing: physical transfer of goods

Plant / Warehouse: physical receipt of goods/ Ship-to

Legend:

Country 1

Country 4

Country 2

Country 5

Country 3

Country 6

Fig. 2.4  Transactional model involving six countries

becomes an intimate task for your leadership throughout the hierarchy across all functions and geographies. The following chapters take you on a journey to explore some of the most basic aspects of international business, any complexity arises from the combination of details and variances.

3

Business Strategy and Transactional Models

Strategy is the predominant topic for future value creation in the corporate world and thus also for investors. Ultimately, it refers to business strategy, namely market strategy: Markets are  understood as industries, geographies, or socioeconomical segments and their developments and conquest determine the success of enterprises. Markets are the base for any transaction. This is the point where strategy and transactional model connect. In line with the Chandler’s well-known “structure follows strategy”,1 transactional models as one component of enterprise´s structure must be chosen and run in line with the strategy. Under the assumption of compliance with national laws, manageable tax risks, and avoidance of double taxation in the long run, transactional models determine parts of these structures and processes for the distribution setup of an enterprise.

Market-Driven Business Strategy Business strategy finds its foundation in the markets the enterprise serves. While the satisfaction of customer needs is one key element, value creation for the shareholder often is the target. Besides corporate and other strategies (such as manufacturing, sourcing, supply chain, innovation, HR, or finance strategy), the marketing strategy is core to value creating by defining the market approach of the enterprise. Cornerstones are the definition of markets and business models on the one hand, the distribution approach along with the corresponding transactional models on the other hand.

 Alfred D. Chandler, 1962: remarkably based on studies on the development of General Motors, Standard, Oil of New Jersey, DuPont and Sears Roebuck in the 1920s. 1

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 M. C. Solbach, International Business Transactions and Taxation, Management for Professionals, https://doi.org/10.1007/978-3-031-39240-5_3

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3  Business Strategy and Transactional Models

Markets and Business Models A business model describes the underlying logic of how an enterprise, or any other organization invents, creates, delivers, and captures value in an economic, social, cultural, or other context.2 The process of business model construction and modification is referred to as business model innovation. Business models are typically part of the business strategy.3 More casually used, the term business model reflects in theory and practice a broad range of informal and formal representations as cornerstones of an enterprise including purpose, processes, target markets and target customers, product, and service offerings, and the required resources to fulfill those, such as infrastructure, organizational structures, trading, and distribution practices and policies. In a way, the term business model thereby is frequently used synonymously to business strategy. Used as a strong narrative, business models help to describe, cluster, and design companies especially with regard to their entrepreneurial element, strategy, and market approach. In a corporate setting within companies, the same applies for business units or customer segments. In that context managers often use business models to explore possibilities for future development, to some extent by transferring narratives of business models to their own environment. Widespread and well-­ accepted business models can thereby serve as powerful blueprints or recipes to substantiate own ideas or concepts.

Widely Known Examples for Business Models4

Over the years, business models have become much more sophisticated as strategies to explore markets and ensure the customer’s loyalty to the enterprise. The "tied products business model" was introduced in the late nineteenth century, supposedly by Rockefeller with giving away the lanterns for free and selling the most suitable oil to run them.5 The model also referred to as “bait and hook” involves offering a basic product at sold a very low price,

 Reference made to Wikipedia “Business Model” on October 25, 2019. Literature has provided very diverse interpretations and definitions of a business model. A systematic review and analysis of manager responses to a survey defines business models as “the design of organizational structures to enact a commercial opportunity.” 3  According to Wikipedia https://en.wikipedia.org/wiki/Business_model. Accessed December 27, 2022. 4  See also Wikipedia https://en.wikipedia.org/wiki/Business_model. Accessed December 27, 2022. 5  According to Wikipedia, Rockefeller’s Standard Oil company as part of their international expansion in the 1880s started selling oil-run lamps in China, using the name “Mei Foo”  – roughly translated as “reliable” or “beautiful confidence” for the company and for the lamps. While the lamps were produced by standard oil themselves and sold very inexpensively, marketing promoted the fact that they were run best with Standard Oil petroleum sold through the same channels as the lanterns. Until then, oil lamps had been run with vegetable oil by the common population consisting mostly of farmers. Wikipedia https://en.wikipedia.org/wiki/John_D._Rockefeller, October 25, 2019. 2

Market-Driven Business Strategy

21

often at a loss (the "bait"), then charging compensatory recurring amounts for refills or associated products or services (the "hook"). Examples: • • • •

Razor (bait) and blades (hook). Cell phones (bait) and airtime (hook). Computer printers (bait) and ink cartridge refills (hook). Cameras (bait) and prints (hook).

A variant of this model was also employed software developer Adobe distributing its document reader free of charge but charged several hundred dollars for its document writer, used by the creators of the documents. The following decades offered in almost each sector new business models reshaping industries: In the 1950s, new business models on the manufacturing side came from McDonald’s and Toyota. In the 1960s, innovators in distribution to end customers were Walmart and other supermarkets replacing smaller grocery and specialized stores, combining them into one self-service platform. The 1970s gave birth to business models from FedEx reshaping mail delivery, the 1980s from Blockbuster (redefining cinema), Bauhaus and Home Depot (redefining DIY), and Dell (customizing IT) and the 1990s started with a digital, net-based economy with companies like eBay and Amazon, but also Starbucks. Each entrant into the market brought a new approach to existing needs that have been satisfied differently before. Typically, the approach included a new technology, speed, and mostly convenience for the consumer.

Over the more recent decades, many new business models have relied on the use of progressing connectivity and digitalization globally. This enables enterprises to reach a larger number of customers at much lower cost. As a result, most of the advertising spend for example has shifted from print, radio, and TV to online media since the year 2000. The rise of globalization along with outsourcing, fragmentation, and specialization along the value chain has led to more complex business models and transactions, quite often even across companies, creating significant dependencies. This implies a need for more sophisticated and thus often complex supply chains and elaborated strategic sourcing to secure supplies. It also results multi-relational legal relations and contracting structures within and between enterprises. Distribution Strategy and Transactional Models The distribution strategy is part of the marketing strategy and comprises several choices for the structural and processual distribution setup. Decisions to be taken include the following:

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3  Business Strategy and Transactional Models

• Customer/market acquisition defining the sales function: distribution process, distribution channels (distribution of goods and acquisition of the customer at the at the point of sale (PoS) or directly to customers) and way of customer acquisition. • Physical distribution referring to the supply chain or logistics function: means for warehousing, transportation, and delivery. The way of implementations typically specified in the supply chain strategy. • Target customers as defined by the marketing function: geographical scope of distribution; socioeconomic or other segmentation. • Distribution partners. Often, several distribution channels exist side-by-side serving different customer segments. The direction for the implementation along with the definition of customer interface and customer relationship is determined in the distribution strategy. From a market-driven perspective, primary factors for the definition of the distribution strategy are typically product/solution- and customer-related:6 Product- or solution-related factors are based on their performance and properties delivered to the market: • How much explanation does the product/solution need? • Can the product/solution be stored? • Can the product/solution be transported? Most prominently, the needs of current and future customers must be considered in relation to the market offering for the choice of the appropriate distribution setup: • • • • •

Number and size of customers. Geographic spread/concentration of customers. Frequency of personal interaction. Frequency of transaction. Purchasing/procurement needs and habits (geography, time, preferred channels, preferred suppliers).7 • Customer segmentation. • Who reaches out to whom? Who physically visits whom? (customer to vendor or vendor to customer?). The result of these factors is the way how customer acquisition then needs to be organized and thus is closely linked to the setup of the sales function:

 Besides those market-related factors, also the competitive position (number and market position, customer interface, competitors’ distribution channels), company-related factors (vision, market position, capabilities and experience, financial power, size), and legal factors (e.g., regulatory aspects) need to be considered. 7  Particularly in the respect, B2B and B2C purchasing differentiates significantly regarding the needs and thus the factors that determine customer preferences to be considered in the customer interaction. 6

Market-Driven Business Strategy

23

• Direct sales (not to be confused with the transactional model “Direct Business”) in the sense of the distribution strategy is characterized by enterprise-owned structures, which might spread across several legal entities. It can further be designed around the way of interaction (personal/phone/email/e-commerce). With regards to the transactional models, the location of the point of interaction with the customer will be key for the assessment whether a permanent establishment exists or not. • Indirect sales is defined as a distribution chain through which the product, service, or solution is brought to the customer through channels not directly controlled by the enterprise acting as vendor. Typically, the product or service in this chain is not or only slightly modified or repacked. Most prominent example is the use of merchant or trading companies (“distributors”), which might even form a chain from producer over wholesaler over retailer to customer. With regards to the transactional models, the control of the vendor over the distributor (or agent, see below) is crucial for determining whether a permanent establishment exists or not. • Special or hybrid forms of sales include agency sales where the customer acquisition process of an enterprise is handed over to another party, and the fulfillment of the transaction, however, still resides with the enterprise acting as principal. Along with this, the whole capital risk of the transaction (product, inventory) remains with the enterprise as principal, while the agent is paid by a commission typically based on revenue. The agent transmits information from the enterprise (principal) to the customers and vice versa, thereby facilitating current and future business. Often, this might also be associated with technical advice, expertise, and relationship management. From a legal side, it needs to be highlighted that the agent is considered solely a messenger of the principal with no authority to negotiate business terms on behalf of the principal. With regards to the transactional models and the assessment of a permanent establishment, it is crucial to determine whether the agent is controlled by the enterprise acting as vendor (e.g., as in the case of a subsidiary) or dependent upon the vendor (e.g., by working exclusively for the vendor) – and whether he is factually acting the way an agent is supposed to act. In practice, only few companies still rely on a single-channel distribution today. Especially through the rise of e-commerce, direct sales facilitated by service providers and platforms has increased tremendously and is used besides the established distribution channel. Consequently, multi-channel distribution is becoming the predominant sales model today in many industries. A key challenge in practice of dealing with transactional models is to differentiate the similarities of technical language (in the sense of “meaning of words”) used by the tax and legal community for the structure of the transaction in accordance with the “arm’s length” principle versus the language used by Marketing, Sales, and Supply Chain functions as a rather management-based language: Practice shows that these similarities tend to cover that the meaning and ideas behind the words have different connotations, ideas, and implications in a lawyer’s head vs. a

24

3  Business Strategy and Transactional Models

marketer’s or sales person’s head.8 A continued dialog on transactional models between functions therefore typically requires very careful listening, asking, and clarifications initially. Transactional models then are part of the implementation of the distribution strategy, integrating the transactional view of customer acquisition with the transactional view of physical distribution. Along with the flow of goods or service delivery between legal entities, transactional models describe foremost the invoicing chains between legal entities: • Invoicing direct to customer –– Potentially in a logistical wholesale/retail structure within the domestic legal entity, or with a foreign subsidiary or partner. –– Within a country or across borders. • Invoicing through merchants as separate legal entities –– Of the same enterprise (subsidiaries) or external. –– Within a country or across borders. • Invoicing direct but using agents for customer acquisition –– Both with agents of the same enterprise (in subsidiaries) or external. –– Within a country or across borders. It is important to note the invoicing flow frequently deviates from the actual physical flow of goods and services as demanded by the needs of the supply chain of customer and vendor. In summary, in a market-driven enterprise, the commandment of market ranks on top of the factors defining enterprise success. Functions must follow and align as supporting units to reach the overarching targets as defined by the marketing strategy.9 Consequently, also the transactional model is defined through the market approach as defined in the marketing strategy or more particularly the distribution strategy.

Synthesis: Triggers for Permanent Establishments The target for the design of the transactional distribution setup needs to be the effective and efficient fulfillment of the marketing strategy’s objective in reaching out to the customer. In an international context, compliance  with the  tax regulations of several countries is the license to operate and create sustainable value to investors, doing this effieciently is a significant add-on. Previous sections addressed PEs in general and outlined the risk of the claim of permanent establishment by a foreign government. This section will focus the attention to the customer interface specifically as a potential source for such a claim.

 See the interview with Hans Maier, Senior Vice President Corporate Taxes and Tariffs of Robert Bosch GmbH. Beha, Sarah, 2019. 9  See also Herhausen and Schögel (2016); Day (1990, 1999). 8

Synthesis: Triggers for Permanent Establishments

25

With reference to the three types of permanent establishments specified in OECD Model Tax Convention, two of them are in focus (see also section “The phantom of permanent establishments”): • Fixed Place of Business PE. • Agency PE, established by the actions of a dependent agent being a legal entity or employees thereof acting as sales agents of a subsidiary of a foreign principal.

Permanent Establishments and Physical Distribution The legal entity of a subsidiary in fulfillment of its duties for the parent company is in primary scope of the authorities for tax collection.10 If there is no legal entity, tax authorities look for other opportunities to collect taxes. A strong indication for the Fixed Place of Business PE is relatively easy to identify as branch, warehouse, factory, mine, or place of management. Nevertheless, most of these settings typically are associated with a legal entity, especially when it comes to manufacturing or similar activities  – but what if there is none?  Offices and warehouse can also be rented by a foreign legal entity to be used for the target country. Maintaining a warehouse in the target country typically constitutes a Fixed Place of Business PE – but not necessarily: While it certainly is a fixed place according to the definitions, it is excluded from the definition of a PE under two basic conditions: • On the one hand, the use of the storage facility solely for transactional purposes, i.e., the delivery of goods to customers. This then must exclude any changes to the product or its packaging even including labelling. • On the other hand, keeping inventories owned by the enterprise solely for purposes of processing (“tolling”) by a third-party enterprise at the location the toller does not lead to a PE. This is always the case for consignment stock, but also particularly important with regard to own tolling activities. In this specific case, it refers to products under ownership of an enterprise being in the possession of and converted by a third party into another product and shipped back to the enterprise who owns the previous products and then converted products throughout the conversions process.

Permanent Establishments and Customer Acquisition Customer acquisition poses a particular risk to constitute a permanent establishment without having the intention of doing so. Particularly affected by this risk are all customer-facing functions of the enterprise entering the target country: sales, customer service, technical service, marketing, and sometimes also management if involved in customer-related activities. In the following, two cases in customer  Cases where a fixed place PE of the foreign parent company next to the local legal entity are established can be thought of, e.g., with regard to non-transactional business activities. 10

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3  Business Strategy and Transactional Models

acquisition as a potential source for a PE will be differentiated: agency PE as defined by the OECD BEPS initiative and a PE based on general customer acquisition activities. Agency PE Referring to customer acquisition strategies the model of using an agent to establish and maintain the contact to the customers of an enterprise has been described. In this model, the agent acts as messenger of the principal with no authority to negotiate on behalf of the principal. The OECD BEPS initiative considers in Action 7 sales activities of dependent agents as cause of a permanent establishment with all the consequences for taxation:11 The foreign enterprise as principal becomes taxable with the earnings resulting from a particular business transaction generated in this particular country while where agency business is being conducted – while paying taxes for the same earnings at the same time through the legal entity in the home country. Furthermore, business travelers from the principal visiting customers in the country of the PE now become taxable with their personal income from day one  of their travel to the country. According to BEPS, only dependent agents cause a PE of the foreign principal. Fully or majority owned subsidiaries of the principal need to be considered as dependent. A customer acquisition model using of fully owned or controlled subsidiaries and their employees as agents would therefore result in a PE of the principal. Also, the case of an agent where the principal has no or only a minority share needs to be analyzed in more depth: The agent would still be considered dependent if it could not continue his business without the principal’s share of business. In cases that result in a PE of the principal, there are few answers to continue business: Bite the bullet and take the additional burden of managing the PE including the significant hurdles to be managed; change to an independent agent; or change the transactional model to a direct or merchandize business model with the respective implications (see section “Switching transactional models”). PE Based on General Customer Acquisition Activities A widespread risk for a creating a permanent establishment resides in existing sales structures and sales processes of many multinational enterprises. The task of the sales function typically is customer and business acquisition or retention, sometimes also initiation or fulfillment of a specific transaction. Particularly for those countries where the direct business transactional model is used, the corridor to operate out of the principal’s country is very narrow and closely monitored in some jurisdictions.12 In Europe, especially Italy is also respected for a very tight fiscal control though the tax authorities and financial police including PE situations.13  See section “OECD triggers attention to transactional models”.  With regard to monitoring days of presence in a country (especially outside of the EU), digitalization, phones, and biometric data upon entry and exit of a country are tremendously helpful for the authorities to determine an exact count of days for each visitor to the country, adding it up to the total days for a specific enterprise. 11 12

Risk-Balanced Choice of Transactional Models

27

Independently of the transactional model, there is a set of watch-out areas for customer-­interfacing activities, here initially listed at a high level with further details and variations provided in the following Chaps. 4, 5, and 6: • Days of presence in a country conducting sales activities. • Contracts of legal entities signed by managers not authorized to sign for these legal entities. • Contracts concluded at a place outside the country the employee’s employment. • Customer service activities going beyond the transactional fulfillment of the contract, but into conclusion of additional contracts (e.g., in upselling). • Technical service (= optimization of runnability, adjustments, replacements) at the customer going commercial e.g., into preparing for new or additional b­ usiness or upselling, transferring technical results to other customers within or outside the country. While from a sales or commercial perspective all these activities are to be encouraged, they might put the enterprise at risk to constitute a PE of one of their legal entities in a country foreign to that respective legal entity. The key question for an international sales manager to his colleague from taxes is obvious: How are these criteria made operational in practice and where are thresholds for each jurisdiction? At this point, it is worthwhile to highlight that the final call for whether the conditions for a PE are met is with the tax authorities and sometimes even the specific auditor in the respective audit situation considering all circumstances. Ideally, it therefore requires workable set of guidelines that allows sales management to operate still with a focus on making the deal instead of following rules that vary between jurisdictions – irrespectively how detailed the rules for each country have been specified internally. In the absence of a setup guidelines, it requires the general understanding of potential pitfalls and watch-out areas to trigger timely clarification and specific risk management.

Risk-Balanced Choice of Transactional Models It is one of the key responsibilities of senior management of an enterprise to define and ensure structures and processes that allow employees to work in a legally compliant environment. The distribution strategy sets the requirements according to the customer and market needs. The business requirements typically include the desired standard for regular physical presence at the customer, including where, how, and by whom business negotiations, are being conducted. It also includes the choice of whether those activities are conducted by own employees of the enterprise or by third parties independent from the enterprise.

13

 See also The Bosch Case  in the Appendix.

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3  Business Strategy and Transactional Models

The choice of the transactional model defines the contracting legal entity of the vendor for the customer abroad and results in further key differences in the business transaction: • In the direct business model, the contracting partner of the customer is a legal entity of the enterprise (also referred to as principal) outside the country.14 • In the merchandize business model, the contracting partner of the customer is a legal entity of the enterprise typically within the same country, either a subsidiary or a third-party distributor, but potentially also in a third country different from customer’s or vendor’s country. • In the principal–agent model, the contracting partner of the customer is a legal entity of the vendor (often referred to as the principal) outside the country, exactly as in the direct business model. However, sales acquisition activities are conducted by an agent within the same country as the customer who is compensated by a commission. Only the commission forms the tax base in the country, not the profits from of the business conducted. In case the agent is dependent from the principal, it would constitute a permanent establishment according to OECD BEPS regulations. With the principal–agent model with dependent agents being sanctioned by the OECD BEPS regulations, the decision for building a new (or changing an existing agency business)  transactional model is between direct business and a merchandize business. Considerations need to include how market access can be gained under local law for the products and services in scope. Specifically, market access might relate to ownership structures of the subsidiary (foreign investors), licenses for the subsidiary to offer such products and services, product-related licenses or registrations, possibility of ownership of the respective licenses by foreign investors or locally-­ owned companies only, permission to handle or store certain products, import process, import duties and specific locale excise taxes, and potentially quotas for the import of products. Beyond those legal and regulatory aspects, requirements of the supply chain regarding local warehousing need to be met. Depending on the transactional model chosen (or forced into by the market and customer requirements as reflected in the distribution strategy), the efforts to run the model in a compliant way might be significant in some legislations or for specific product and services (Fig. 3.1).15 The topic typically becomes more complex with the size of an enterprise and its portfolio of customers, products and services. Furthermore, an increasing integration of an enterprise globally or regionally requires a consistent approach to the topic across the enterprise. This does not necessarily mean one single streamlined

 Direct business within a country is not considered as this is not relevant for the PE discussion.  Especially in the B2B area, such products frequently include dual-use products, health products, narcotics, food, and feed-related products. 14 15

Risk-Balanced Choice of Transactional Models

29

Fig. 3.1  Decision grid for transactional model

transactional model for all businesses; a differentiated approach along well-defined lines such as divisions or strategic business units can be considered to be implemented. A consistent and coherent overall approach, however, offers several advantages: On the one hand, it provides a consistent picture to stakeholders such as tax auditors within a country. On the other hand, a consistent and thus also  simpler approach allows employees to operate more efficiently. Especially in countries or entities with smaller structures  a “one transactional model approach” allows full and efficient representation of the overall enterprise by few employees. While one might argue that the risk for incompliance is rather theoretical and that the risk to be discovered and penalized is low, also the following needs to be considered: • The need of some government for tax revenues is steadily increasing. • Technical capabilities of the tax authorities and availability of data are increasing, driven by digitalization. • The bigger the company the more of a target this enterprise is. • Finally, penalties are high as they include the missed tax revenues of several years (up to 10 years) back plus a multiplier in addition to the fine. As a result, a decade of profit or more generated in the respective country might be lost. The following chapters will describe the implications, advantages, and disadvantages of each transactional model in detail to give guidance in the decision-making process. Each chapter will take the following key elements into consideration: • • • • •

Which legal entity sells from and to which country? Which legal entity buys in which country? Which legal entity receives the goods in which country? Who negotiates and by which legal entity are the persons employed? Who fulfills the transaction and what other tasks is the person entrusted with?

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3  Business Strategy and Transactional Models

Based on the answer to these questions, the risk for constituting a PE can be assessed and action taken accordingly. Potential action  – if necessary  – might include a change in transactional model, a change in the way to operate it or simply bear the risk. The choice of the transactional model is a commitment lasting several years – tax authorities will certainly be alerted if it is (frequently) changed.

4

Direct Business

Direct business (sometimes also referred to as export business) is for many companies the most efficient way to conduct crossborder transactions, especially if customer acquisition and retention do not require much presence in the country of the customer.1 This chapter provides a definition of the basic variances of the direct business model, followed by details regarding the implications for the activities and tasks of the functions of the vendor’s and customer’s enterprise in their respective legal entities. It closes with an overview of implications of the direct business model for the customer and for the vendor.

Definition Direct business as a crossborder transactional model describes the case of classic export business: a transaction of goods directly from the vendor in Country A to a customer in Country B. It offers the advantage to the vendor that he can build business with foreign customers from the comfort zone of the domestic legal framework he is familiar with. Customer acquisition might be facilitated by employees of the vendor’s legal entity based in (home) Country A or a third Country C (as “crossborder agent”); following international tax guidelines.  A  “permanent” (to be defined  based on

 This is largely simplified; more specifically, the country of the legal entity that finally is invoiced or that where negotiation takes place need to be considered. 1

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 M. C. Solbach, International Business Transactions and Taxation, Management for Professionals, https://doi.org/10.1007/978-3-031-39240-5_4

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4  Direct Business

duration and other factors) presence of an employee or a legal entity of the vendor in Country B (country of the customer invoiced) would be defined as permanent establishment. 2 Transaction focuses specifically on the parties involved in the legal and financial part of the transaction including negotiation, contracting, invoicing and payment. The physical flow of goods might deviate from this based on the internal supply chain setup of vendor (“shipped from”), but also of the customer (“shipped to”) with respect to the location of their legal entities for manufacturing involved.

Basic Model In the basic model for direct business, transactions include two countries with goods being sold from the vendor in Country A directly to a customer in Country B. The critical point of the transaction regarding tax risk refers to the financial transaction of invoicing and payment. The flow of goods follows the invoice from Country A to the Customer in Country B (Fig. 4.1). Also, customer acquisition follows this flow with sales personnel such as Account Manager operating from Country A into Country B. It will be explained later that the presence of the company for sales-related activities (such customer acquisition, negotiations and contracting, and customer retention) is limited to minimize the risk of constituting a permanent establishment.

Fig. 4.1  Flow model for crossborder direct business transactions [“Basic Case”]

 It is assumed that the legal entity serves a purpose and maintains offices and personnel serving the business in question. In large companies with a business unit structure, a different approach can be defended. 2

Definition

33

yes

Direct Business:

Variation 2

Direct Business:

Variation 3

Crossborder Agent Direct Business:

no

Direct Business:

Basic Case

Variation 1a Variation 1b Special Case

Sold-to = Ship-to

Sold-to ≠ Ship-to

Customer Sold-to & Ship-to Fig. 4.2  Generic Variations of the direct business transactional model

Attention also needs to be paid to customer service and technical service in the country of customer: Both functions must focus purely on the fulfillment of existing contracts and avoid everything that could create the impression of acquiring new contracts or additional business within an existing contract.

Variations of the Basic Direct Business Transactions Key variations of the basic model for direct business transactions commonly found in practice result typically from two dimensions (see Fig. 4.2): • The flow of goods deviates from the flow of invoices and money, originating from the vendor’s and/or the customer’s manufacturing setup (Variation 1 and Variation 3). • The customer acquisition process is conducted from a legal entity of the vendor based in a third country through so-called crossborder agents as defined by the structures of vendor’s sales organization (Variation 2 and Variation 3). Flow of Goods: Customer “Sold-to” and “Ship-to” On the dimension of the flow of goods, the deviation between the flow of goods and the flow of money might result from two facts: On the one hand, the buying legal entity of the customer (“sold-to” from the vendor’s perspective) might be situated in another country than the country or countries where the goods are used (“ship-to”

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4  Direct Business

from the vendor’s perspective). This fact has implications especially for the supply chain function with regard to the foreign trade (import/export) processing of goods. On the other hand, goods might be manufactured in legal entities in other countries than Country A of vendor’s legal entity selling the product (“sold-by” ≠ “ship-from”). Finally, cases can be combined and coexist in different combinations, thereby creating an even complex network of supply relationships, while the transactional financial relationship remains the same as a direct business transaction between Country A and Country B.3 The deviating flow of goods from the financial transaction needs to be backed-up by internal structures defining the ownership of the product on both sides, the vendor and the customer. Therefore, a secondary layer of financial transactions at both parties needs to ensure that the internal ownership (i.e., within the network of legal entities of buyer and seller) of goods is also defined for each stage of the process: At the vendor’s side, in case of a deviation of the legal selling entity from the manufacturing legal entity, the selling legal entity needs to buy the products from the manufacturing legal entity first in an internal transaction before selling them to the customer, independently from the customer’s location inside or outside country (Variation 1a, see Fig. 4.3). At the customer’s side, two cases need to be differentiated in case of shipment to another legal entity than the buying legal entity (Variation 1b):

Fig. 4.3 Direct business transactions  – variation of vendor’s manufacturing locations [“Variation 1a”]

 Further complexity arises in practice in case of multiple ship-to and ship-from locations, which are changing from transaction to transaction. 3

Definition

35

Fig. 4.4  Direct business transactions – variation of customer’s manufacturing locations A (“ship­to”) [“Variation 1b1”]

• Ownership of goods transfers to the manufacturing location’s legal entity between purchase and before delivery through an internal transaction (purchasing or procurement hub, see Fig. 4.4). • Alternatively, the customer operates a supply chain hub where ownership remains with the buying legal entity (in this case: Country B) and the manufacturing site (in this case placed as special case  even in the same country as the vendor’s manufacturing site, but could also  reside in any other third country) acts as a toller (see Fig. 4.5).4 In practice, one will find other combinations or even further variations of the variations shown here. The basic concepts, levers, and guidelines for action, however, remain the same and can be followed in the consistent rationale laid out in this Chapter. Customer Acquisition with Crossborder Agents A crossborder agent is defined as an employee of a legal entity of the vendor in a country that is not involved in the invoicing chain between the legal entities of vendor and customer. There are several reasons to engage in (or end up) such an organizational setup: • Serving markets that do not sustain dedicated resources financially (e.g., based on country size, target market presence in the country, and/or own business size) or do not allow permanent presence for legal reasons. • Responsibility of Account Manager  for an industry segment across several countries. • Key account management (multinational/global).  This differentiation is independent from the vendor’s transactional models and applies to the principal–agent and the merchandize businesses transaction equally. 4

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4  Direct Business

Fig. 4.5  Direct business transactions – variation of customer’s manufacturing locations B (“ship­to”) [“Variation 1b2”]

• Unique expertise of a person who is located in a third country and needs to serve a set of markets, or who is unable to relocate. Different to his colleague who is employed by the selling legal entity as vendor directly, the crossborder agent does not (legally) represent the vendor and therefore – same as the agent in the principal–agent model – can only act as a channel or medium between vendor and customer legal entity. This fact restricts his ability to close the contract directly by himself but act only as a messenger of the seller who is the principal in the transaction (see Fig. 4.6).5 While Fig. 4.6 (“Variation 2”) shows the base case for a crossborder agent situation on the side of the Vendor, Fig. 4.7 adds a further variation at the side of the customer “Variation 3”): • The purchaser is based in Country B  representing the buyer of of customer’s legal entity in Contry B. • The crossborder agent interacts with the purchaser in Country B, visiting from Country X, Y, or Z. • The contracting legal entity of the vendor is based in Country A. • The goods are received by the customer in Country C, D, E, shipped from the legal entity of the vendor in Country A.

 The possibility for a legal representation by an employee who is not employed by the legal entity in question can be reached by other means, e.g., by issuing a proxy. 5

Definition

37

Fig. 4.6  Direct business transactions – crossborder agents [“Variation 2”]

Fig. 4.7  Direct business transactions  – crossborder agents and ship-to outside sold-to country [“Variation 3”]

• The relationship between the customer’s legal entity in Country C, D, E and the contracting legal entity in Country B is backed up by an internal agreement at the customer about the ownership of goods. Depending on the internal setup of the customer, this is referred to as a purchasing hub or supply chain hub. Key element for the determination is with which legal entity the ownership of the goods resides.

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4  Direct Business

Functional Considerations for Implementation The direct business transactional model offers significant advantages to the vendor to keep administrative efforts on his side minimal. This advantage, however, comes with limitations especially for Marketing and Sales that need to be considered for a compliant setup, specifically not to expose the organization to an infringement of tax regulations and thus an (undesired) permanent establishment. Advantages and limitations of direct business transactions will be explored in this chapter, following those functions of the company, which are predominantly affected by the choice of transactional model: • • • • • • • •

Business Management: Marketing and Sales. Legal. Finance. Transactional Taxes and Duties. Regulatory and Trade Control. Supply Chain Management. IT. HR.

Business Management: Marketing and Sales Customer acquisition along with the negotiation, conclusion, and signature of the contract is the activity in focus with regard to the Marketing and Sales functions – and all other functions that engage in these activities. It is the responsibility and in the best interest of the vendor’s leadership to ensure organizational structures and processes that allow the most crucial functions activities of a market need-driven, customer-centric enterprise to act powerful and with confidence on legally safe grounds. Tax authorities in their audits will not only review the books of the seller’s entity – in the case of direct business transactions there are none in the country of the customer. The tax auditor will therefore also audit the procurement of the customers in the country – and ask questions. The key test for an initial assessment can be condensed to one sentence: “What will the Customer answer if asked by the authorities: Who sold you this product?” The key risk factors with respect to accidentally establishing a permanent establishment for the Marketing and Sales functions will be reviewed in this section:  “Presence in the country of the customer” including the special case of “crossborder agents” on the one hand, and “negotiations and contracting” including “conclusion and signature” on the other hand. The matter of so-called “umbrella framework contracts” is commented in the next section “Legal”. Presence in the Country of Customer Following the definition of a permanent establishment reviewed above, the “regular presence” of employees of the seller combined with selling activities constitutes a PE.

Functional Considerations for Implementation

39

The crucial part is the definition of “regular presence” along with the variety of levers, such as to purpose of the visit, by whom, how much total time spent, for what duration, or which frequency and over which period. The following section covers key criteria that authorities might consider for judgment on this matter. Purpose  The presence in the country for the purpose of sales-related activity leading to a contract, including negotiations, their preparation and the conclusion of the contract, is one strong indicator for a PE. However, the transactional execution of the contract itself (which might consist of many separate transactions over a longer period) would not be considered sales activity. Therefore, it is organizationally advisable not to combine these activities and even responsibilities in the role of one single person. The differentiation which presence in the country had been conducted for which particular purpose might not be followed by the authorities at a later point in time. Presence by Whom  Furthermore, a careful and defendable definition of “presence” is required: Who is present in the foreign country? As a PE refers to a legal entity of a foreign country, the organizational structures and responsibilities of the enterprise abroad might need to be considered, especially in the case of larger entities. Three common cases are briefly commented on: • The first case refers to a “one product line” enterprise integrated into one legal entity per country, leaving little room for interpretation, so here the judgment for presence by whom is relatively straightforward: Each person’s presence in the country is always attributed to that product line. • For the second case of a larger enterprise with legal entities that are set up separately for each product line, the answer can also be simple – as long as no organizational  synergies particularly in Marketing and Sales (e.g., by shared sales resources, joint sales channels or shared distribution) are captured: Each visit of the represesentative of the legal entity of the respective product line will be attributed to the commercial presence for that particular prodct line; other attributions will be difficult to argue and proof, especially if there in an overlap of customers as in the case of cross-selling. In such a situation of shared resources, a more detailed assessment to “presence” for the business operating under the direct business model needs to be given. Conclusions from this assessment can be disillusioning from a “common business sense” perspective, as joining forces between legal entities of the same enterprise might not be advisable if different transactional models have been implemented. • The third case of a larger enterprise operating under one or few legal entities per country with many product lines under one umbrella makes it more difficult to separate activities. Even if all product lines operate under the same transactional model, the use of synergies or sharing of resources might become a risk in this transactional model with regard to the time spent in the country. If different transactional models are used by the product lines, a differentiation becomes virtually impossible.

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4  Direct Business

Time, Duration, and Frequency  The total time spent is composed based on the number of days the employee from the seller spends in the buyer’s country, assuming he always engages in selling activities. However, as presence refers to “the business” the employees represent, authorities might be inclined to look not at the person as an individual, but also on the cumulative count of days of all persons from the seller representing this business in the buyer’s country. In some cases it had been argued that even vacation days of the persons during other visits in the country could be considered to the count. A counter-argument (to both concepts) would be that one visit of two persons for two days at the same time and the same customer would count for only two days instead of four, as “the business” was represented. So – what is the number?6 It has not been spelled out in the OECD BEPS guidelines – and it probably is not OECD’s task to do so. Across a wide set of legislations (and numerous  tax auditors and their assessments  within these legislations), the interpretation for defining “regular presence” unavoidably will result in different answers, e.g., based on consistency with existing laws or culture. Therefore, from a multi-country or global perspective, the number must naturally result in a range. Rigid legislations or countries with a focus on international tax situations (in their eyes tax revenue opportunities) might see a case for issuing a tax claim already at a single-digit number of days of presence with sales activity in the country; other with less focus on the topic (for whatever reasons  – enforcement capacity/capability, silent approval for economic or political reasons) might be more generous and tolerate a mid-double-digit number of days of presence – or even more. Period  “Frequent visits” – but throughout which period? A fiscal year, rolling 12 months, a quarter? In most industries and legislations, a rolling 12-month period is reasonable to be considered, as it is a good proxy in the absence of a legal entity that a fiscal year could be attributed to, covering the duration of a year.7 Along with the size of the company, typically also the complexity of structures increases and data of presence of employees in a country become more difficult to assess for complicated structures with shared resources turning into complexity, e.g., due to changes, restructuring, or reassignment of responsibilities. Also the sensitivity for data protection plays a role, e.g., if vacation days are to be counted equally as days of presence and would need to be recorded by the employer. These factors make structured measurement or even a qualitative assessment of “regular presence” or “frequent presence” difficult to impossible. In combination with a lack

 The duration triggering a permanent establishment also inducing a personal income tax for employees is different to the “183-dys-rule” of most DTAs, which determines permanent residence as trigger for personal income tax. 7  Exceptions from this could be argued for irregular but intense negotiations covering long contract periods covering several years as, e.g., some areas of the oil and gas industry. 6

Functional Considerations for Implementation

41

Fig. 4.8  Direct business crossborder transactions – crossborder agents

of clear guidance from tax authorities, the low-risk conclusion must follow these prerequisites for using the direct business model: • Infrequent and short sales activities are required in the country of the buyer. • Clear separation from sales activities vs. other tasks (like technical or transactional support at the buyer’s country) is possible. • Preferably no other (sales and other) resources from the same legal entity of seller are active in the country of the buyer. Even a different business unit with the same business model and considering all other circumstances of the enterprise needs to be argued for with credibility at the tax authorities. Special Case: Crossborder Agents Crossborder agents in the sense of the direct business transactional model are employees of a legal entity (based on another country than A or B) of the same enterprise as the seller (based in Country A) who engage in the customer acquisition at the buyer (based in Country B). Figure 4.8 recaps the context. As crossborder agents are not employed by and do not (legally) represent the seller (who will become the contracting party), the assessment of the risk to constitute a PE of the seller or of  their employer  is more differentiated. This also allows more degrees of freedom in some regards.8 As a result different guideline sapply for crossborder agents compared to a representative employee of the seller in direct business:  Although it might be perceived by the customer and the crossborder agent this way, it remains crucial that agents only act as messengers for the principal; otherwise, the risk of creating a PE significantly increases. 8

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• Rules on “presence in country” are relaxed to mid- to high double-digit number of days per period [ otherwise risk of PE for legal entity of both, seller and employer in third country]. • Only possible if crossborder agent’s employer does not maintain direct business relationships in Country B [ otherwise risk of PE for legal entity of employer in third country]. • No authority to negotiate, conclude, or sign, as they do not represent the seller [ risk of PE for legal entity of both, seller and employer in third country]. • Authority only as a messenger of the seller as the principal to pass on and receive messages to/from the buyer, messages specific or in predefined ranges (e.g., prices). [ otherwise risk of PE for legal entity of seller in third country]. In a conceptually simple setting constituted by few individuals, few products, few crossborder business transactions, or similar, a combination of a crossborder agent and a representative employee of the seller in a direct business transactional model could be managed. With increasing complexity or increasing need for frequent and intense interaction with individual customers or the market in a specific country, the risk giving hints to establishing a PE rises significantly.  Especially cross- and upselling activities increase the risk to create a PE substantially. Negotiations and Contracting Negotiations and the conclusion of a contract are the nucleus and final target of all sales-related activity: It is about the DEAL. In terms of the perspective of transactional business models, two phases need to be strictly separated: preparation, closing, and signature on the one hand and fulfillment on the other hand. While fulfillment of the transaction without any changes to the contract (such as prices, total quantity, and kind of product or service) is less burdened with risk of constituting a permanent establishment, anything in the process up to signature needs to be conducted diligently by representatives of the contracting parties. In the basic case of the direct business transactional model, an employee of the legal entity of the seller visits the buyer abroad and negotiates the deal – within the limits of the restrictions given by presence in the country as shown above. Key element is the representation of the legal entity of the seller in the negotiation with the power to enter into an agreement, conclude the deal, and finally have a contract signed which puts the legal entity of the seller into rights and obligations (Fig. 4.9).9 Conclusion and Signature With regard to the conclusion and signature of the contract, tax representatives might take the position that the location of the conclusion of the contract defines a

 Internal authorizations of the seller for the signature of contracts do not have an influence as the focus is on the conclusion of the agreement. For seller’s internal policy, however, they need to be considered. 9

Functional Considerations for Implementation

43

Fig. 4.9  Generic flow model for direct business crossborder transactions

permanent establishment at this  specific  location  – as shown in the following examples: • Account Manager as employee of seller signs contract at (foreign) location of buyer. • Account Manager as employee of seller concludes contract by phone (or email) in country of buyer, e.g., after the visit at the airport. • Account Manager as employee of seller concludes contract by phone (or email) in third country, e.g., during travel  to  another customer  in another country  or while working offsite in another country.10 • Account Manager as crossborder agent and not employee of seller signs contract at location of buyer or anywhere else. These cases might look awkward and academic at first sight but exist in reality. As a single incidence, the potential harm seems negligible: As part of a tax prosecution, they might form the bigger picture against the interest of the enterprises and in favor for the tax authorities. While location and timing of the conclusion (when has a deal really been reached and when is it final?) are more difficult to defined, the timing of the signature of a contract is very clear und thus also the location can be more easily determined and through the signee’s digital footprint principally be proofed. It is therefore advisable

 With increased working flexibility for emplyees following the COVID-19 pandemic, further risks surface: the emloyee of a German based seller negotiating, concluding and potentially even signing a direct business contract with an Spanish (and potentially also with a third country) customer during his winter stay in Mallorca, Spain increases the risk to constitute a PE of the German company in Spain. 10

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for the direct business transactional model to ensure signature in the country or even at the location of the seller. In summary, there are several potential triggers for constituting of permanent establishment by chance through lack of knowledge or ignorance in the customer acquisition process: • Presence in country. • Negotiation without legal authority (role as representative of the contracting party). • Location of conclusion of contract. • Location of signature of contract. For ending this review on Business Management: Marketing and Sales, one additional key point to remember is the following: permanent establishment means not only corporate taxes, but also individual income taxes of the employees travelling to the buyer’s country – with all consequences to be born on the personal level of the (customer-facing) employee.

Legal The direct business transactional model offers several advantages for the seller, as the contract and its conditions typically are governed under the jurisdiction of the seller’s residence or registered address, unless agreed upon differently. Depending on the structures of the company, this familiarity also goes along with further synergies in handling of contracts and transactions. Besides the commercial laws and rulings of the transaction itself, this fact also makes a case for any liability claims based on product or application of the product, as well as against the company for any other claim. Cornerstones of each transactional relationship are the contracting parties. From a legal point of view, it needs to be ensured that the transaction is conducted (i.e., negotiated, signed, and fulfilled) in line with the internal setup of the contracting parties. The implications of the direct business transactional model on the contracting process, including conclusion and signature, have been explained in the previous chapter. Key point is that an employee may only negotiate, conclude, and sign for the legal entity of own employment; alternatively, employees could also act with a proxy of this legal entity. It therefore must be noticeably clear, which legal entity enters a contract that will be base for the transaction. Special Case: Umbrella and Framework Contracts

Frequently “umbrella contracts” or “framework contracts” allow other legal entities of the buyer’s and seller’s enterprise to enter business with each other under predefined conditions. From a seller’s perspective, this is typically also the case when negotiating with supply chain or procurement hubs. From the

Functional Considerations for Implementation

45

perspective of transactional business models, this does not generate legal or tax exposure in general under certain key conditions: 1. The contracting parties do not change, buyer and seller remain the same legal entities who have negotiated the deal (while ship-to/ship-from entities may vary). 2. The contracting parties do not contractually oblige other parties of their own enterprise (without their respective indication as parties joining the contract at a later point). Independently of any obligation, other entities of the respective enterprises of seller and buyer may agree based on their own decision to use the terms negotiated in that particular contract also for their purposes.11 Through  the governance of each enterprise, global contracts can still be enforced to be concluded between local legal entities. In that sense, the framework contract then becomes a blueprint for other agreements between legal entities of seller and buyer.

Finance and Taxes In the areas of finance, the following topics need to be considered in the direct transaction with customers’ abroad: • • • • • •

Terms of payment. Credit risk management and security mechanisms. Foreign currency risk. Invoicing. Cost of capital (CoC) and related financing. Transactional taxes and duties.

Terms of Payment Payment terms typically are part of the negotiation and can in most cases be determined freely between vendor and customer. They consist of a whole array of elements regarding the financial part of the transaction (such as way and modality of payment,12 due date for payment or term of credit, prompt cash discounts and rebates, and finally the transfer of title). In the direct business transaction, the applicable law for these factors is typically governed by the residence of the seller.

 The question of global contracting is independent from the choice of transactional model but becomes crucial in key account management (global or multinational). 12  Bank details, cash, full or partly prepayment, credits, central payments, and more. 11

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Starting point for payment terms with regard to the due date of the invoice depends on the transfer of ownership of the goods as determined by the Incoterms agreed upon by the parties.13 For goods shipped under the terms of the “C-group,” payment terms usually start when the product leaves the warehouse of the vendor: The transfer of risk and ownership triggers invoicing, and only the commercial ownership transfers to the customer at this time. In most cases, legal ownership only transfers after payment of the invoice (retention of title). The term of credit given to the buyer requires attention: In some countries, government has restricted the right of free negotiation of payment terms broadly or for specific industry sectors and has limited the maximum term of credit to be granted by the seller. Under the spirit of free trade internationally, this regulation can only restrict legal entities of the same country  – anything else would be an obstacle imposed by one country to free trade. Therefore in case of a direct business transaction, such a local restriction usually cannot apply to the parties, as the seller resides abroad. As it refers to the financial part of the transaction, it must be noted that this is the case independently of where the goods ship-to or ship-from.14 Credit Risk Management and Security Mechanisms Credit risk management is essential in any business transaction and not limited to crossborder activities. When doing business abroad, additions to this risk surface. The general del credere (= credit) risk is mostly accompanied by currency risk and specific country risk. A huge advantage to the seller in a direct business transaction is the domestic jurisdiction (see section “Legal”). Still, the credit risk is with the vendor’s legal entity as the selling party. In a business and especially in MNEs that operate with terms of credit as part of their payment terms, an assessment and mitigation, or conscious decision for taking the risk is state of the art. There are several ways to handle these risks proactively: • • • • •

Diligent assessment of the contracting party of the customer. Assessment of overall credit risk portfolio. Mitigation through insurance. Mitigation through documentary business. Mitigation through cash-in-advance.

Assuming no local presence of the enterprise in customers’ country (as per the nature of direct business transactions), sources to judge the credit risk of a customer are as follows:

 For a summary, see Wikipedia with Reference to the new Incoterms 2020, effective as of January 01, 2020, and as primary source ICC International Chamber of Commerce: Incoterms 2020. 14  A special case is the ship-from to be in the same country of the buyer’s purchasing entity, which might result in the legal entity of the ship-from (if manufacturing or warehousing unit) to be the sold-to party due to local laws. 13

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Functional Considerations for Implementation

Customer Credit

Risk Seller

Cash in advance

Buyer

Factoring

Bank, private institution, fully or in parts Bank, private institution, fully or in parts Bank or Government

Reverse Factoring Letter of Credit

Cost Cost of capital accounted for at Seller Cost of capital accounted for at Buyer Seller Buyer typically Seller

Fig. 4.10  Credit risk mitigation

• Reports of credit rating agencies. • Client-specific report of a credit rating agency. • Information generated by the enterprise internally (research, market information). The result of the risk assessment determines the course of action for the business, especially whether mitigation measures need to be taken. Most ways to mitigate the risk result in additional cost to the transaction, either to the seller at the vendor’s side or to the buyer at the customer’s side. These costs go along with a shift of risk between buyer and seller or to a third party (see Fig. 4.10).15 Ways to mitigate credit risk internationally depend on the respective legislation of seller and buyer. The mechanisms vary in cost, timing of receipt of money (at due date or before), and party issuing the security or bail. With regard to export business, documentary payment modes give assurance to both, seller and buyer, at the price of a transaction fee to banks or other (financial) institutions. Effectively banks handle documents representing the goods and essential for clearing of the goods at customs against payment to the bank. Payment will only be forwarded under agreed upon conditions regarding the goods (receipt, condition). Common forms of documentary business are letter of credit or collection against documents. Furthermore, banks also offer services for the guaranteed collection of money such as factoring (initiated by the vendor) or reverse factoring schemes as initiated by the customer, often also associated with payment terms to ensure timely payment to the seller. All other forms of payment leave the risk with either the seller (terms of credit) or the buyer (advance payment, prepayment, deposit, or down payment) and are referred to as non-documentary or clean payment modes.

15

 See also Kouvelis and Xu (2021).

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International credit risk can also be covered by export credit insurances. These insurances are privately or sometimes also publicly available. Like Fx-hedging (to secure currency risk), insurance for certain countries might not be available on the private market. In these cases, sometime public guarantees or insurance is available, which have been put in place politically driven. 16 Foreign Currency Risk Management of foreign currency (Fx) risk is a factor with immediate and dynamic impact on both, P&L and cash flow. Key decision in any export business therefore is about the invoicing currency. In the direct business transaction, this decision can principally be taken between the following: • Currency of the seller’s country. • Currency of the buyer’s country. • Third country currency of choice by seller or buyer, e.g., driven by the currency of their consolidated financial report or their currency exposure on a consolidated level.17 A real choice only exists if the jurisdiction of seller’s and/or buyer’s country permit invoicing or receiving invoices in foreign currency. Obviously, both parties will try to keep currency risk at a minimum. At first sight, preferred invoicing currency chosen by the seller will be the currency of the country of his residence, while the buyer will have corresponding preferences for the currency of his residence. So, currency becomes a part of the negotiation way to resolve these conflicts of interest. If the seller can negotiate his preferred currency as invoicing currency, his currency risk is eliminated. In all other cases, decision needs to be made whether to bear or mitigate the risk. One common way to mitigate currency risk is Fx hedging, which is available at banks for most currencies against a fee. For direct business transactions, invoicing in the currency of the seller is widespread in many businesses.18 Merchandize business transactions might leave fewer choices based on local legal requirements; section “Finance and Taxes” will provide a closer look to the management of currency risk and specifically hedging.

 In Germany, for example, public guarantees (e.g., “Hermes-Bürgschaften”) support especially also small- and mid-sized companies to enter into transactions with companies even in high-risk countries. 17  The currency exposure depends also on overall revenues and obligations of the respective company. This can be raw material purchases or markets the final product is sold to. For example, an export-oriented shoe manufacturer in Indonesia is likely to prefer to pay raw materials in USD (instead in local currency), as his revenues will also be largely in USD. 18  Deviations from this might be caused, e.g., by a general practice in the industry for trading certain goods like crude oil or gas being commonly traded in USD. 16

Functional Considerations for Implementation

49

Invoicing The creation of the invoice in the ERP and the physical or electronic creation of the document including the submission to the customer need to be considered in the setup of the vendor. It needs to be ensured that the invoice is issued by the contracting party following legal and tax requirements of seller’s and buyer’s legislation. In case of direct business transactions, the requirements for the seller – compared to invoices within the same country – to meet the requirements of a buyer abroad vary from country to country and must be matched. Services such as e-billing, self-­ invoicing, electronic invoicing (e.g., via EDIFACT), invoices per email or pdf might not meet formal requirements for transmission of the countries involved. Therefore, direct business transactions in some cases need to revert to paper-printed invoices. Particularly, VAT needs to be considered: While export invoices would conceptually not include VAT, further consideration needs to be taken in cases where the flow of goods deviates from the flow of invoices, e.g., if the goods remain within the country while the financial transaction is a direct sale to a foreign customer.19 Also, formal requirements for B2B business within the European Union apply. Direct business transactions do not require any specific setup of the process itself for issuing the crossborder invoices. External service providers or internal Shared Service Centers can be used for this purpose as for non-crossborder (= within the country) transactions, even if they are located offshore. Cost of Capital and Financing Cost of capital driven by the choice of transactional model touches accounts receivables and inventories, so current asset or working capital positions. Both, accounts receivables and inventories, are driven by the agreement between seller and buyer on the Incoterm to be applied, as this defines the transfer of ownership and risk. On the seller’s side, transfer of (commercial) ownership triggers invoicing and thus a switch from inventories to accounts receivables, thus increasing the value of working capital by the margin of the transaction. Accounts receivables, however, will only be converted into cash upon payment, normally around the due date of the invoice. The sale itself therefore principally changes the financing position of the seller by changing the proportion of the balance sheet, the transactional model along with the result of the negotiations over payments term and Incoterms determines, when this happens. Compared to transactions within the same country, payment terms with extended due dates are not uncommon depending on the location of the buyer. This reflects to transfer time until goods reach the buyer (shipment, customs clearance, local transport), which is particularly the case if “C-group” Incoterms are used.20 This  VAT is a complex topic with many shades; thus, the reference is to the basic concept only. Within the European Union and other economic areas, specific regulations apply. 20  The alternative to use “D-group” Incoterms delays the transfer of ownership to a later point, thereby keeping — compared to accounts receivables — lower-valued inventories on the balance sheet; however, also the risk for these goods in transit remains with the seller, while at the same time also the time between manufacturing and return of cash is extended compared to a local business. 19

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situation potentially triggers a financing need for the seller (compared to local transactions) and therefore requires special attention, particularly when export business is expanding significantly under direct business transactions. Transactional Taxes and Duties Transactional taxes and duties affect both sides, import and export, and need to be considered equally from a seller’s and a buyer’s perspective again: • Value-added tax. • Excise duties. • Special taxes upon import in certain countries. VAT has been referenced before in the invoicing section of this chapter. Excise duties apply to the use of product. Examples particularly applicable to B2B transaction include packaging tax, mineral oil tax, or even banking tax applied to each transaction, as e.g. in the case of Argentina. In direct business transactions, the taxpayer for excise duties in the foreign country is principally the buyer, not the seller outside the tax regulation. The same logic applies to any taxes or duties on imports. As with VAT, the physical flow of goods and the flow of invoices need to be considered by country to identify tax liabilities.

Regulatory and Trade Control Regulatory and Trade Control topics are essential to market and/or handle the products in a specific jurisdiction, ensuring the proper licenses. Generally, it is differentiated between company licenses and product licenses. Company licenses refer to the legal entity, e.g., to import, handle, market, or use the products. Those need to be carried by the importer of the goods, which in direct busines is the customer in the foreign country. The logic applies to the basic case in which the flow of goods is the same as the flow of invoice. If the flow of goods deviates from this way, any legal entity associated with the product flow needs to be evaluated, which licenses it needs to be equipped with. Product licenses refer to the product itself, e.g., whether the product is permissible to be marketed or used in the country at all. Typical examples include food or pharma products, dual-use products, and sometimes software or technology components. It also applies to any potential import restrictions, e.g., on quantities in general or from certain geographies as defined by the local trade law. Exceptions from this can be found in Free Trade Zones in general or – mostly associated with these zones – specifically regarding products used for conversion, followed by an export of a value-added product. For the case of direct business transactions, the topic straightforward: Seller is not part of the jurisdiction, so any company licenses do not apply for them, but for the buyer only. Regarding product licenses, it needs to be made sure that the product is registered in the target country. Depending in the jurisdiction, this can be initiated by either the seller or the buyer, who is then becoming the license holder with the corresponding implications.

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Supply Chain Management The tasks for Supply Chain Management for direct business transactions typically span across the following areas: • Order entry. • Order fulfillment. • Logistics: transport and warehousing. A brief description will help to create a picture of the specific tasks above: Order entry is considered the first transactional step after closing the business deal. Cornerstones for this step include the capture of customer, product, quantity, price, delivery location, desired delivery time, and delivery conditions, also referred to as Incoterms. Order fulfillment allocates product to the order and ensures availability from stock or directly from production. Transport refers to the organization and booking of the transport as agreed upon with the customer, while warehousing is rather a conceptual matter of the general supply chain infrastructure than of the transactional model per se. Crucial step for transactional models with regard to a potential PE risk is the order entry along with the consideration whether it is purely transactional or associated with sales activity.21 In a direct business transaction, order entry can happen at three places: • Country of Seller: Order entry in the country of the seller is not a concern for a PE. • 3rd Country: In a setup where services are shared between legal entities of the vendor or even located in a centralized Shared Service Center, the location of the order entry (along with the employees) might be outside of the country of the buyer and the seller. Again, risks for accidentally constituting (and identifying/ successfully proving) a PE can be considered low like the crossborder agent situation in sales, especially when strictly limited to transactional activities only. • Country of Buyer: Order entry might be allocated to the country of the buyer for several reasons (beyond the potentially accidental location of a Shared Service Center for these tasks in this country): language, geographical or cultural proximity to the buyer, time zone, or specific expertise. Risks for accidentally constituting a PE need to be considered but can be avoided when strictly limiting all activities to transactional services only.22 Along with the order, the supply chain process ensures that all documentation for transport, export, and import are available at the time and place needed – which is specific to the country and the means of transportation.  Purely transactional activities including even the warehousing PE are explicitly excluded by OECD BEPS; see section “Synthesis: Triggers for permanent establishments” and OECD Guideline on Base Erosion and Profit Shifting, Action 7. 22  A frequent risk for customer service to constitute a PE with the order entry task is a deviation from the pure transactional service to sales-related activities like upselling. 21

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Another key element in the order is the Incoterm used for the shipment of the product to the buyer in the other country:23 As the importer of goods typically is (in many cases: must be) a resident in the country of import, it is the buyer who formally imports the goods and holds the required licenses. Agreement on payment of duties, however, can be differing from the formal importer: The seller may take over or pay directly the duties if, e.g., DDP (=delivered duty paid) is agreed upon  – although the buyer formally imports the goods. Finally, matters of process design for the invoicing chain within the vendor and transactional models to be used frequently are part of the tasks for Supply Chain Management. In the direct business setup, these tasks are very similar to the tasks also performed for transactions within the country of the seller. Key differences include the following: • • • •

Special attention to customer service to focus on transactional tasks. Transportation requirements along with documentation for export. Potentially different Incoterms. Potentially warehousing in country of buyer.

IT and Master Data The IT function serves the transactions by providing the necessary technological infrastructure to enable them. Basic requirements are process- and workflow-­ oriented and based on the respective requirements. Besides conducting the transaction by itself, requirements include reporting and documentation for external purposes (audits for taxes, certifications like ISO 9000, compliance with laws and regulations) and internal purposes (e.g., controlling and management of business, inventories, cash, and HR). For a company that is already set up to handle export business to the respective country of the buyer, technically no additional requirements for crossborder transactions are to be considered for most countries.24 For a company that has conducted business only within its own country, there are a few additional requirements to be satisfied by the IT structures as compared to a transaction within the country of the seller. The degree of desired automation as defined by the IT strategy and direction of the enterprise in this matter determine the scope of the adjustments: ERP and master data for product and customer can be

 The Incoterm defines key elements of the transfer such as transfer of ownership, transfer of title, allocation of freight cost, and payment of duties. See section “Finance and Taxes” and further references there. 24  However, specific documentation requirements of the receiving country might demand specific processes to be reflected in the IT landscape, if automated. 23

Functional Considerations for Implementation

53

equipped and structured in a way to allow an efficient handling of the requirements, especially in the following functional areas: • • • •

Finance (e.g., VAT). Supply chain. Foreign trade (e.g., export statistics, generation of reports). Trade control (e.g., automatic block for sanctioned products).

Depending on size and complexity of the enterprise and on the number of transactions in total, not every aspect of the direct business transaction needs to be integrated into the existing IT landscape, but potentially can also be handled manually in a more efficient way. In this case the integration of manually conducted activities into following automated process steps must be secured. On the matter of master data, direct business transactions are the most straightforward setup: Master data repository is required only in (or for) one ERP system of the seller, as there are no other entities of the seller involved. The structure of the business of the seller itself drives in the end the structure and potential complexity of the structure of their master data, i.e., when operating different transactional models for different business lines in the same country at the same customer.

HR and Leadership At first sight, the direct business transactional model does not affect HR with any specific topics. However, topics to be considered falling under the responsibility of or support by the HR function mostly relate to the customer-interfacing functions and include the following: • Providing platform and process for education and training to ensure PE compliant activities and actions implemented by the customer-facing personnel. • In case a system of permanent establishments is part of the distribution setup of the vendor, management of the income tax-related topics is required to protect the company and the employee from not paying taxes owed and the consequences thereof. If PEs are established by intention of the company, HR needs to provide respective tools to manage the income tax determination and payment in each country for the employees and support for the annual reconciliation between various tax obligations for each employee. This might also include a solution to bridge employees’ “cash gap” by being taxed in several countries. • In case permanent establishments are to be avoided, but direct business transactions still to be managed, HR might choose to support leadership either by providing comprehensive travel monitoring tools to allow for steering sales presence or by ensuring leadership is equipped to modify their sales structure or manage it on a qualitative basis (“leadership enablement”). Monitoring of business travelers to customer-related activities in a direct business transaction setup typically ends in a controversial discussion as it becomes a two-edged sword: On the one hand, it provides measurable data by monitoring days

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of presence in a specific country. With an increasing size of the company, typically also the complexity of structures increases, and the data become difficult to assess, e.g., due to changes, restructuring or reassignment of responsibilities. As lined out in at the beginning of the chapter, “frequent presence” as a term allows for a range of interpretation, which potentially spans over several tax periods. Therefore, hard actual numbers would be measured against a more qualitative guidance regarding presence. On the other hand, these data are also accessible to auditing authorities and provide hard facts on cases, which in the absence of data are more difficult to discuss: Such data might then be helpful for tax auditors to define a precise, rigid line what “frequent presence” means and how it could be measured and applied to support their view for tax collection.

Summary of Implications for Vendor and Customer The summary of the direct business transactional model focuses on selected key factors of the model. Depending on the industry and the specific setup, the weight of these factors might shift, or others might need to be added. Vendor Direct business transactions allow most degrees of freedom for shaping business transactions to own needs. The synopsis reveals why conceptually it is very much favored by enterprises when acting as vendors: • Generally, no requirement to maintain any installations in the country of the customer along with all consequences, especially continuing to operate under a familiar legal framework. • Credit terms can be more freely negotiated. • Currency risk limited; default setting is own currency. Negotiations offer full freedom to choose (currency of own country, of customer’s country or third country). • Invoicing based on home countries legislation. • No VAT to be charged to the customer (with specific regulations for the European Union): favorable for customer cash wise. • Export regulations only referring to own country’s legislation, e.g., on dual use, weapons, and other sensitive products. • No concerns about import of products – licenses and process managed by the customer. • Warehousing and logistics component potentially to be addressed with the help of external service providers. • Customer interfacing activities to be orchestrated diligently in order not to establish a PE by chance in customer’s country. • Option to voluntarily declare and manage a PE.

Summary of Implications for Vendor and Customer

55

Customer For the customer, the following implications go along with a direct business transaction: • Applicable law for the transaction might not be the law of the residence of the buyer, but rather of the seller or another international place as agreed upon by the parties. • Potential to negotiate advantages through extended payment terms also outside of the regulations of the home country (e.g., Spain – limited to 60 days).25 • Currency risk typically resides with the customer as invoicing is from a company outside the country. This can also play to the customer’s however favor when working in an export-oriented industry, meaning that majority of goods manufactured from the products bought is being exported (in the same currency as the one used for procurement). • Company license required for importing/buying, selling, or converting specific products (dual use, pharma, food, feed, electronics, etc.) • Product registrations remain in own possession – potential for competition by supplier or other domestic players can be managed. • Import process managed by buyer if the goods are brought into the same country as the customer’s buying enterprise (ship-to = sold-to): –– Import licenses. –– Handling of products licenses including storage facilities. –– Regulations for the import of specific products. –– Acquisition and management of quotas on the import of goods, if applicable. • Import duties, as applicable and agreed in Incoterms, such as follows: –– Import turnover tax. –– Custom tariffs. –– Specific excise duties (such as mineral oil tax or packaging tax). • VAT of the seller’s country typically is not to be paid, import duties instead. General Advantages of or preferences for one or the other transactional model depend on the industry, structure, and market position of the companies involved and finally on the countries in question. The choice for a transactional model needs to be the result of a careful evaluation, both before entering a business with another country, but also for already existing businesses relationships. While the direct business model wins for simplicity, it clearly loses for market presence and flexibility.

 Law for Spain limiting payment terms to 60 days between companies both with domestic residence, France similar. See Law 3/2004 of December 29, 2004, establishing measures to combat late payments in commercial transactions (based on EU Directives 2000/35/CE and 2011/7/UE). https://cms.law/en/int/expert-guides/cms-expert-guide-to-payment-term-legislation/spain. 8. November 2022. 25

5

Merchandize Business

Merchandize business is the way of choice to operate “at arm’s length” between legal entities generally, but especially in an international environment. It requires legal entities of the vendor in both countries and therefore is by its concept a setup that demands more attention and thus resources than the direct business transactional model. In return for this investment, it opens the tight boundaries of direct business and offers more degrees of freedom to operate, especially when it comes to matters of customer proximity. This chapter starts with a definition showing the basic variances of the merchandize business transactional model, followed by more details regarding the implications for the activities and tasks of the functions of the vendor’s and customer’s enterprise in their respective legal entities. It is obvious that the flexibility gained through merchandize business has a price for both, the vendor and the customer. The choice and design of the transactional model might in some cases even determine whether a business relationship can be established at all. The chapter closes again with a summary of implications of the merchandize business model for the customer and for the vendor.

Definition Merchandize business as a crossborder transactional model describes a local sale to a customer abroad by a foreign local subsidiary of the enterprise: a transaction of goods manufactured in Coutry A to a customer in Country B by a local entity of vendor (“seller”) in Country B, which sources the goods from another entity of the this  enterprise abroad.1 Specifically, it is internal merchandize business, so  The reference to the enterprise is particularly important. Of course, also external parties not being part of the same enterprise could operate under merchandize business, which would then rather have the character of a distributor or license partner. 1

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 M. C. Solbach, International Business Transactions and Taxation, Management for Professionals, https://doi.org/10.1007/978-3-031-39240-5_5

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transactions take place within the same enterprise as crossborder intercompany transactions before the customer is invoiced locally. Customer acquisition conceptually is conducted by own personnel of the subsidiary in Country B.  It can additionally be facilitated or solely be conducted by employees of the vendor’s legal entity based in Country A or a third Country C (both as “crossborder agents”). The use of such “crossborder agents” in cases when own sales personnel is not maintained in the country at all, but rather only sourced from legal entities outside the country of the same enterprise requires special tax considerations. Transaction focuses specifically on the parties involved in the legal and financial part of the transaction including negotiation, contracting, invoicing and payment. The physical flow of goods might deviate from this based on the internal supply chain setup of vendor and customer with respect to the location of their legal entities for manufacturing or warehousing.

Basic Model The basic model for merchandize business transactions includes two countries with goods being sold across the border and within the same enterprise from the vendor in Country A to its subsidiary in Country B. The subsidiary then sells the goods within Country B to a customer.2 The transaction refers again to the financial transaction of invoicing and payment. In the basic model, the flow of goods principally follows the flow of invoice from Country A to the subsidiary in Country B and then to the customer in Country B. It is advantageous and therefore frequently common practice to physically ship the goods directly to the customer, avoiding unnecessary cost (warehousing, local  in- and outbound logistics). Whether this advantage exists also depends on supply chain requirements: The product might require further localization such as labeling or technical modification (Fig. 5.1). Customer acquisition is conducted with local sales personnel such as Account Manager in Country B with all freedom for unlimited sales-related activities in Country B (such customer acquisition, negotiations and contracting, customer retention). Opposed to direct business, now any sales-related activity of customer service, technical service, and management outside Country B must focus purely on the fulfillment of existing contracts closed locally in Country B not to risk a PE of the legal entity of Country B abroad.

 Beyond the model presented, the subsidiary of course can engage in other business outside its own country, using the same or a different (= direct business) transactional model. 2

Definition

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Fig. 5.1  Flow model for crossborder merchandize business transactions [“Basic Case”]

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Merchandize Business:

Variaon 2

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Variaon 3

Crossborder Agent

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Variaon 1a Variaon 1b

Sold-to = Ship-to

Sold-to ≠ Ship-to

Customer Sold-to & Ship-to Fig. 5.2  Generic variations of the merchandize business transactional model

Variations of the Basic Merchandize Business Transactions Variations of the basic model for merchandize business transactions typically result from the two dimensions introduced for direct business transactions, leading to a similar grid with consistent variants, but different consequences across the functions (see Fig. 5.2):

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• The flow of goods deviates from the flow of invoices and money as defined by the vendor’s and/or the customer’s manufacturing setup (Variation 1 and Variation 3). • The customer acquisition process is conducted from another legal entity of the vendor based in a third country through so-called crossborder agents, as defined structures of vendor’s sales organization (Variation 2 and Variation 3). Flow of Goods The  deviation from the basic case regarding the flow of goods can be the  result of two facts: On the one hand, goods might be manufactured in legal entities in other countries than Country A of vendor’s legal entity selling the product (“sold-by” ≠ “ship-from,” Fig. 5.3). On the other hand, the buying legal entity of the customer (“sold-to” from the vendor’s perspective) might be situated in another country than the country or countries where the goods are received and/or used (“ship-to” from the vendor’s perspective, Figs. 5.4 and 5.5). This fact has implications especially for the supply chain function with regard to the foreign trade (import/export) processing of goods. Figure 5.4 shows the case of a contract closed in Country B locally for a flow of goods between Country A and Country C (or even further countries). The vendor’s entity located in Country B acquires the product from the manufacturing company of his enterprise in Country A and sells it to a customer Country B locally in Country B. The customer in Country B in turn sells the product internally to the manufacturing (or sales) company in Country C (and potentially other countries) for further use. Physically, goods transfer from Country A directly to Country C (and potentially other countries) directly. The whole situation comes with a set of implications and questions, e.g., for matters relating to Regulatory and Trade Control:

Fig. 5.3  Merchandize business transactions  – variation of vendor’s manufacturing locations [“Variation 1a”]

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Fig. 5.4  Merchandize transactions – variation of customer’s manufacturing locations A (“sold-to ≠ ship-to”) [“Variation 1b – variation of vendor’s and customer’s manufacturing locations”]

Fig. 5.5  Merchandize business transactions  – variation of customer’s manufacturing locations (“ship-to” in the same country as vendor’s source) [“sub-Variation 1b1 – two countries only”]

• Does the vendor in Country B hold all licenses required to sell the product Country B, even if the product does not even enter the country? • Is the customer in Country C equipped to import the product, including any licenses required for handling it? This situation is common in globalized industries with manufacturing facilities in several countries, e.g., textiles industry, shoe industry, and pharmaceutical or chemical industry.

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As the contract is closed involving several other entities of each party outside Country B, each contracting party must define internally following the “arm’s length principle” the details relating to ownership of product, compensation, liability, warranties, and obligations. In the case described Fig. 5.4, the vendors have an intercompany agreement between legal entities in Country A and Country B.  The customer in turn ensures that agreements between his legal entities in Country B and Country C are in place, practically assigning the legal entity in Country B in the role of a purchasing or supply chain hub. A special case is shown in Fig.  5.5, as goods remain in Country A while the (financial) transaction fully takes place in Country B. An exchange between vendor and customer in Country A is likely for the reasons of proximity, common language, technical service, or troubleshooting. It might, however, pose a tax risk to both if the conditions of the contract between entities in Country B are altered or further negotiated by their entities in Country A: This could be considered a separate agreement of the legal entities in Country A. Consequences then depend on the specific internal setup of the vendor and customer, which both have established between their entities of Country A and Country B. The larger the company, the more likely is it that all these (and other) variations coexist in different combinations for the same countries,  within the same company and same business relationship between vendor and customer, but for different business units. This often creates an even more complex (because changing from transaction to transaction) network of supply relationships, while the transactional financial relationship remains unchanged a merchandize business transaction. As in direct business and explained above, a deviating flow of goods from the financial transaction needs to be backed up by internal structures within the vendor and the customer. Customer Acquisition Supported by Crossborder Agents In contrast to the direct business transactional model, merchandize business typically is equipped with local sales resources. Despite the choice is for merchandize business, dedicated resources for a country might not be appropriate in some cases for the following reasons:3 • Lack of critical mass of market in country. • Legal reasons. • Internal structures, e.g., key account management (multinational/regional/ global). • Unique expertise. In these cases, different organizational solutions result in so-called “crossborder agents”.4 Different to the colleague as an employee of the local subsidiary of the vendor in Country B, the crossborder agent does not represent the seller (local  See further details in section “Variations of the Basic Direct Business Transactions”.  Recap: A crossborder agent is defined as an employee of the vendor located in a country that is not involved in the invoicing chain between the legal entities of vendor and customer. 3 4

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Fig. 5.6  Merchandize business transactions – crossborder Agents [“Variation 2”]

Fig. 5.7  Merchandize business transactions  – crossborder agents and ship-to outside sold-to country [“Variation 3”]

subsidiary of vendor in Country B) and therefore can only act as a supporting channel or medium between seller and customer’s legal entity (“buyer”). This fact forbids him to close contract directly but act only as a messenger of the local seller in the transaction (see Fig. 5.6). Legal and tax reasons require an employee of vendor’s local legal entity in Country B (or someone equipped with a proxy for or acting as institution of this local legal entity) for  negotiating, effectively closing and signing a contract with customers in Country B. Figure 5.7 describes Variation 3 as the case where in addition to the activity of a crossborder agent also the flow of goods deviates from the financial

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transaction – involving already four countries with different roles. In such cases and independently of the transactional model used, activities and settings across of almost all functions need to be cross-checked and validated for compliance. As in the case of direct business, particular attention needs to be paid to the business management functions for the reasons of tax and legal compliance. But as highlighted for direct business, also  regulatory, Foreign Trade, Supply Chain, Finance, IT, and HR  are essential to enable the transaction physically and financially and require an appropriate setup for each transactional model. The next section will provide the cornerstones resulting from the choice of merchandize business as transactional model, giving further insights and input for considerations to the specific cases in practice.

Functional Considerations for Implementation The merchandize business transactional model offers significant advantages to the vendor when customer proximity is essential for the business with foreign customers. One key element is that the enterprise engages in doing business on the grounds of another legal framework, along with the requirement to establish and manage a legal entity in this framework. This comes with set of key elements, which need to be considered across most functions of the company: • • • • • • • •

Business Management: Marketing and Sales. Legal. Finance. Transactional Taxes and Duties. Regulatory and Trade Control. Supply Chain Management. IT. HR.

The section will provide a framework for evaluation, which topics of the respective functions with regard to the merchandize business transactional model need to be considered for a compliant setup. While the risk to expose the organization to an infringement of tax regulations and thus an (undesired) permanent establishment is much lower compared to the direct business model, cost for maintaining this setup tend to rise, along with other burden to the business. We will take a special look at these factors and review options to keep this cost low or even avoid them at all.

Business Management: Marketing and Sales In merchandize business transactions, the vendor maintains a local legal entity in the specific country. This entity as seller is the contracting party, so the question of a permanent establishment of another company of the vendor is not applicable: The local legal entity is taxed with all their profits.

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Typically, the seller keeps structures for the acquisition of new customers, the expansion of business with and commercial service to existing customers along with the negotiation, conclusion, and signature of contracts and with all other activities Marketing and Sales are entrusted with. As described above, additionally, or sometimes even alternatively, own personnel of the subsidiary are supported by employees of another legal entity of the vendor based outside the country. The key risk factors with respect to accidentally establishing a permanent establishment that are predominant in the direct business setup for the Marketing and Sales functions (“presence in the country of the customer” and “negotiations and contracting”) will also be reviewed and assessed for the cases of the merchandize business setting. Presence in the Country of Customer and Crossborder Agents Even if it does not need to be spelled out because it seems to be the normal case: The employees of the local seller are present in the country.5 They can be present and act with customers in this country without any limitations. The question of presence in the country of the customer by other persons than those employed by the local seller of the vendor is not of relevance anymore in the merchandize business model: The seller as a legal entity provides a firm base for authorities for taxation of any business activity conducted by the seller. Any resources from outside the country supporting sales efforts of the seller support growing this tax base without incurring cost for the seller, so to the advantage of the seller’s country.6 This is the simple case of a one-business-unit company that fully runs its activities exclusively in the form of merchandize business transactions in a particular country. In case of several business units, different models between the business units might coexist, resulting in a more differentiated situation caused by: • Sales personnel of Business Unit I operate  direct business transactions  in Country B, acting from a foreign Country A, while Business Unit II works in merchandize business locally: a differentiation of a visit to the country and separation by business unit will be difficult to prove to the tax auditor when looking at it from the customer’s books (“Who sold you this product?”). Direct business rules for presence need to be followed by Business Unit I to avoid the PE risk, and the representative of Business Unit II is strictly forbidden to engage in any support for Business Unit I, even at potentially shared customers: Cross-selling over different transactional models is a risk in each direction.

 In practice, cases of employees living in another country than their employment frequently exist also beyond near-border situations; while these cases are well regulated regarding income taxation, they need to be reviewed separately regarding the PE  risk associated with them, e.g. regarding the location of closure and signature of contracts in combination with more frequent home office practices. 6  This is under the assumption that no crossborder Service Level Agreement (SLA) or an ICTP agreement  that  describes the service level to be provided by the internal selling entity exists, thereby capture value from the local entity. 5

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• Customers buying one product line under the merchandize business model from the local seller, another product line under direct business from a seller (legal entity of the same vendor) abroad: By no means personnel of the local seller shall support the direct business commercially. This includes not to negotiate, close, or even modify contracts for this business unit. Even passing on messages for the foreign seller of the direct business might be considered an indicator for a PE, resulting in double taxation (of the direct business) and local income taxation for the business travellers of the direct business. Other activities, such as technical support or transactional customer service, if strictly limited to these tasks and not expanded by any sales activities, can be conducted by employees of the local seller in the country without establishing a PE for the business unit in direct business transactions. The size of the company typically drives complexity, reflected in variations of transactional models. Efficiency often created by shared resources in Marketing and Sales are one key element, which make management of rules and guidelines for compliant behavior difficult and time-consuming. On the other hand, standardization, and simplification also in this regard for the purpose of efficiency come at the cost for effectiveness, often leaving the organization with a much  more limited room to act. For “crossborder agents” (see also sections “Business Management: Marketing and Sales” and “Variations of the Basic Merchandize Business Transactions”), the same rules as under the direct business model apply for both cases: whether  the local seller is operating with own sales personnel, or not: Potential reasons for using crossborder agents if no local sales personnel are maintained have been discussed in the introduction of this Chapter.7  Even in the presence of local sales personnel, crossborder agents might come into play: hierarchy, key account management structures, special expertise, increased frequency of visits customers, customer/industry segmentation or different business units are internal determining factors driving this kind of organizational setup. It is important to always remember that crossborder agents are not employed by and do not represent8 the seller (who will become the contracting party). This limits their freedom to sign, conclude, or even negotiate contracts without running the risk of a PE for their employer outside the country of the customer – even if more relaxed compared to the basic direct business situation.

 Own sales personnel does not necessarily need to be maintained but can be sourced as crossborder agents from within the enterprise from legal entities outside the country if special tax considerations are taken. 8  Although it might be perceived by the customer and the crossborder agent this way, it remains crucial that agents only act as messengers or supporter for the seller; otherwise, the risk of creating a PE increases. 7

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Special Case: Representatives of “the Ultimate Shareholder”

Employees of “the ultimate shareholder” (the legal entity where all entities of the enterprise finally consolidate into) or employees of companies involved in the preceding value chain (e.g., employees of manufacturing units within the country or abroad), a legal and tax position is formed, which supports that these employees can negotiate, conclude, and even sign contracts also for other legal entities than their own without constituting a PE. This is legally binding externally only within the limitations given by the law of the respective country, internally within the regulations of the enterprise. A practical example is the CEO of the Holding Company signing an agreement with another CEO, which becomes binding for all subsidiaries without other bilateral agreements of their respective local subsidiaries.

Negotiations and Contracting With regard to negotiations and the conclusion of a contract for the seller, there are no limits for the employees of the local seller – except the “Grant of Authority” set by the seller or the vendor for their enterprise internally as part of their control systems. Both seller and buyer are based in the same country, and even if “ship-to” or “ship-from” deviate, it does not harm the contractual relationship and financial transaction. As for direct business, two phases can be considered also for merchandize business transactions: preparation, closing, and signature on the one hand and fulfillment on the other hand. In the case of merchandize business, both phases can be fully conducted by the employees of the local seller with a local customer without any harm to the tax position neither of the local seller nor any other party of the vendor: The fulfillment phase of the transaction therefore can be fully or in parts conducted by employees of the vendor’s enterprise based in legal entities within or outside the country. This typically needs to be captured in the ICTP guidelines of the vendor.9 In summary for crossborder agents, none of the potential triggers for constituting of permanent establishment in the customer acquisition process, as shown for the direct business transactional model, disappears completely, but overall the risk is reduced significantly.

9  In this case, a PE risk is not imminent, but a case could be made under specific conditions outside the country of the seller, e.g., in the country where customer service is employed. These conditions again would include sales-related activities of the customer Service personnel. Practically, such a situation could arise at Shared Service Center locations with sufficient critical mass to make a case for tax authorities. It thereby also becomes a topic of the SLA between the entities.

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Legal The key headlines regarding legal aspects remain the following as in direct business: • Clarity regarding legal entities entering into an agreement = contract as base for the transaction(s). • Contracting process: negotiations, but especially conclusion and signature need to be conducted by an employee of the seller of the legal entity that enters the contract.10 Under merchandize business transactions, the legal aspects between seller and buyer entity take place locally in the same country and thus are governed under the law of this country. The parties might agree to a different law, if permissible in the jurisdiction. Compared to the direct business transaction, there are implications for the vendor: The local legal entity of the vendor enterprise acts as seller and takes the role as contracting party; the vendor is therefore affected as follows: • Local jurisdiction requires local general terms and conditions of sale, expertise for the local jurisdiction either in-house or externally, both for contracting and in case of disputes. Place of jurisdiction is local accordingly, increasing the cost is case of disputes. • Conclusion and signature of any agreement as seller need to be taken by an employee of seller only; this is particularly important in case of sales organizations working internationally. • Product liability and any other liability are borne by the local seller as contracting party. Local Jurisdiction and Place of Jurisdiction With regard to the jurisdiction, principally local laws apply. It then is a matter of interest and negotiation power to agree to a different jurisdiction, if allowed by local law. The transactional cost for maintaining local general terms and conditions, but even more the cost of supporting local contracting legally needs to be considered. The cost for solving disputes adds further to the bill, especially since local customers might be less reluctant to enter a legal dispute locally than at a foreign place of jurisdiction: emotional hurdles and cost are lower, potentially increasing the number of disputes also for lower value to the legal portfolio. Compared to a direct business transaction, some of already existing cost shift to the local subsidiary, but some are additional. For the Legal function, synergies of direct business transactions (driven by bundling of transactions in one or few

 Technically, employees of other legal entities of the vendor (or even third parties) could also be acting as an institution of the legal entity or with a proxy of the legal entity in the role of the seller. From a management and leadership perspective in larger organizations, this route should be used with caution in practice. This includes also the concepts of the employee of the “ultimate shareholder” or of a legal entity involved in the previous invoicing chain. See also box on the ultimate shareholder concept in section “Business Management: Marketing and Sales”. 10

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entities) are lost, and furthermore complexity increases including the additional cost of managing it. Conclusion and Signing With regard to conclusion and signing of an agreement locally, questions arise specifically for larger corporations: Several hierarchical levels along with signature and “Grant of Authority” guidelines reach into the whole enterprise and across country borders. Example  A typical situation is the local Account Manager of a product line who is equipped with internal signing power up to a certain value. This Account Manager is functionally led by a global Vice President Sales based in a different country, internally equipped with an extended signing authority. On the other hand, the internal signing authority of the local Managing Director of this country (of disciplinary manager of the Account Manager) is limited by value or material matter (i.e., might not cover sales contracts). The contract in question affects only the country where the Account Manager is active in. While it looks like a dead-end for the signature of the contract initially, the following solutions are possible: • Negotiation: The word of the local Account Manager to the customer as representative of the company counts legally. Internally, he needs to make sure that he is in line with the guidelines of his enterprise for this negotiation: Otherwise, he might face consequences (internally). The VP sales employed in a foreign country legally may join and participate in the negotiations, tax-wise acting as a “crossborder agent” (with no power to negotiate) — but he is legally not in a position to sign for the local legal entity. • Conclusion and signature of the contract need to come from an employee of the seller. As the signing authority of any local employee is not sufficient based on internal guidelines, it is advisable that the local employees ensures back up of the agreement – in our case by the VP Sales – before the conclusion and signature of the local employee. In specific cases (e.g., proxy for legal entity, employee of “ultimate shareholder”), the VP Sales (or similar) may legally sign. The case of a contract agreed in one country, which shall also take effect for several other countries, needs to be reviewed separately. Conceptual options of such “framework contracts” or “umbrella contracts” include adaption of other legal entities of vendor and customer, the signature of a person at vendor and customer who has legal reach and signing power into all legal entities affected, or signature by representatives of all legal entities affected of vendor and customer (see also section “Business Management: Marketing and Sales”). Liability Along with local contracting, product liability and any other liability questions are arising, independently of whether the seller is the manufacturer of the goods or not.

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The local seller can be protected to some extent and at least financially by corresponding agreements with its internal supplying company. Potential financial implications of product liability claims typically are managed through intercompany transfer pricing (ICTP) agreements, which also specify the liability split between the legal entities of the vendor.11 The risk of the local supplier of being legally addressed, however, remains: This legal entity is contracting partner of the customer  and remains legally responsible locally with the right (and obligation)  to claim back damages from their supplier accordng to the law or agreements. The assessment of these considerations is dependent on the business itself, its customers and customer structure, markets and industries served, product portfolio, and finally the interaction between customers and suppliers that has established in a specific industry: A B2B enterprise with few customers will therefore come to a very different assessment compared to a B2C company with a large customer base.

Finance and Taxes For the fields of Finance and Taxes, merchandize business transactions seem to be simple if seen through the view of the local country only. Further matters in the field of Finance and Taxes have not been obvious under a static or local setting only surface in relation to foreign countries or compared to the option for direct business transactions. This section reviews those topics by first addressing finance-related topics and then selected taxes-related topics. The following topics will be discussed for the merchandize business transactions: • • • • • •

Terms of payment. Credit risk management and security mechanisms. Foreign currency risk. Invoicing. Cost of capital (CoC) and financing. Transactional taxes and duties.

Terms of Payment Terms of payment are reduced in the following to the level of due date for payment (term of credit).12 In most countries, those terms be agreed upon freely by the contracting parties based on business needs and influenced by the negotiation power of the parties. Business needs include industry-specific habits or country-specific matters (such as a high inflation).

 Nucleus of ICTP agreements is the definition of goods, pricing, and payment conditions, it also comprises elements known from third party supply contracts such as services, and liability arrangements. 12  For further elements on the terms of payment, please refer to section “Fiance and taxes” in Chapter “Direct Business”. 11

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In some countries, local laws might restrict contracting parties to agree freely on the due date for a transaction. Reason for such limitation has regularly been the need of a government to influence the financing and risk position of companies in course of economic crises. Financing is influenced on both sides by payment terms: The seller faces increased need for financing with long payment terms, while the buyer benefits from a reduced need for financing with long payment terms. With inflation entering the stage, this effect makes a huge difference also on value created by the extension (or reduction for the seller) of payment terms. Such laws can only be enforced if buyer and seller are residents of the country. Therefore, these restrictions cannot apply for import or export business, in which by definition one of the parties is not a resident of the country. Examples of such regulations can be found in France and Spain, partly introduced, or modified after the financial crisis of 2007/2008.13 Objective of the laws in this case was to ensure sufficent liquidity in the overall economy and avoid customer financing by vendors through overly extended payment terms. In the case of merchandize business (and in contrast to direct business), such regulations apply between the local contracting parties. Credit Risk Management and Security Mechanisms In the merchandize business transactional model, the credit risk of the vendor is borne by their local legal entity as the seller. Compared to a direct business transaction, this adds complexity to the vendor as the credit risk needs to be managed locally by each legal entity individually, having less critical mass by number and volume of transactions. This results in less synergies and less economies of scale. In addition, potential portfolio effects of a smaller pool of accounts receivables need to be considered, leading to a less diversified risk position. Finally, the risk carried in the accounts receivables position on the balance sheet affects the financing position of the local legal entity. These effects can be managed by specific measures, such as factoring (for limiting the credit risk, but this comes with a cost) or the design of the ICTP agreement according to the situation specific to the legal entity facing extended payment terms.14 For larger enterprises, synergies, economies of scale, and portfolio management still can be captured by using (regional) Shared Service Centers that pool expertise and critical mass in one existing or even a separate legal entity (e.g., for the credit risk assessment of customers, credit risk coverage through insurances, or documentary business). Such a setup pools several countries for higher efficiency. This, however, requires efforts for the design of processes and systems, which typically pay off only with sufficient critical mass.

 See Law 3/2004 of 29 December 2004, establishing measures to combat late payments in commercial transactions (based on EU Directives 2000/35/CE and 2011/7/UE). https://cms.law/en/int/ expert-guides/cms-expert-guide-to-payment-term-legislation/spain. 8. November 2022. 14  Intercompany transfer pricing. The terms of the ICTP agreement also include internal payment terms, which can be adjusted according to the market situation of the local legal entity. 13

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On the customer side, merchandize business transactions also affect the consolidated credit lines of the (multinational) customer with the vendor across borders, as VAT is charged at any local transaction, adding to the invoiced amount in the range of roughly 15–25% and increasing the credit risk for the vendor by this amount. This is not the case in a direct business transaction. In a change in transactional models, this effect needs to be considered. Foreign Currency Risk In business transactions where both contracting parties reside in one legislation and thus in one currency area, discussing foreign currency risk may seem strange. There are, however, cases in which these considerations matter either for the vendor or for the customer. From a vendor’s aggregate perspective, all or most of the goods sold in the country to the customer between its local legal entities as seller and a local buyers are imported via an intercompany transfer to the vendor. Unless located in a currency union, this means foreign currency exposure to the vendor resulting from the intercompany transactions and the accumulation of profits in foreign currencies in the local legal entities, which needs to be managed. For the vendor, currency risk originating from the intercompany transactions with the subsidiaries in the countries can be managed in the classic way of currency hedging, along with a fee to the bank. Another way is risk pooling of currencies internally, which balances and then manages the remaining exposure centrally. Even with a focused approach, certain requirements need to be met for efficiently running such a system: • Critical mass. • Focused on few key currencies. • On-time and daily availability of data (accounts receivables/accounts payables) from all legal entities in scope. • An ERP system with corresponding capabilities implemented, spanning across, or connecting all legal entities in scope. • Experts to manage such an internal system actively. The seller as local legal entity of the vendor  can also choose to manage  their overall foreign currency risk in a way that a portion corresponding to the local cost of business is invoiced in local currency, and the remaining portion is invoiced in the foreign currency to the amount that reflects the obligations of the seller in this currency (“structural hedge”). Local laws must permit (or not forbid or limit) invoicing in a foreign currency between local parties. Also, customers must agree to take over the currency risk or benefit from invoicing in foreign currency. Traditionally, the US Dollar plays a strong role globally when invoicing in foreign currency is agreed upon. Around 20 years after its birth, the Euro increasingly becomes an alternative to the USD also outside Europe. Regionally and depending on the individual situation of seller and buyer in combination, also other currencies such as the Japanese Yen or Swiss Franc might be chosen. On the buyer’s side, Fx risk management is simpler under the assumption of a transaction in  local currency, especially for the base case of commercial activity

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only in the country of the transaction. For customers engaging heavily in export business, also merchandize business might create a currency risk on the sourcing side with local currency invoiced  compared to their revenues  in foreign currency.  These customers benefit from sourcing in the foreign currency of their revenues. An agreement to invoice in a foreign currency is therefore particularly easy to reach in cases of export-oriented customers: Parts of their revenues are in foreign currency, while their cost base is local. They similarly can achieve a “structural hedge” by transferring a portion of their cost base to the foreign currency of their revenues. In extreme cases, the share of revenues in foreign currency can reach close to 100%, like in the textiles or shoe industry, e.g., in Indonesia or Vietnam. Even if invoicing in foreign currency is not permissible, countries often have established Free Trade Zones with special customs and commercial regulations to attract foreign investment and thus – besides the capital – provide know-how and employment opportunities to the local population.15 Changes in the transactional model  of a supplier therefore might have severe implications on the viability of the business model of the customer by changing their Fx risk position to such an extent their business becomes impossible. Invoicing Invoicing the customer comes with different facets and thus carries different meanings in different functions notably in enterprises with highly fragmented processes and specialized process steps: From the formal step in the ERP to the physical (or electronical) delivery of the invoice  to the customer, a shared understanding of when invoicing takes place frequently needs to be created. On top, regulations on invoicing differ between countries. Those do not become obvious in the organization in a steady state, but only when trying to change the process, e.g., to address synergies or economies of scale (leverage through Shared Service Centers). Particularly, local regulations might prevent certain steps of the invoicing process of a local merchandize business to be taken outside the country.16 In merchandize business transactions, the local ERP must be equipped with the function to issue the invoice. Tax authorities in some countries require interaction before or after issuing the invoice. Examples include a specific identification number for each invoice to be received electronically from the tax authorities (e.g., in Portugal) or reporting of all invoices issued to the tax authorities in short frequency (daily or sometimes even online). Such regulations normally apply only for seller and buyer residing in the same specific country, which makes them a specific attribute for merchandize business.  The advantages of Free Trade Zones or similar setups are, however, typically limited to a certain period and not only for this reason heavily disputed. 16  When switching the transactional model, such a limitation might result in significant structural effects to the vendor, e.g., in case invoicing (or a certain process step of it) has been performed in a Shared Service Center under direct business before and now would need to be performed locally. 15

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Requirements varying by country also apply for e-invoicing, adding modifications, and thus cost to the overall ERP system. Even for a traditional way of transmitting the invoices via regular mail, a variety of regulations might apply: These range from local issuance of the invoice to local printing or locally sending the letter. As a result, the vendor must setup or maintain local structures and processes, raising the cost of overall business. In sum, regulations on invoicing deviate between jurisdictions and might unexpectedly turn out to be a hurdle for centralization and efficiency for the vendor. At the same token, the field of invoicing shows the requirement for local knowledge and expertise to manage merchandize transactions in a compliant way. Cost of Capital and Financing Capital requirements are the base for determining the cost of capital. These requirements are also driven by the choice of the transactional model, which influences two components of the balance sheet: inventories and accounts receivables. While inventories are almost completely under the influence of the vendor, accounts receivables are dependent on a variety of variables: order quantity, price – and payment terms. Therefore, they are the result of a negotiation process, which requires the agreement of the customer. In the merchandize business transactional model, inventories need to be carried by the seller from the time the overseas shipment starts and intercompany invoice is issued, as the time the economic title of goods transfers at that point from a vendor company to the seller in the local country. The time span of inventories in transit triggers consists of the time taken for the shipment (e.g., by ship from some places in Europe to Asia) and clearance of goods at the customs. Inventories remain with the vendor’s subsidiary (“seller”) until the third-party invoice is issued (“Invoice” in Fig. 5.8 upper part). Thus, inventories stay overall significantly longer on the balance sheet of the vendor in the merchandize business transaction compared to a direct business transaction. It creates a financing need for the vendor’s subsidiary as the seller – which in a direct business setting resides at the customer’s side. What initially might look like a disadvantage of merchandize business offers the potential to reduce the cost of capital to the vendor as a whole, as the goods are valued as inventories at manufacturing cost on the vendor’s balance sheet until they are sold – and not as accounts receivables. Only at the point of the sale to a third party, inventories convert into accounts receivables for the seller, resulting in a higher base for the valuation of cost of capital. In the direct or agency business in contrast, this point is reached much earlier – often at the cost of extended payment terms, then affecting two factors of the cost of capital calculation: value and duration. The  buyer carries the inventories already during the overseas transfer time as the invoice is issued at the time of shipment from the seller abroad (see Fig. 5.8 lower part), the vendor carries accounts receivables at typically extended payment terms, leading to higher cost of capital from a consolidated perspective (see Fig. 5.9): While the time span for determining the cost of capital  of the vendor  remains the same, the proportion of the time of the

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Fig. 5.8  Working capital implications of transactional model – vendor’s perspective

transaction’s value as accounts receivables increases and thus the overall base value for the calculation. Why could payment terms expected to be extended when applying direct business or agency business? Accounts receivables to third parties are a result of a negotiation and determined by the transaction between seller and buyer with the underlying payment terms. They normally follow the standards of country and industry in the (local) merchandize business transaction. In direct business transactions with long overseas shipping times to the country of buyer, it is not unusual to extend payment terms (meaning the due date for payment) by the time of overseas shipping. The anchor to the buyer is the time when the goods are received, followed by the timespan between receipt of goods and payment. This is the only time the buyer can already work with the material and already benefit from the physical possession of goods without having them paid already  – which is clearly  crucial in both,  a manufacturing and  in a wholesale environment. Payment terms normally used under purely local merchandize business within a country applied in an international business transaction would typically not allow for such an “extra time” financed by the vendor, but rather quite often result in the invoice to be due even before the receipt of goods. While this may be accepted in some industries or in a B2C setting, it puts the customer in a B2B context quite often in a strong

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Merchandize Business

Intercompany Transfer Time (days) Payment Terms (days) Total Days "Order to Cash"

Transfer to Subsidiary, Manufacturing incl. Customs, Safety Stock Company

Order

45

Sales: Subsidiary

5 55 200 -200 Cost of Capital:

4,77

10,0%

Inventory @ Intercompany Transfer @ Subsidiary (kEUR)

100

115

ICTP Accounts Payable / Accounts Receivables net out

115

-115

Sales (kEUR) Contribution Margin (kEUR) Third Party Accounts Receivables @ Subsidiary (kEUR)

Direct / Agency Business

-115

1,44

200 85 200

Sales & Manufacturing Transfer Company incl. Customs

Sales: Subsidiary

3,33

Customer

x --------------- CONTRACT --------------- x

Payment Terms (days) Total Days "Order to Cash"

105

Transfer Time (days) Goods physically available as Accts. Payables no cash effect (days) Inventory (kEUR) Cash / Account Payables (kEUR)

Cost of Capital Vendor (kEUR) Inventory (kEUR)

ICTP Accounts Payable / Accounts Receivables net out Sales (kEUR) Contribution Margin (kEUR) Third Party Accounts Receivables (kEUR)

Total

45 60 105

60

Transfer Time (days) Goods physically available as Accts. Payables: no cash effect (days) Inventory (kEUR) Cash / Account Payables (kEUR)

Cost of Capital Vendor (kEUR)

Customer

x -- CONTRACT -- x

Total

105 105

50 55 200 -200 Cost of Capital:

10,0%

100

0

0

0 200 200 200

5,83

0,00

5,83

Fig. 5.9  Working capital calculation for transactional models – vendor’s perspective

negotiating position, leading in extended payment terms for overseas direct or agency business. This then results in relatively higher accounts receivables on the consolidated balance sheet of the vendor with increased working capital and thus cost of capital – which in turn can be reduced when a merchandize business transaction is applied. This implies the opportunity and thus the mandate to the seller to reduce payment terms when switching from direct or agency to merchandize business. These correlations and their effect are shown in an example calculation in Fig. 5.9 for the merchandize business and the direct/agency business. The assumption is to hold the goods physically available for the customer for 55 days before payment is due.

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This assumption results in a total cost of capital to the vendor of 4,77 kEUR consisting of 1,44 kEUR CoC accounted to inventories and 3,33 kEUR CoC to accounts receivables. In contrast, and ceteris paribus all other variables unchanged, a physical availability with 55 days left for payment results in a direct/agency business setting in 5,83 kEUR CoC only consisting of accounts receivables at the vendor abroad. Compared to merchandize business, this means an increase in CoC of over 20% (at a given contribution margin, payment terms, transfer time). How do these differences in transactional models now affect the companies’ financing requirements and cost of capital? Compared to direct or agency business, merchandize business from the perspective of the vendor… • …results in an overall lower cost of capital: the higher the margin of the product, the higher this effect. • … triggers a financing need at the subsidiary for carrying the inventory during overseas transfer time and for safety stock; this can be accounted for internally by intercompany payment terms aligned with the local customers’ payment term: This shifts the financing requirement to the vendor’s supplying company; however, only at ICTP as opposed to third-party prices, thus at a lower base for the cost of capital. • … requires an adjustment of payment terms to balance cost of capital when transitioning from direct or agency to merchandize business. It is the general interest of the buyer to shift part of its financing need to the seller, thereby reducing its financing through other sources. The same holds vice versa true for the seller. Therefore, negotiations between seller and buyer often are influenced by the specific and sometimes even temporary financing needs, which then have the potential to influence the setup of the business transaction over other factors. Accordingly, changes to the transactional setup need to be analyzed for their impact to the financing needs at both sides, seller and buyer. Transactional Taxes and Duties For considerations on taxes, the following section addresses these areas: • VAT. • Excise taxes/excise duties. • Special taxes. VAT  Value-added tax (VAT) is a tax to be applied in the merchandize business transaction between seller and buyer locally. Implications for both sides might be significant, when compared to a direct business setting, especially when VAT rates are high. On the buyers’ side, cash out of the goods purchased is increased by the rate of the VAT applied to the value of the goods received and accounted for. As the VAT paid can be claimed back against the VAT collected from customers, this effect in a steady setting is balanced and requires a one-time financing: The financing need

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arises for the time between payment of invoice to supplier and reimbursement from the local government. Depending on the country, practice shows that this timeframe sometimes stretches over several months to more than a year. On the seller’s side, sales tax on the import based on the intercompany invoice is to be paid besides potential customs duties, while VAT is collected from the customer. This system does not seem to be complicated, but it experiences quite some dynamics if the way of goods and the way of invoices are different, i.e., if the ship-to is in a different country than the country of the seller and the buyer. In this case, the legal entity of the seller must be registered with (= apply for) a VAT number in any country of the ship-to locations of the buyer to be able to claim back VAT paid in course of the intercompany transaction. While this is also in direct business transactions the case, the vendor enterprise in case of merchandize business transactions multiplies their VAT registrations by the number of merchants it maintains. Maintaining VAT registrations across all merchants of the ship-to countries of their customers can therefore become a significant cost factor. The orchestration of the flow of goods under merchandize business transaction therefore is a crucial task also in the negotiations with the customer. The consideration of VAT aspects also in the supply chain strategy can optimize the conceptual flow of goods within the network of vendor’s legal entity and thereby optimize the cost for VAT registrations to be maintained. Excise Taxes/Excise Duties  In contrast to VAT as an “ad valorem tax,” excise taxes are based on the unit of a good at the time when it is manufactured or brought into the country.17 The meaning “excise duties” refers therefore to the fact of a per unit duty of a good entering the country of the seller. Excise taxes or excise duties are frequently imposed on mineral oil, packaging, alcohol, and tobacco. While in a direct business setting solely the customer is responsible to manage these taxes and duties, the merchandize transaction requires the local seller of the vendor to pay the tax/duty and then pass it on as indirect tax to the buyer in the country. In case of a ship-to location outside the country or in a Free Trade Zone of the country, special considerations need to be taken for the specific jurisdiction. Especially when considering a change in the transactional model, these questions become relevant not only commercially, but also with regard to the IT landscape to support the tax and duty administration of the transactions. Special Taxes Taxation still differs among jurisdictions for numerous reasons, but after more than two decades of intense globalization of economies and enterprises, many tax concepts have already been aligned, creating a more harmonized understanding of  An excise tax is a duty imposed on manufactured goods, which is triggered at the time of manufacture (inland) rather than at the moment of sale. They are typically also raised at with the import of goods as a customs duty, which fulfill the conditions for imposing the tax 17

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international taxation. Large differences and unique taxes, however, continue to exist within  (or are created) by individual countries, applicable to anyone doing business within the borders of the respective country. Consequently, all merchandize business transactions are affected by such taxes. One example for this the banking tax in Argentina, which is applied to the value of any bank transaction within the country. It is obvious that this tax negatively affects the commercial position of any merchandize business transaction versus a direct business transaction from abroad. When deciding on the transactional model, this needs to be considered. The analysis of the topics above has shown that the choice of transactional model has implications not only on the commercial but potentially also on the financing side, especially when changing from a direct business transactional model. Key drivers explained in this chapter are as follows: • Seller: accounts receivables on balance sheet; in a consolidated view increased by the amount of the VAT. • Seller: increase in inventories in case of overseas shipments from vendor enterprise. • Buyer: VAT included in invoice create need for additional capital. Furthermore, excise taxes/duties might shift from buyer to seller and special taxes create an additional commercial burden.

Regulatory and Trade Control The aspects of Regulatory and Trade Control gain importance for the vendor when engaging the merchandize business transactional model. In direct business transactions, the vendor is mainly concerned with foreign trade with regard to export. A merchandize business transaction expands the view to import considerations as well. Import again relates to regulatory matters, which a vendor acting from abroad (in direct business) is concerned only to a very limited extent, mostly in the form of supporting customers in regulatory questions. When using merchandize business transactions, three main categories need to be looked at: • Regulatory: company licenses. • Regulatory: product licenses. • Trade control: import of the product by the subsidiary of the vendor. Regulatory: Company Licenses Company licenses address the obligation of a legal entity to import, handle, market, or use products falling under the regulations of a specific country. The seller as the importer of the goods needs to be equipped with those licenses as “license to operate.” Even in cases where the flow of goods from the flow of invoices deviates – so if the product is not physically imported into the country – an evaluation on whether licenses still are required for the trade of such products is

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recommended. Products typically falling into this category often come along with special requirements and obligations to the seller: Food, pharma, and dual-use products tend to have documentation and tracing requirements that need to be met by the seller. Company licenses for importing, marketing, and/or handling dual-use products sometimes are restricted to companies with a majority of capital owned by local shareholders which frequently is not the preferred choice for a subsidiary abroad. Still, a business transaction under merchandize business might be possible also for companies that do not fulfill this requirement by using a variant of the merchandize business transaction. This variant is referred to as “customer-to-clear” or “client-to-­ clear” and will be discussed in the  paragraph “Supply Chain Management” further below. Regulatory: Product Licenses Product licenses address the requirement of the product itself to be registered in a country. They determine whether the product is permissible to be marketed or used in the country for specific purposes. Typical examples include food or pharma products, dual-use products, sometimes software or technology components. For the purpose of this book in the context of merchandize business transactions, the topic is expanded to any potential import restrictions, e.g., on quantities in general or from certain geographies as defined by the local trade law. Exceptions from such regulations often exist in free trade tones or – mostly associated with these zones – regarding products used for conversion only, which then is followed by an export of a value-added product. Along with the company licenses, the seller also needs to hold or be able to refer to licenses for the products of the transaction. These can refer to the import (see Paragraph “Trade Control” below) or to the marketing and use of the product in the country for specific purposes.18 Especially for food, pharma, and chemical products, typically narrow regulations exist along with the requirement to prove that the product is not harmful, sometime even to prove that it is useful. More recently, also environmental factors become part of product registrations. Another area of regulation and thus license requirement refers to dual-use products, which can be used for civil or military purposes.19 Trade Control: Import of the Product Trade control refers to the product physically crossing the border. In the case of “standard” merchandize business with a synchronized flow of goods and money, the

 As a reminder, in the direct business setting, these product licenses are typically acquired by the customer as importer and user in the country. 19  Classical examples are 4x4 cars and trucks,  the GPS system, and for the chemical industry ammonium nitrate as a raw material for fertilizer production, but also for the manufacturing of explosives. The need for the special handling requirements of this product became obvious again in the disastrous explosion in Beirut, Lebanon on Aug-04, 2020. See https://www.nytimes. com/2020/08/04/world/middleeast/beirut-explosion-blast.html. 18

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vendor is also the importer of the product. The role of the importer goes along with obligations that have partly been addressed before. The declaration of goods at the border captures… • … any duties, excise taxes/duties, and sales tax on imports.20 • … whether the importer is equipped with the corresponding licenses. • … whether the products are permissible to be marketed and/or used in the country. • … any restrictions of importing certain quantities of the product. Restrictions on quantities often are established to protect local industries, either in their growth phase or to extend the lifecycle of industries that suffer from global competition. In such case, the vendor needs to be sure that sufficient quantities are allocated to his local legal entity as seller for import of the product. Free Trade Zones might offer a loophole providing exceptions, especially for raw materials used in products for conversion and export.

Supply Chain Management Merchandize business transactions require the supply chain not only to be robust for the physical flow of goods, but also to be well designed to ensure a financially efficient transfer of goods between the countries. This requirement is based on the requirements on products and legal entities by different countries for the marketing, sale, and use of products. This section reviews the following topics of Supply Chain Management: • Order entry. • Order fulfillment and process design. • Logistics: transport and warehousing. Order entry by concept is delivered – as described for the direct business case – as a purely transactional service. Especially when conducted outside the country of seller and buyer, the same considerations apply as in direct business, but vice versa: Risks for PEs (here: of the local seller in a country abroad) might increase, especially if tasks beyond transactional services leading to new or modifying existing contracts are performed. As such a case is difficult to prove and then to enforce, it is  a more theoretical play: The merchandize business transactional model practically offers a very high degree of freedom to operate for all functions. Order fulfillment along with process design plays a crucial role in the merchandize business setting, optimizing the way to handle expensive  registration and license matters. Especially, the process variant referred to as “customer-to-clear” (CtC) offers a range of advantages for the vendor by involving the buyer in the import process:  Sales tax on imports is easily confused with regular VAT levied inland because of the same rate in many legislations. 20

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• The requirement for company licenses for the import can be mitigated if the buyer holds those licenses.21 In these cases, the shipment must reach the buyer (or logistic service providers of the buyer) via customs clearance directly from abroad and may not go through a warehouse of the seller. • The requirement for product licenses or registrations in the country can be mitigated, if companies registered for marketing, sale, and/or handling of the product can be referred to. • Equally, regulations on dual-use products might be easier complied with compared to the seller being the importer. • Quotas or allocations for the import of products, which are allocated to the buyer, can be attributed to the transactions.22 • Customs clearance: In some countries, customs clearance is faster for companies with local shareholders or with a proven track record with the customs authorities (red line/green line principle) • The potential choice between seller and buyer as importer offers the opportunity to use potential economies of scale, special expertise, or other organizationally favorable setups of the local parties in importing the goods, which results in an overall cost advantage in the supply chain. Customer-to-clear comes with the huge advantage that the process can be used in parallel to other merchandize business transactions. In contrast, a combination of the different models (direct business vs. merchandize business vs. principal–agent) within a defined business area is not permissible.23 Biggest disadvantage for CtC is the fact that it is very difficult to identify whether this process is legally and technically feasible in a specific country, as it is not codified in one regulation, but resulting from the combination of a set of regulations. On top of this, both seller and buyer must be willing and be technically equipped from an ERP perspective to run this process. The determination of feasibility requires a detailed, often also practical (= empirically testing the transaction), and in the end costly country-by-country evaluation beforehand. A further disadvantage to be considered is that the shipment does not enter the warehouse of the seller (or their logistical service provider). While this is a cost-­ saving initially, the consequence is that synergies get lost as the number of shipments to the country (e.g., containers) might not be optimized: Goods for different

 Payment of duties must not be affected by the CtC process, as duties they still can be paid for by the seller as defined by the INCOTERMS (e.g., DDP). 22  Another example for hurdles to import is a regulation defining under which circumstances a nonpublic (=privately owned) jetty may be used for unloading bulk tankers: While this was permissible for locally owned companies, it was not for companies held by foreigners. As a jetty cannot be easily replicated, only customer-to-clear solves the dilemma. 23  The definition of business area is whatever is reasonably defendable against the tax authorities: most simply the whole company to more detailed by business unit or strategic business unit. The degree of differentiation is largely determined by the separation of management and reporting structures. 21

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customers cannot be combined and then  separated by the vendor in an own warehouse. With regard to logistics including transport and warehousing, the merchandize business transactional model might require local warehousing along with the corresponding inbound and outbound logistics. Besides the complexity of maintaining additional warehouses which – depending on the products stored – need to comply with extensive and thus expensive regulations, there is also an increased complexity in inventory management regarding stock level and ability to supply. Beyond the direct cost associated with maintaining the warehouse, there are also effects on a less consolidated the inventory level (compared to direct business) and thus  frequently cost of capital to the vendor.

IT and Master Data The merchandize business transactional modes require the same modules and level of granularity in the ERP of each local seller (merchant) as the headquarters if the full benefits of automation shall be achieved. While its installation is one major one-­ time cost factor at the beginning, licenses for additional users in the countries and the regular maintenance add to the permanent  cost of the local legal entity and finaly to the overall IT spend of the vendor. Compared to the direct business transactional model, the local entities additionally need to be equipped with the financial components of the ERP for accounting, invoicing, cash management and reporting, tax-related modules (e.g., for VAT), and the respective supply chain modules for order and inventory management, again along with reporting requirements back into the financial module to reflect, e.g., the base for excise duties. Beyond the functionality of the ERP, the vendor needs to manage master data of customers and products now across several ERP systems of the local legal entities, potentially across different time zones, ensuring in-time  data accuracy and integrity.24 While this is a technical challenge alone, the organizational challenge is a strict governance of the master data needs to be ensured across several places. Both elements come with the need for an elaborated user rights management to ensure the right level of transparency and integrity of data.

HR and Leadership Independently from the organizational setup of the seller (as local legal entity of vendor), all basic HR topics are imminent to the merchandize business transactional  Cloud technology becomes a game changer compared to the established technologies of the 1990s and 2000s, which, however, can be expected to persist as a legacy for some years in many companies for reasons such as cost and risk aversion in the replacement of the existing systems. 24

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model. Besides the administration of personnel, especially, the need to attract, hire, manage, develop, and finally retain qualified personnel is key. While this is often already a challenge in the home market of the vendor, it is even more challenging in foreign markets where the employer brand (if existing) is competing against the local heroes of the labor market. A common challenge for larger enterprises, especially when organized in matrix organizations, is management and distribution of power in leadership. A common understanding within the enterprise about the balance of power must be reached and practiced: Who has the last word? The matter of functional leadership surfaces with significant implications.25 In cases where overall P&L responsibility, e.g., for a specific business unit, resides outside the seller’s country, local representatives are legally responsible in the country for the action of the seller. This fact shifts immense power to the local organization also for decisions with financial impact, affecting the  local P&L.  It furthermore has implications in areas of interest to authorities, such as tax position or financing requirements.26 Especially, in large multinational organizations this argument is frequently used to give weight to interests of a local legal entity over the interest of the overall (regional or global) business. Other topics considered for the direct business model remain valid, but are to a lesser extent directly related to the choice of transactional model.  As the avoidance or management of PEs conceptually does not play any role in the merchandize business setup, HR does not need to perform certain activites (such as tracking of days spent abroad for customer visits or managing foreign income tax declarations) required for direct business.  The  focus therefore can be  to provide platform and processes for education and training to ensure compliance with transactional models when working across borders, particularly for crossborder agents.

Summary of Implications for Vendor and Customer Crossborder transactional models require specific settings from the vendor and from the Customer, more precisely from seller and buyer in the country in scope. There is rarely a need, reason, or choice in a business relationship to influence or change the existing transactional model. It is important, however, to be aware of the implications and requirements along with the risks and opportunities for increased efficiency of the model one is operating in. For merchandize business transactions, key factors for vendor and customer have been selected. Depending on the industry and the specific setup, the importance and weight of these factors might change, or others might need to be added.

 Functional (= not necessarily, but frequently from outside the legal entity) vs. disciplinary (= within the legal entity, therefore enforceable with labor law) leadership. 26  Other areas beyond the discussion of transactional models include EHS (Environment, Health, Safety) decisions, workforce decisions, or general contracts and investments. 25

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Vendor Merchandize business transactions allow most degrees of freedom for customer proximity, but also require compliance to the local laws of the legal entity in the country of the customer. The synopsis reveals key areas of attention for the merchandize business transactional model, despite it is the only solution for maximum customer interaction for vendors. • Requirement to maintain installations in the country of the customer along with all consequences, especially operations under a foreign legal framework. • Credit terms potentially governed by local laws. • Currency risk if forced to use local currency by law or lack of negotiation power. • Invoicing according to rules of foreign countries legislation, adding complexity due to varying local requirements of tax authorities. • VAT to be charged to the customer locally, along with requirement to reflect this in credit management and credit lines. • Export regulations of own country remain, import regulations of foreign country to be considered additionally (unless customer-to-clear is possible). • Company license required for buying, selling, or converting specific products (dual use, pharma, food, feed, electronics, etc.) and also for importing, unless customer-to-clear process is possible. • Product registrations required. • Import process if the goods are brought into the same country as the customer’s buying enterprise (ship-to = sold-to), not in case of CtC (seller imports products): –– Import licenses. –– Company license required for buying, selling, or converting specific products. –– Handling of products licenses including storage facilities. –– Regulations for the import of specific products. –– Acquisition and management of quotas on the import of goods, if applicable. • Import duties potentially to be paid by seller, depending on Incoterms: –– Import turnover tax. –– Custom tariffs. –– Specific excise duties (such as mineral oil tax or packaging tax). • Warehousing and logistics component to be managed by local legal entity or with the help of external service providers. • Requirement to run an ERP for an additional legal entity in line with the overall IT strategy and desired degree of transparency and automation. • Leadership matters based on shift of power to local legal entity. • Need to attract, hire, manage, develop, and finally retain qualified personnel in a foreign country. • Customer interfacing activities with hardly any restrictions from a PE perspective, particularly for local employees with customer-interfacing activities, but also less tight for crossborder agents.

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Customer For the customer, the merchandize business transactional model results in the following: • Applicable law for the transaction is the local law of the buyer, unless otherwise agreed upon by the parties. • Bound to local regulations potentially limiting payment terms. • Unless agreed differently (if permissible), invoicing in local currency eliminates own currency risk for all local business. If majority of goods manufactured is exported again, currency risk arises (compared to buying in foreign currency). • In any transactional model: –– Company license required for buying, selling, or converting specific products. –– Handling of products licenses including storage facilities. • Import duties potentially to be paid by seller, depending on Incoterms: –– Import turnover tax. –– Custom tariffs. –– Specific excise duties (such as mineral oil tax or packaging tax). • Product registrations might (need to)  be acquired or referenced  by seller; if importer – potential competition. • Local VAT to be paid, reimbursement by government only later potentially creating a financing need. General Overall assessment of the merchandize business transactional model depends on the specific setting of the vendor, the requirements and structure of the industry along with the market position of the companies involved for the countries in question. Under the paradigm of full control over in-house resources at the vendor, the merchandize business model is the transactional model allowing maximized flexibility for customer interaction, especially when considering the process variant of customer-to-clear. Its flexibility compared to the direct business transactions comes at the price of a legal entity to be maintained in the foreign country: Synergies could be captured by leveraging such an entity to a hub for own direct business transactions, e.g., into (smaller) neighboring countries. The principal–agent transactional model comes as a hybrid between the merchandize business transactional model and the direct business transactional model. While internal agency business transactions are under scrutiny of the OECD BEPS guideline, external agents are still permissible. The price to pay in that case is a reduced control over market access and customer relationships.

6

Agency Business

The agency business transactional model is a hybrid between the direct business and the merchandize business transactional model. It brings most of the benefits of merchandize business along with the significant cost advantages of direct business. Agents (defined as either principal-controlled or independent local companies, their employees, or individuals) are compensated by a commission to act as messengers of the principal. Furthermore, they build and manage local relationships, monitor the transactions, and observe market developments. Beyond this, they might also become involved in negotiations, closing, and eventually even signing an agreement with the customer. All these activities reach far beyond the role of a messenger and – in case of internal agents – practically create a permanent establishment (PE).1 This fact has been explicitly confirmed by the OECD BEPS guidelines with the result that the agency business as transactional model using internal agents becomes increasingly unattractive for most companies. The chapter starts with a definition showing the several variances of the agency business transactional model including the role of crossborder agents. The implications for the activities and tasks of the functions of the vendor’s and customer’s enterprise in their respective legal entities are reviewed as in the previous chapters. The chapter closes with a summary of implications of the agency business model for the customer and for the vendor.

 Internal agents are employees of a (mostly local) legal entity where the vendor is the major shareholder or has otherwise control over. 1

© The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 M. C. Solbach, International Business Transactions and Taxation, Management for Professionals, https://doi.org/10.1007/978-3-031-39240-5_6

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Definition The agency business transactional model, also referred to as principal–agent or agent–principal model, is characterized by one legal entity of the vendor acting as principal and another legal entity, typically located in the country of the customer, acting as agent for customer acquisition and as customer interface. If the legal entity of the agent is owned or effectively controlled by the principal directly or indirectly through subsidiaries, agents are considered internal agents; otherwise these entities are external agents. The mechanism works across borders between Country A and Country B for international business transactions. In case the customer interface is supported by other persons from a third Country C, these persons (and the legal entity behind) act as “crossborder agents.” The status of being an agent is assessed by their activity, i.e., whether typical tasks of an agent are being conducted. It does not require to have an agreement with the principal describing scope and compensation schemes in order to qualify as an agent from the perspective of the authorities.  Similarly, also definition of dependency from the pricipal is not limited to the share of ownership, but can also be established through other indicators, e.g. commercial dependency from principal’s products. “Transaction” relates specifically to the parties involved in the legal and financial part of the transaction including negotiation, contracting, invoicing and payment. The physical flow of goods might deviate from this based on the internal supply chain set up of vendor and customer with respect to the location of their legal entities for manufacturing.

Basic Model: Internal Agents – Addressed by OECD BEPS By character, the agency business transaction is a direct business transaction supported by the presence of a (local or crossborder) agent. The basic model refers to two countries with goods being sold from the vendor in Country A directly to a customer in Country B.2 The flow of goods follows the flow of invoice from Country A to the buyer as customer’s legal entity in Country B (see Fig. 6.1). Other than the transaction itself, the customer interface is designed differently compared to a direct business transaction as selected activities relating to the sales function are conducted by the agent. In the example chosen, the Account Manager as customer interface is employed by the local subsidiary in Country B (Agent), which in fully owned by the principal in Country A; accordingly, the agent is an internal agent in scope of OECD

 In the context of the book, the focus is on crossborder business transactions. Agency business within a country is conducted frequently also with internal agents and is not subject to the restrictions of international business transactions. 2

Definition

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Fig. 6.1  Flow model for crossborder agency business transactions [“Basic Case”]

BEPS. Under OECD BEPS, this setup results in a permanent establishment of the seller (principal) in Country B.3 Compared to the “pure” direct business transaction, the key advantage lies in the fact that the presence of a customer interface (account management, marketing) for sales-related activities (such customer acquisition, customer relationship, and – in a certain way – also the support of negotiations) is less limited compared to a direct business transaction as the agent is resident and employed by a local legal entity of Country B. As a consequence, business travelers from the principal now can engage in customer activities to almost any extent.4 Downside of the model is that the agent only may act as a messenger for the principal. From the moment, agents actively engage in the negotiation or even close and sign an agreement they become either contracting party or principal as the intended contracting party becomes represented in the country by their action and thereby taxable as permanent establishment. Figure 6.2 below adds these details of the limitations of agents to the picture: They attend negotiations, convey commercial messages from and to the principal, and manage the relationship. Conclusion of the agreement and signature of a contract – if applicable – remains in the hand of a representative of the principal. The local legal entity employing the agent is compensated for the efforts through an (internal) agency agreement between the vendor entity in Country A acting as principal and the local subsidiary in Country B.

 While this is not desirable for some companies, others might opt to establish and manage a permanent establishment in selected or all countries of their activity. 4  Personal income tax considerations left aside. If a Double Taxation Agreement (DTA) exists, a typical time for maximum presence is 183 days per year before income tax is imposed on the individual. 3

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Fig. 6.2  Crossborder agency business transactions with internal agents

It is important to highlight that the principal–agent transaction is permissible also involving internal agents, as long as the PE is declared and managed with the implications lined out in section “Managing a Permanent Establishment” for some enterprises, this might be an option while for others this might not be desirable or even prohibitive to their business from a cost, efficiency, or organizational perspective.

Basic Model: External Agents Agency business involving external agents is visualized in Fig. 6.3, following the same basic principles as internal agency business except for the agency agreement: This is concluded between the principal and an external legal entity. By definition, this may not be owned by, under the financial control or dominating influence of the vendor as principal. If this nonetheless would be the case, the external agent would not be considered external and therefore structurally establish a PE of the vendor in Country B.5 While this seems attractive at first sight for the organizational advantages, using external agents is also associated with risks: • Dependency of the vendor on the agent managing customer relations. • Management and protection of proprietary knowledge.  If the external agent would still sign a contract for the principal, it became primarily a matter of rightful representation of the principal from a legal perspective. From a tax perspective, the principal could hardly be held responsible for the wrongdoing of a party not under his control – unless the principal would accept the agreement, e.g., by executing it. 5

Definition

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Fig. 6.3  Crossborder agency business transactions with external agents

• Exclusivity considerations go both directions: for the agent and for the vendor. • Limited influence on priorities if agent acts for several, even non-competing principals. Negotiations can take place anywhere without any harm to the tax position, the agreement itself between the buyer in Country B and the seller in Country A – the principal – must only be concluded by a representative of the seller, advisably in the country of the seller and especially not in any premises potentially rented or maintained by the seller in Country B as this could already hint to a permanent establishment. This is especially important as activities and contacts with the potential to create PE are likely to happen during one and the same visit of the principal in the agent’s country: managing the agent and equipping him with know-how, technical support, representation at the customer, and visits at industry associations are activities that are frequently combined. The “direct-sales-piece” of it however needs to remain outside the country to avoid hints to a PE. In practice, some countries also rejected this argumentation by not accepting the external agent as an agency setup, thereby reverting the model back to a direct business transaction with the corresponding implications for a PE including  corporate taxes and income taxes of principal’s business travelers to this country. Any commercial activity of the principal’s employees – such as negotiations in the country or signing of a contract – therefore needs to be strictly separated from agent- or general market-related to avoid indications for a permanent establishment. The strict limitations of the direct business transactional model with regard to days of presence therefore also apply to the principal when using external agents,

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yes

Agency Business:

Variaon 2

Agency Business:

Variaon 3

Crossborder Agent Agency Business:

no

Basic Case Internal Local Producon Basic Case External

Agency Business:

Sold-to = Ship-to

Sold-to ≠ Ship-to

Variaon 1

Customer Sold-to & Ship-to Fig. 6.4  Generic variations of the agency business transactional model

especially for the commercial, customer-facing activities of its employees in the country of the agent. Consequently, these commercial activities should not be conducted in the country of the agent.

Variations of the Basic Agency Business Transactions Using the same parameters as for the direct and merchandize business transactions, variations also unfold for the agency business model (Fig. 6.4). The deviation of ship-to and sold-to locations of the customer (Fig. 6.5) does not impact the activities of the agent itself as compared to the basic agency transaction, but rather activities supporting the changed flow of goods, i.e., in matters of VAT, trade control, and regulatory and supply chain in general. In these cases, direct business guidance for the flow of goods to the ship-to country needs to be applied. Sub-variations are possible, each with specific implications, which need to be considered. One of them refers to the case of an “outbound” crossborder agent conducting sales-related activities in a third country with a ship-to and sold-to location of the customer (see Fig. 6.6, Variation 2). Compared to the previous case (without a sold-to location in the third country), also the sold-to entity of the customers is located outside the residency country of the agent, thus making him a crossborder agent. This implies that not only the flow of goods is affected, but also the contract and thus the invoice is directed to the entity in the third country. By design of the agency

Definition

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Fig. 6.5  Agency transactions: variation of customer’s manufacturing locations (ship-to ≠ sold­to): [“Variation 1 – with no local manufacturing”]

Fig. 6.6  Agency transactions outbound crossborder agent covering third country [“Variation 2”]

transactions, it is handled comparable to a direct business transaction to the third country by the seller in Country A, while additionally paying a commission to the vendor’s legal entity in Country B. In this setup, it is likely that the government of Country X is looking for opportunities to tax the transaction; the vehicle for potential taxation is the PE.

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Fig. 6.7  Inbound crossborder agent into agency country

In a crossborder setting in agency business, the guidance for sales-related activities to the organization therefore is also no different than for other crossborder agents, even though ship-to is the same as sold-to in Country X. The reverse case is the activity crossborder agents from Country X in Country B, as for example, a global key Account Manager or specialist based in a country, which is neither the country of the principal nor of the agent joining for customer interaction. In this case, the guidance for this crossborder agent also remains valid, while for the flow of goods and for the financial transaction the guidance for direct or merchandize business, respectively, applies. Rules for the flow of goods are equal to those applied in direct business transactions for the ship-to country in question (Fig. 6.7). Variation 3 of the matrix is illustrated in Fig. 6.8. The crossborder agent situation arises since the sold-to entity of the customer is not located in the country of the agent, while the ship-to is. When serving the customer at the ship-to location, the agent acts as an “regular” agent, while he becomes a crossborder agent (with a different guidance) when serving the customer at the sold-to in Country X. While such a setting seems awkward at first sight, it makes much sense in case where proximity to the factory of the customer, e.g., for technical or logistical support and for relationship management to decision-makers is more important than proximity to the purchasing organization or the sold-to entity of the customer, potentially being a global purchasing or procurement hub at the another part of the globe. As far as the presence and interaction with the sold-to entity of the customer is concerned, the agent acts in the role of a crossborder agent with the corresponding rules. As sub-case of this variation adds a further component: The ship-to location of the goods is not based in Country B, but in yet another country, which is neither the country where the agent is located, nor the country of the sold-to location of the customer. A fourth or even several other countries thus might be involved as ship-to countries, making the agent a crossborder agent at both locations.

Definition

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Fig. 6.8  Agency transactions: outbound crossborder agent covering third country and sold-to ≠ ship-to (Variation 3)

Fig. 6.9  Agency transactions: local manufacturing of vendor

Multiple Manufacturing Locations of Vendor in Country of Principal and Agent A specific situation exists through one variation of basic model: The case a manufacturing location of the vendor is situated in the country of residence of the agent for the same or another product sold to customers in the country of the agent requires further consideration (see Fig. 6.9).

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• On the one hand, the local entity of the vendor acts as agent to local customers for products sold by the vendor’s principal abroad, from the flow of goods perspective technically in a direct business transaction. • On the other hand, there is also local production in the country of the agent manufacturing the same or other products. These products are also sold locally to the same customers. • In the latter case, the local legal entity needs to take the role as seller and thus contracting party for the locally manufactured products only in parallel to the role as agent for the portfolio from abroad for which the legal entity of the vendor abroad remains the seller (as marked in pink in Fig. 6.9). Deviating countries of vendor’s manufacturing locations have therefore implications for both, the invoicing flow and physical flow of goods, as shown for direct business and merchandize business transactions in previous chapters. It applies to different products and to different transactions of the same product sourced from different manufacturing locations. Some implications of this case are covered in the following chapter. Independently from any details, however, it must be concluded: Agency business setups require a very distinct awareness of the respective role as agent, crossborder agent, or full representative of local legal entity, especially in the sales-related functions like in business and account management. Figure 6.10 further expands the range of variations in international business transactions by adding an inbound crossborder agent (e.g., a global key Account Manager) to the local agent and the principal negotiating in Country B as residence of the headquarters of the customer. Additionally, the customer is supplied at two or more ship-to locations.

Fig. 6.10  Agency transactions with local and crossborder agent

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The picture could be further expanded by adding manufacturing locations of the vendor in different countries, same or different to the ship-to locations of the customer. While from a supply chain, foreign trade, legal and financial perspective such a setup is typically matched by the IT systems or corresponding functional routines, the awareness for roles and responsibilities depending on the business transaction on the commercial side tends to be weaker in many companies. The additional complications unfolded here in the context of agency business can largely be applied to merchandize business (by replacing the local agent through a merchant) and even in direct business: Crossborder agents remain an element in almost all cases of more complex international business transactions - and a dormant risk for creating a PE. As there are rarely specific rules defined the advice is to train the organization for a high awareness regarding the role individuals are taking in each situation and avoid any structures, processes or activity that could give reason to believe that a permanent establishment is created. Finally, it needs to be recalled that – in case of internal agents – OECD BEPS guidelines as implemented in local legislation require the installation and maintenance of a permanent establishment with all consequences in terms of cost, complexity, and taxes. External agents, however, can still be used in transactional models, then with the disadvantages and risks as discussed out before. For the discussion of agency business, the following section on implementation will focus on the basic model and some common variations from the vendor perspective.

Functional Considerations for Implementation The agency business transactional model offers similar advantages for customer proximity to the vendor as the merchandize business transactional model based on presence in the country of the customer and buyer. In case of the internal principal– agent model, this is even the case in form of an owned or controlled subsidiary. At the same time, the vendor is safeguarded by the legal framework of the seller’s (= principal’s) country, frequently the home market or chosen place advantageous for the vendor. While the contractual relationship with the customer is based on legal grounds familiar to the seller, a local legal entity still needs to be managed abroad for running the internal principal agent model. In this regard, it is the same as for the merchandize business setting. Owed to the hybrid form of the agency business, functional considerations will be limited to the following three areas and based on the transactional similarity to direct business summarized for the others: • Business Management: Marketing and Sales. • HR. • Corporate taxes.

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• Remaining functions summarized • (Legal, Finance and Transactional Taxes, Regulatory and Trade Control, Supply Chain Management, IT and Master data). The chapter will provide a framework for evaluation which key topics of the respective functions with regard to the agency business transactions need to be considered for a compliant setup. Particularly, the “freedom to operate” for the agent and the corresponding way of managing it will be in focus. Internal agency business as defined in the  OECD BEPS guidelines (if ratified locally) always triggers a permanent establishment to be managed by the principal. The basic perspective chosen is therefore from internal agency business including crossborder agents; external agency business will be highlighted for specific considerations only.

Business Management: Marketing and Sales Agency business transactions are facilitated by a local agent typically at the interface to the customer regarding sales-related activities. As illustrated above, this setting allows to combine the transactional advantages across borders of a direct business setting with a local representation abroad. As OECD BEPS sanctions the internal agency business, the principal might still opt to actively pursue a permanent establishment for the purpose of maintaining agency business transactions (as opposed switching to a different transactional model, i.e., merchandize or direct business). This decision has the following key implications for the agent: • Setup of a permanent establishment in the reporting of the local legal entity for corporate tax purposes. • Monitoring of business travelers from the principal for customer visits as their income becomes locally taxable from the first day of presence in the country (income tax). • Setup of training programs for employees to ensure compliance with role as agent, crossborder agent, or – in case of local production – representative of the local entity; • Ensure structural documentation  and operational (day-to-day activity) reporting by employees for the activities in their different roles described above. Besides the implications for the agent, there are also consequences of the permanent establishment for the principal, affecting (customer) visits of representatives of the principal in the country significantly: • Management of income tax and thus cash situation of employees of the principal visiting the agent’s country (to be covered in more detail in the HR section below). • Platform for monitoring travel days and purpose, including guidance on for combined travel (business and leisure) and vacation days spent in country independently from business travel. • Support of local legal entities for training of agents.

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From the perspective of a representative of the principal with a heavy travel schedule (Account Manager, technical service, management) engaging in sales-­ related activities at the customer, customers in countries with such documentation requirements and personal tax consequences become a significantly less attractive target for visits and service. Through the bachdoor, the choice of agency business as transactional model takes significant influence on the effectiveness of the marketing strategy. These arguments indicate that the use of agency business transactions needs to be supported by very strong business reasons that pay off for the huge supporting efforts to be undertaken for compliantly operating this model. Increasing size and complexity of the entity, especially on the principal’s end, result in decreasing attractiveness for the internal agency business setup – if attractive at all from a corporate tax point of view. While the management of a PE solves the legal topics on the tax side, the legal side regarding negotiations and contracting remains unchanged for both, external and internal agents: They remain not to be legal representatives of the seller (this role stays with the principal), unless equipped with a proxy of the principal. This implies that neither agent is in a position to really negotiate, close, or even sign contracts on behalf of the principal or – particularly for the internal agent – make (binding) offers to the customer. Negotiations thus become more formal as any position proposed to the customer needs to be framed with relativizing clauses like “I could imagine the Principal would consider….”. Binding offers are to be made by or based on a specific instruction of a representative of the principal only.6 While a proxy would solve the conflict of legal representation, issuing a proxy to an agent needs to be carefully considered and backed up by solid control mechanisms (or fundamental trust). Potential fraud is difficult to detect over geographical, cultural, and legal distance, and foreign jurisdictions typically make it more difficult to enforce rights or claims. Besides legal considerations, the psychological moment of a Sales function without power to negotiate sends a negative sign to both, the agent and to the customer, and therefore is not to be underestimated. Especially directly in front of the customer, it requires a solid rootage in the role of the agent combined with the discipline not to decide, accept, and make offers. Instead, the conversation needs to be taken as is and brought it back to the principal for evaluation and messaging back. With regard to sales leadership, a management across borders in a regional leadership role of the Sales function requires a high degree of training for the leader to understand the different roles he takes himself as principal, as agent, or potentially as representative of the ultimate shareholder. Furthermore, sales leadership needs to be able to explain and enforce the very differentiated roles of the Account Manager acting as agents, crossborder agents, or potentially as principals of own local production.

 This general statement applies to any agency business transaction, also if conducted within a country and not across borders, unless supported by a proxy of the principal. 6

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This requirement applies independently whether the leadership role is based on the principal, the agent, or a legal entity in a third country. The consequence of these different roles is less standardized processes for contracting (negotiation, agreement, signature, fulfillment) reflecting the specific setting. This results in increased support requirements not only for the Account Manager but also for the back office for preparation and fulfillment. Besides the technicalities of the process, biggest challenge for the sales leadership of agents is the stretch between reminder of the role designed as messenger and the mantra of contemporary leadership demanding entrepreneurship, ownership, and empowerment: As agents by design formally are not the ones to decide on the business, it requires outstanding leadership of management skills to keep agents motivated for ownership and responsibility for their customers. Working with external agents avoids some of these complications but adds others. While tax considerations regarding a permanent establishment or income tax for visiting employees of the principal disappear or can be argued, general concerns on the business side remain similar to business via a distributor. These topics include in addition to those listed in section “Basic model: External agents”: • Management of proprietary knowledge of the principal. • Exclusivity for the principal. • Rights toward jointly acquired knowledge, e.g., of the application of the product at the customer. • Performance management of the agent balancing short- and long-term goals. • Loyalty and further development of the agent. For a sales management that is working with a combination of own resources, external agents, and potentially distributors, it is crucial to ensure effectiveness for all channels. External agents, especially if individuals instead of organizations, therefore tend to be led very similarly to own resources, thereby consuming leadership capacity and potentially sacrificing a portion of the efficiency of the setup.

HR and Leadership A requirement to the HR function for supporting the agency business transactional model unfolds at both sides, the legal entity of the principal, and the entity of the agent.7 Requirements at the Agent Key areas for HR at the agent are training, recruitment and development, and leadership.

 A footnote to remember: Internal agency business results automatically in a permanent establishment as defined by OECD BEPS. 7

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The local company (legal entity) of the agent must ensure, monitor, and document training of employees in sales about the do’s and don’ts for the roles as agent, crossborder agent, or representative of the local entity, as mandated by the organizational design of these tasks. With regard to local employees in customer service, it needs to be ensured that their activity is strictly following their role for transactional services. This means a strict limitation to the implementation of existing agreements, which is not to be expanded to sales-related activities such as cross- or upselling. For companies with a stringent line organization consisting of one or few strictly separated business units, guidance per organization and employee is based on one perspective and thus straightforward to implement. With an increasing integration of business units, locations and resources of a company (broad portfolio of business units, shared resources in sales and customer service across business units, and Shared Service Centers working across borders), the variety of roles of each individual increases to the point that in the very same discussion with a customer, several roles and their actions might need to be differentiated.8 For a successful implementation of a managed PE under agency business, it is crucial to keep the number of variations extremely limited. While there are many reasons to limit complexity, two reasons are particularly important here: • Firstly, an increasing number of variations between business units significantly increase the risk for negotiations and contracting beyond the legal authority to do so. • Secondly, an increasing number of variations require attention and energy of the whole organization, but particularly of sales, to execute action differentiated by the role taken in a situation. This energy should rather be focused to the core task of serving the customer than to largely administrative (although important) topics. Also in this case, simplicity ensures focus for market success. On the topic of recruitment and development, employees must be hired with extraordinary qualifications. New hires need to bring (or be trained) a high degree of awareness for roles and the ability to manage multiple roles, sometimes even in the same moment – and then act accordingly in a differentiated way. This requirement goes along with a self-understanding for ownership and entrepreneurship, which is rather team-based than egocentric when it comes to decision-making and success. Accordingly, compensation schemes need to be established rewarding a team approach rather than individual success. Regarding employee development, a unified approach for training on business transactions, which are standardized for all business units, facilitates internal transfers and ensures focus to products, markets, and customers instead to administrative processes.  Examples: (1) Agent for Product A as agency business from abroad (messenger), full representative for Product B from local production (negotiator); (2) agent (= messenger) for Business Unit A [“tooling”] working with a managed PE, negotiator for Business Unit B [“supplies”] operating under a merchandize business transactional model. 8

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These tasks add on top to the general challenge of a foreign company to compete against the local heroes of employers and attract, hire, develop, and retain qualified personnel.9 Leadership across country and legal entity borders typically – and especially in organizations with matrix structures – requires a profound skillset based on team spirit and motivational and other “soft” skills. This is required to an even larger extent than leadership within one legal entity with a solid disciplinary line.10 In case of larger organizations and shared resources across business units, individuals frequently own several reporting lines to different managers. Coaching and accompanying Account Manager in such an organizational setup for itself is a challenge. In case role of an Account Manager regarding the transactional model varies, complexity increases and results in even more and functionally highly specific leadership requirements. Consistency of content across different leadership relationships and leadership levels becomes even more important to ensure clarity and impact. Therefore, agency business requires leadership time and resources to be dedicated to roles, rules, and permissible actions instead to the customer and other general leadership topics. The alternative choice is to focus on business while accepting the risk and gradual incompliance, while hoping for no complaint or prosecution.11 Under good governance and for a responsible sales leader, this is no choice: The alignment with other leaders needs to be managed and time shifted from customer to coaching and leadership. Requirements at the Principal and Support by the Agent In a managed permanent establishment, local HR of the agent needs to support the principal several ways. Especially, the liability on taxation of income of employees of the principal from the first day of presence in the country of the agent triggers a set of obligations for the principal, which requires local know-how for guidance in taxation of business travelers. Administratively, also the interaction with local authorities in that matter needs to be supported. From a HR management perspective, the following questions need to be organized: • Management of income tax situation of employees: –– Support in international taxation matters, mostly through external service providers, including coverage for their cost.

 This challenge applies in the same way as in the merchandize business setting; see also section “HR and Leadership”. 10  Disciplinary here is referred to in the very narrow sense indicating both employees as part of the same legal entity as employer. 11  It is fair to state that the main risk of an internal agent locally under a PE organization installed would be falsely representing the principal, which is out of scope of the authorities, but rather be a matter of potential claims under civil law; as a crossborder agent, however, he still runs the risk of accidentally establishing a PE in another country, no different than any other crossborder agent, e.g., in merchandize business. 9

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–– Liquidity management for employees, as income taxes need to be paid in several countries at the same time, potentially leaving employees with significantly reduced, no, or even negative monthly income. –– In case of DTA (Double Taxation Agreement): double taxation to be avoided by claiming back taxes paid in excess. –– In case no DTA exists: compensation mechanism for employees affected. –– Personal disclosure matters: taxation for income taxes might require declaring other components of income or even total wealth in some legislations. • Platform for monitoring travel days and purpose, including guidance vacation days. The documentation for the income taxation requirements for business travelers to the country of the agent needs to be fulfilled. Initially, the scope needs to be clarified with regard to the following questions for each country specifically: • Whose presence to be counted: –– Sales. –– Technical service. –– Customer service/logistics. –– Management visits. • Purpose of presence to be differentiated by: –– Business days: Customer visits only or internal visits to be included? –– Vacation days: Only in combination with business travel or all? • How to be counted: two people, one customer visit, one day: one or two days? These matters need to be assessed in close alignment with the Tax function or even specialized external support to form the basis for building up corresponding tools for documentation.12 Especially, the high efforts required for managing the income tax issue of the agency business model make it almost prohibitive in terms of cost to run it at a broader (e.g., in terms of geographies or employees) extent in most organizations with meaningful business on countries abroad. Besides this corporate view, from the individual perspective of an employee the setup is to most people highly unattractive in terms of efforts, financial uncertainty, personal risk, and finally broad information disclosure of personal financial information to authorities in countries visited for business purposes. Additionally, the time lag of income tax filing and returns might put up an extra hurdle for changing employers. Based on this, leadership challenges are obvious for motivating employees of the principal for customer visits in an agency business run country (see also section “Business Management: Marketing and Sales”).

 Leaving documentation to employees individually is no choice because of lack of control over quality, consistency, and format of data received. This is especially the case when the risk for owing the income tax remains with the employer by law, as in some jurisdictions. 12

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External agents would neither maintain a functional relationship with the local legal entity of the vendor, nor would their activity require the foundation of a PE. Therefore, the use of external agents in parallel to an own legal entity maintained in the country for other purposes or even for sales activities of other business units would not trigger an immediate effect on the HR function. Requirements for steering and control by business or sales management and the documentation of visits of the principal to the country remain in place, as discussed previously in this chapter.

Corporate Taxes at Principal and Agent Agency business transactions with internal agents can only be operated according to OECD BEPS guidelines by maintaining a permanent establishment of the principal in the country of the agent. This PE is formed by creating financial statements for the agency business with the respective country in the ERP of the principal. These data determine the profit base for taxation according to the tax-applicable legislation based on the ERP of the principal. The principle mechanism for corporate taxation under agency business with PEs is summarized as follows: • Taxation of full profits (including those generated from agency business transactions) at the residence of the principal. • Taxation of PEs in agency countries. • Reclaim of taxes paid in residence country for profits taxed in agency countries, –– as per DTA if applicable. Besides the corporate taxation of the principal, agents are taxed in their respective countries for the profits generated based on their turnover. In the simplest setting, the turnover is exclusively generated from agency fees paid by the principal.

Remaining Functions Operate as in Direct Business The remaining functions analyzed for international business transactions operate under agency business in the same (or very similar way) as in direct business: Key reason for this is the contracting parties to be the same in both transactional setups. As explained earlier in this chapter, special attention needs to be paid to the negotiation and contracting process, based on the involvement of the agent as – compared to directbusiness – additional party involved. Legal Key consideration for legal in term of business transactions is the contracting parties, which in the case of agency business are the principal as seller and the buyer as the legal entity of the customer in the country abroad. The framework for contracting remains as in direct business setting; i.e., only an employee of the principal may negotiate, conclude, and sign an agreement.

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The advantages of the direct business setup from a legal perspective have been discussed in previous chapters: • Agreements typically governed under the jurisdiction of the seller’s residence or registered address. • Familiarity of seller with jurisdiction. • Liability considerations. • Synergies in handling agreements from a qualitative (know-how and specialization) and quantitative (economies of scale) perspective. Finance Agency business requires the same setup in finance as direct business (see section “Finance and Taxes”). Specifically, this refers to: • • • • • •

Terms of payment. Credit risk management and security mechanisms. Foreign currency risk. Invoicing. Cost of capital (CoC) and related financing. Transactional taxes and duties.

Compared to the direct business setting, the presence of an agent adds advantages to fulfilling these tasks, e.g., in credit risk management, independently whether it is an external or internal agent. Local knowledge acquired directly or through the local market, visits, observation, and access to databases provide valuable first-hand information to the credit decision; the local agent is even allowed to be – from an internal perspective – decisively involved in the credit management process relating to the transaction. In case of an internal agent, this requires the installation of the PE. Access to and assessment of locally developed security mechanisms – in some cases offered only locally or only to the buyer – make a further difference to direct business. No deviations from or additions to direct business, however, are to be considered for Fx management or invoicing. Financing requirements have been analyzed already regarding differences in the cost of capital resulting from merchandize business vs. direct/agency business in the Chapter “Merchandize Business”. In agency business transactions,  financing requirements arise for the principal mainly driven by a set of tax-implied differences compared to direct business transactions as shown in Fig. 6.11. The table differentiates between the primary financing needs as capital requirements on the one hand and cash cost reducing the capital contribution to the principal on the other hand. Next to the establishment of a local subsidiary along with cost for employees, building, energy, and advisors and the base financing of the legal entity, further financing needs are tax-related as an “entry ticket” to establish the agency business. Income tax-related effects refer to the taxability of business travelers from the principal into the country of the agent from the first day of presence in most

6  Agency Business

106 Consolidated Financing Need for Vendor induced by … Topic Local subsidiary (Agent) incl. sales personnell

... Capital Requirement

... reduced Cash Contribution

financing of legal entity

cost of local legal entity

Income-tax related effects of business travelers of Principal

pre-financing of double tax payments prior reimbursement

cost for tax advisors & admin risk of non-reimbursement

Corporate Tax: PE´s tax payments prior potential DTA -based reimbursement by country of Principal

pre-financing of double tax payments prior reimbursement

cost for tax advisors & admin risk of non-reimbursement

Value Added Tax (VAT) on Agency fees - non reimbursable -

cost

Fig. 6.11  Financing needs for principal of internal agency business compared to direct business

countries and include the financing of the double tax payments in their local country of employment and the country of the agent before reimbursement by the respective jurisdiction. Depending on the countries, this process can be expected to range between several months to several years, supported by tax advisors and – depending on the size of the company – a significant administration requirement, especially considering professional mobility of employees within or outside the company. On top, there remains the risk of non-reimbursement and the requirement to the company to potentially compensate for the damage to the employee. Effects resulting from corporate taxes include the corporate tax payments for the permanent establishment in the country of the agent: Although it needs to be considered pre-financing initially, it remains uncertain whether and to which amount the jurisdiction of the principal will reimburse these payments which then would turn into cost and this lost cash contribution. The “Bosch Case” as described in the appendix might be an example of how expectations for reimbursement based on the DTA have been disappointed. Additional cost is generated in the administration for managing the PE including tax advisors. Additionally, value-added tax accounts for an additional financing need in the form of additional cash out compared to direct or merchandize business. As the VAT on agency fees of the principal to the agent is non-reimbursable in a broad number

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of countries, this does not only affect the cost position, but also results in a permanent and repeating loss in cash contribution.13 Transactional Taxes and Duties The effect on corporate income tax has already been described in the section above and in section “Corporate Taxes at Principal and Agent”, along with the tax considerations for the employees of the principal in section “HR and Leadership”. Particularly, VAT needs to be considered the same way as in direct business (see section “Finance and Taxes”): Export invoices typically do not include VAT, thereby reducing the amount of the financial transaction and thus financial requirements on the buyer’s side. Within the European Union, specific formal requirements for B2B business need to be followed, including official VAT registrations of seller and buyer in the respective countries. On the vendor side, this need is concentrated at the principal as the seller instead of being spread over all agents and their respective sourcing relationships. This becomes transparent when compared to merchandize business: The vendor benefits from the advantage not to have to invest in and (annually) maintain VAT registrations for the all agents in each country for each of their supplier countries, as the agents would not source from the supplying countries separately, but rather using the principal as one single hub. This provides significant efficiencies of the agency vs. merchandize business, which need to be balanced against the cost for managing and maintaining the PE. Furthermore, the flow of goods needs to be considered when it deviates from the flow of invoices: especially goods manufactured within the agent’s country and remaining within the country, while the financial transaction is a direct sale to a customer in the agent’s country from the principal abroad require a different VAT handling than the cases where the flow of goods follows the flow of invoices. Excise duties apply to the use of product and are to be considered as in direct business: 14 The taxpayer for excise duties in the foreign country is the buyer, not the seller outside the tax regulation. Also in these cases, the physical flow of goods and the flow of invoices need to be considered by country to assess the specific tax situation and identify tax liabilities. Regulatory and Trade Control The processes and topics for regulatory topics and for trade control do not deviate from those applied in direct business transactions: Importer of goods is always the customer with the buying legal entity or ship-to location.15 As a consequence, all applicable licenses related to the company, for import and with regard to use of the goods are with the customer entity.  The field of VAT in taxation is requires experts with international VAT experience to review the situation in the full context of transactions and countries involved. 14  For example, Packaging Tax, Mineral Oil Tax, Energy Tax, or Banking Tax, but also on a consumer’s level Beer Tax, Coffee Tax or Tobacco Tax. See also section “Finance and Taxes”. 15  Unless otherwise though Incoterms agreed, parallel to any agreement in direct business. 13

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Supply Chain Management Order processing and order fulfillment along with the logistics involved are principally run in the same way as in a direct business transaction. IT and Master Data Compared to direct business, additional requirements for IT and master data in agency business are limited to the task managing PEs in the principal’s ERP for financial reporting for tax purposes. Further support requirements might be generated from HR with regard to the taxation of income of principal’s business travelers to the agency countries. Training modules on agency business with regard to different roles of a sales employee of an agent’s entity go beyond the ERP, but rollout and monitoring of training implementation can be supported by IT to cover compliance requirements. Master data for products and customers are not affected compared to direct business; considering it from a merchandize business perspective, master data locally available might not be available at the principal’s ERP and – in case of changing the transactional model from merchandize to agency – would need to be migrated.

Summary of Implications for Vendor and Customer The agency business transactional model combines the advantages of efficient direct business with some key elements of merchandize business, so implications to vendor and buyer show some of these advantages accordingly. Even disadvantages of merchandize business in particular business settings that prove to be superior in many aspects but especially with regard to flexibility of interaction with the customer do not exist.16 The advantages of agency business as a hybrid, however, come at a big cost for the vendor: the managed permanent establishment, as lined out at the end of this summary. Vendor Agency business as a variation of direct business allows most degrees of freedom for shaping business transactions to own needs. The synopsis reveals why conceptually it has been favored by enterprises when acting as vendors in the past: • Almost no requirement to maintain any significant installations in the country of the customer along with all consequences, especially avoiding to operate under a foreign legal framework. • Credit terms can be freely negotiated.

 Disadvantages reconsidered are, e.g., the freedom to freely agree on payment terms and invoicing currency, which play an important role particularly in export oriented industries (“shoe industry Indonesia”), but also import or handling related hurdles, e.g., for dual-use or other regulated products. 16

Summary of Implications for Vendor and Customer

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• Invoicing currency and thus currency risk based on choice according to needs or negotiation power (currency of own country, of customer’s country or third country). • Invoicing based on home countries’ legislation. • No VAT to be charged to customer (with specific regulations for the European Union), but regularly non-refundable VAT to be charged by agent for agency commissions. • Export regulations only referring to own country’s legislation, e.g., on technology, dual-use products, weapons, and other sensitive products. • No concerns about import of products – managed by customer. • Warehousing and logistics component can be fulfilled with help of external service providers. • Customer interfacing activities to be defined and orchestrated including exact role definitions (agent in PE, crossborder agent, representative of seller), which results in high leadership requirements. Customer For the customer, service of the vendor operating under agency business largely has the same implications for the own setup as direct business: • Applicable law for the transaction might not be the law of the residence of the buyer, but rather of the seller or another international place as agreed upon by the parties. • Potential to negotiate advantages through extended payment terms also outside of the regulations of the home country. • Currency risk typically resides with the buyer as invoicing is from the seller outside the country. This can also play to the customer’s favor when working in an export-oriented industry, meaning that majority of goods manufactured from the products bought is being exported (in the same currency as the one used for procurement). • Company license required for importing / buying, selling, or converting specific products (dual-use products, pharma, food, feed, electronics, etc.) • Product registrations stay in own possession  – less potential for competition by Seller. • Import process managed by buyer if the goods are brought into the same country as the customer’s buying enterprise (ship-to = sold-to): –– Import licenses. –– Handling of product licenses including storage facilities. –– Regulations for the import of specific products. –– Acquisition and management of quotas on the import of goods, if applicable. • Import duties, as applicable, such as –– Import turnover tax. –– Custom tariffs. –– Specific excise duties (such as mineral oil tax or packaging tax). • VAT of the seller’s country typically is not to be paid, import duties instead.

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General Advantages of or preferences for one or the other transactional model depend on the specific industry, structure, and market position of the companies involved and ultimately also on the countries in question. OECD BEPS regulations have limited the free choice of the transactional model between vendor and customer fundamentally, particularly due to effects on corporate but especially personal income taxation. The requirement to maintain a permanent establishment for operating under an internal agency business transactional model brings along significant financial, administrative, and psychological burden. Especially, the burden for vendor’s employees traveling on business to disclose personal financial information to many countries makes it highly unattractive for vendors to maintain or initiate this agency business as transactional model to a broader extent, particularly in larger organizations.

7

Conclusion

Business transactions form the foundation of our economy. For transactions within one single legislation, their rules are governed by the civil law of this country, codifying the fundamental beliefs of this respective society. Taxation has always been part of it in any society. When it comes to international business transactions, one common codification must embrace many varying civil and taxation laws. In a competition for taxes between countries, rules have been established on which country gets which share of the pie, depending on how the transactions are designed. OECD and G20 have engaged in this topic and issued with BEPS a further instrument to reach a fair distribution of taxes in global trade. This step has boosted the need for attention to tax compliance initially for large MNEs but increasingly also for midsized and small international players: Taxpayers need to limit the economic risk and protect themselves from double taxation. Current international business transactions tend to be complex involving many entities in the role as buyers, sellers, ship-to, and ship-from locations combined with Shared Service Centers handling specific pieces of the transaction for several legal entities of the enterprise or even several enterprises. The fragmentation of the transaction increases the risk to lose transparency about the location of (taxable) value creation for both sides, managers, and tax authorities. Managers can equip themselves for the challenges by ensuring high awareness for the topic, clear definition of commercial roles and responsibilities, constant training of the organization, and finally sensitivity to deviations from the agreed-upon standard procedures. From a company perspective, choices must be made. These choices are defined in their strategy, which also defines how to operate internationally – and as a result which transactional model to apply best. The three basic models of international business transactions have been analyzed in this book: • Direct Business. • Agency Business. • Merchandize Business. © The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 M. C. Solbach, International Business Transactions and Taxation, Management for Professionals, https://doi.org/10.1007/978-3-031-39240-5_7

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From a taxation point of view, direct business (“Export”) creates no tax base abroad but does leave the company with the risk of constituting a permanent establishment created by accident, insufficient know-how of people involved, or simply  habit. Agency business as a variant of direct business is from the foreign countries’ perspective tax-wise driven by the provision to the agent and their local structures (employees’ income tax). In case of an internal (= dependent)  agent, OECD BEPS defines the agency business as PE.  Engaging external agents still leaves some PE risk with the principal abroad: Independency of the agent needs to be maintained and might need to be proven, and activities of the principal’s employees in the foreign country might be considered entrepreneurial or sales activity. Taxation in merchandize business for the foreign country is based on the profits of the vendor’s local subsidiary, which acts as seller. The foreign country benefits from corporate taxes, local employees’ personal income taxes, and VAT. While this model comes at a cost for the local structures, it is also not risk-free: ICTP defines the profit left with the local entity. As a key driver for profit distribution, the ICTPs are equally regulated through OECD and frequently disputed by the countries on both sides of the border.1 On the positive side, merchandize transactions allow for maximum customer proximity and are therefore likely to be the most practiced model for international business transactions. With these facts in mid, how would a company choose the transactional model that suits them best? How can this be made a conscious decision, and if required, how can business be switched from one transitional model to another?

Choosing and Running Transactional Models The choice of a transactional model will only be perceived by few people as a significant task in most companies. Typical criteria for consideration would include the following: • Effectiveness in customer proximity (number of customers, intensity of contact). • Need for efficiency in marketing and sales. • Experience with or confidence to run subsidiaries in foreign countries vs. working through external agents. Except in larger companies, hardly anyone would typically think about commercially induced tax risk associated with the way of running international business. This marks the first key challenge for the topic in general: awareness. A further challenge for any company in determining their transactional model lies in the uncertainty which comes with it. Clearly, the size of a company drives complexity of the decision, as often a several transactional models are used within the company for different business lines, for different countries, in different industries. Effects to the customer and businesses need to be considered under the uncertainty of decisions that come years later in course of the tax audits abroad.  OECD (2022) Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations.

1

Choosing and Running Transactional Models

113

On the side of the tax authorities, not the single indicator area will trigger a case, but the broader picture of the company in the country: The sum of several “gray areas” will certainly not create a “white” picture, while a single gray point might be accepted or create less damage. The assessment of tax authorities might then be influenced by the value large enterprises bring to the local economy and the perception it has in the respective public. Political factors and public opinion have the power to influence such decisions. Approaches to conclusions to tax audits in some countries must not necessarily follow a strict legal rationale but might be politically influenced. If the choice for a transactional model then is one which is made consciously considering the aspects above, the confidence in the assessment of international tax risks becomes a strong force. Key objective therefore must be to implement and run transactional models which are well-defendable in the respective jurisdictions while at the same time effective and operational in an efficient way. Key pitfalls in running them are associated with few areas, covering by the far most of the tax risk associated with them directly. Mostly, the risk for unknowingly creating permanent establishment builds up in the customer interface. A typical example for this are efficiencies created by shared resources in foreign countries for marketing and sales. Management to achieve compliant sales and marketing activity becomes difficult, time-consuming, overly burdened with restrictions and finally discouraging; in some case, rules and guidelines even become contradictory for the individual. Simplification and standardization for the sake of efficiency on the other hand often are compromising effectiveness; translated to the case of transactional models, this results either in a more restricted room to act for the organization (direct business, running a permanent establishment) or in a more costly of effective solution (merchandize business or external agency business). A decision for applying internal agency business transactions would need to be supported by very strong business reasons to pay off for the huge supporting efforts to be undertaken for compliantly operating this model by creating a permanent establishment. Significant cost and effort for managing the income tax situation of employees affected need to be included in this calculation. Increasing size and complexity of the entity, especially on the principal’s end, tend to result in decreasing attractiveness for the internal agency business setup  – if attractive at all, also from a corporate tax point of view. For a market-oriented company requiring close and intense customer intimacy in various countries, all indications direct toward a merchandize business setup. This alone, however, does not let the OECD BEPS concern for the tax base and profit shifting disappear: ICTP and Service Level Agreements enter the room for discussion with the tax authorities, moving the attention from business model compliance to the underlying intercompany contracts. Focus areas here typically are next to the cost of the product also the service provided and risk borne by the receiving entity.

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Switching Transactional Models Section “Changing transactional models” in the “Introduction”  provided an initial perspective on the functional areas and topics to be analyzed when switching the transactional model. Focus of this section is to share a perspective on potential triggers for switching transactional models and high-level views on how to address this task effectively through proven project management structures. Triggers for and Directions of Switching Switching transactional models is not an activity that adds immediate value to the bottom line or account of company but rather one that reduces risk and only potentially saves cash. Most notably it is expensive. So if it is not the profit, what are the triggers that would force a company to engage in such an activity? Typical examples are as follows: • Changes in laws and regulations resulting in future incompliance. • Current incompliance, officially uncovered or internally noticed. • Revised tax risk assessment. Based on these triggers, a good place for the governance of the topic within the organization is the corporate tax department or corporate risk management, both in most organizations under the responsibility of the CFO. Their task needs to be a regular risk assessment considering the legislative framework in relation to  the setup of the transactional models. Compliance with this setup needs to become part of the regular corporate risk audits. A systematic approach to change is always advisable, especially when core processes are affected (see Fig.  7.1). A stimulus triggers the decision for analysis resulting in a risk assessment and recommendation based on a thorough understanding of the topic and its implications. Already at this stage, it is advisable not only to include experts from corporate functions but also consider the input of the business at the interface to the customer.

Fig. 7.1  Business model transformation and monitoring

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115

Decision on an acceptable risk level and resulting change requirements lies with top management paving the way for full commitment of the organization from Day 1 of the project and includes – as best practice – also the provisioning of resources to run the project effectively. The overall timeframe from trigger to decision should not span over more than a quarter, depending on urgency, availability of resources, and information required. While the project phase itself is detailed out further  below, the  governance phase  closes the loop for an ongoing verification of compliance to internal processes and also monitoring of the external environment. Regular mandatory trainings for all international commercial and sales personnel including their senior management are strongly encouraged to keep awareness high. Directions for switching transactional models are visualized in Fig.  7.2 along with an indication about the “ease of switch” (resource requirements, duration, complexity of topics, changes to processes and extent to which customers and employees are affected by these changes), and an indication for the PE risk associated with the respective transactional model. These indications are estimates based on experience and may vary case by case depending on size, business, industry, and countries involved. From the whole selection of possibilities, four changes of transactional models are most likely to be found in practice: • • • •

(Internal) Agency Business → Merchandize Business (driven by OECD BEPS). (Internal) Agency Business → Direct Business (driven by OECD BEPS). Merchandize Business → Direct Business (e.g., due to need for efficiency). Direct Business → Merchandize Business (e.g., due to need for customer proximity). to from

Merchandize

Merchandize

Direct

Internal Agency

External Agency

Switch: medium PE Risk: medium

Switch: low PE created

Switch: high PE Risk: medium

Switch: medium PE created

Switch: high PE Risk: medium

Direct

Switch: high PE Risk: low

Internal Agency

Switch: high PE Risk: low

Switch: low PE Risk: medium

External Agency

Switch: high PE Risk: low

Switch: high PE Risk: high

Switch: high PE Risk: medium Switch: medium PE created

Fig. 7.2  Transactional model switching matrix: efforts required for and PE risk of switch

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What Needs to Be Done? The book has shown the key areas, which require attention to run transactional models compliantly. The focus needs to be on the following topics, which are also the areas requiring most attention of the vendor when switching transactional models: • Commercial: customer preparation for change, revision of organizational structures and processes, especially in decision-making and closing an agreement with customers. • FT&TC, Regulatory: ensuring legal entities to be equipped with all licenses for trading, handling, and storing the products of the transaction; ensure availability of additional documentation requirements; depending on industry (automotive, pharmaceutical, food, feed): Different contractual and/or receiving entity means new customer qualification process. • Supply Chain: considerations regarding changes in physical handling of goods (warehousing, loading/unloading); changes in efficiency of logistics. • IT: Ensure all modules of the ERP are available, prepared and tested in the to-be seller’s legal entity. • Master Data: equipment of legal entities with required master data for products and customers fully compliant with the governance requirements of the vendor; ensuring consistency of master data; for the customer: setup of new master data for the seller. • Legal and Tax: adjustment of contracts also considering whether a different law applies, potentially ICTP implications; changes in import duties, excise taxes. • Finance: changes in currency risk, financing implications, VAT registrations, managing credit risk (→ credit lines) for new customers (“new” for the legal entity stepping in). It must be well considered that the change in the transactional model very likely triggers also changes for the customer: A change in the contracting party affects in most cases also the law governing the contract, it means significant changes to Fx risk (especially for export-oriented customers used to import in foreign currency if forced into local currency, ultimately depending on the local laws for invoicing in foreign currency between local companies), foreign trade and trade control regulations, tariffs and tax implications (VAT, excise duties), and potentially it even affects financing requirements of the customer (e.g., through VAT owed vs. reimbursement by tax authorities significantly later). How Does It Needs to Be Addressed? Switching transactional models is a business transformation, which needs to be managed by a dedicated team that has the full endorsement of top management. Depending on size and complexity of organizational structures such an endorsement needs to be supported on different leadership levels across the organization and – owed to the duration of such a project – constantly be reiterated. It needs to be remembered and acted upon that this transformation will be even less welcomed by the organization than most other projects as the benefit compared with the status

Switching Transactional Models

117

Fig. 7.3  Project organization for transformation of transactional models

quo is not obvious. Typically, it adds cost top the business for just for the “entry card” to compliantly stay in business. Figure 7.3 shows an example of a project organization for the transformation of business transactions as required for a multinational enterprise with a high degree of organizational and leadership complexity. The target is to ensure broad and lasting commitment throughout all levels, functions, divisions and geographies for a successful trnasformation. The leadership of key functions comes together on different levels to support Project Leadership and the Core Team in the implementation of the transformation: While the Steering Committee typically would be composed of Level 1 and Level 2 of the organization to make top management engagement visible and endorse the implementation by their (disciplinary) leadership power, the Sounding Board serves the project also on the content level providing functional advice on concepts and scenarios. Content, solutions, and implementation are driven by the Core Team consisting of Project Leadership and Work Package leads. It is strongly advisable to closely connect to the business and functions at a very early stage, especially for the validation of solutions and timing of implementation, but also during implementation for addressing current topics and issue resolution: especially from the perspective of the market-oriented functions in the company any change in such “administrative” matters will be considered “tax driven.” Key success factors for the transformation of transactional model therefore are as follows: • Sense of urgency: Money is only earned if in the pocket – and kept there. • No ivory tower: –– Ensure respect of the Project Team by staffing it with experienced, well-recognized opinion leaders.

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–– Interlink the project team on all level in the organization. –– Business and functional units are responsible for implementation, not the Project Team. • Authenticity of leadership and communication: It is not very likely that changing the transactional model will benefit the financial position; rather, it provides the license to operate. • The activity is in the interest of the business and whole enterprise – not of tax department. For supporting the communication  and acceptance of these facts, a Validation Board can be organized for the whole project, in large MNEs also by work package or by country/region. “Day 1” of the switch can only be successful if the whole chain involved works according to the new transactional model. Therefore, it is crucial not to lose anyone during the transformation project. A successful transformation mandates as a result no disruption and minimal friction to the customer – finally the transformed business transactions are the base for the existence of the company. The transformation project needs to be structured and planned over time (see Fig. 7.4). The Design Phase is intended to lay the ground for and staff the project including the teams and ensure stakeholder buy-in, the Pilot Phase serves as a proof of concept, bringing together the teams and functions and ensuring a solid understanding of the interfaces. Especially in this phase, the role of the sounding board is crucial to capture concerns and advice from the organization, depending on size and scope of the transformation (one country vs. globally, one business vs. several). Preparation, Implementation, and Hypercare might be executed in iteratiions for the project, covering a different scope each time. During Preparation, key elements are a true stakeholder buy-in and staffing with resources with capacity for the project and the right capabilities. The Implementation Phase is the technical “doing” of the transformation which is executed by all work packages, covering the redesign of legal contracts, communication, and negotiations with the customers and

Fig. 7.4  Phases of business model transformation

Ten Commandments: Key Takeaways

119

(end-to-­end) testing of the IT modifications to ensure consistency of system and master data changes respectively. It ends with the go live on Day 1 of the switch to the target transactional model. Key activities include – again – customer engagement and preparation, training of all employees involved a constant, consistent communication to the stakeholders. The structures set up in Hypercare Phase are designed to ensure quick management and resolution of customer issues and optimization, e.g., of specific cases not captured by previous testing. Beyond the actual activity in the phase itself, the planning for such a phase gives confidence to the stakeholders already during the previous phases. The confidence relates to the fact that there are – in addition to the own resources – structures in place provided by the project team to resolve emergencies and catch any issues resulting from the switch of the transactional model. On a final note, the Governance of business model compliance must be ensured especially after a transformation to avoid a fallback to activities of the previous transactional model. While this can become a routine of internal audits (as usually conducted by corporate audit), the risk assessment may lead to the conclusion that a dedicated governance structure for the communication about training of and compliance with transactional models has its merit. Experiences like the Bosch case in Italy favor such a decision (see Appedix: “The Bosch Case”).

Ten Commandments: Key Takeaways No matter whether you studied the whole book or not, these ten considerations should be in the back of your mind when thinking about or discussing transactional models: 1. Business transactions are the nucleus of business activity and thus the generation of profits and cash: internationally, a set of risks unfolds also through the interest of different countries and their need for taxation. The price for non-­ compliance through well-intended but wrongly conducted action creates the risk that profits generated over several years in a specific country might be eaten up by fines and subsequent payment of (often increased) taxes and interest. These mistakes are mostly made at the interface to the customer. 2. There is no right or wrong transactional model – firstly, it is a matter of fit to the business strategy and markets of the enterprise, and secondly, it is a matter of managing tax risk (i.e., avoiding a permanent establishment) by implementing the consistent structures and processes, and ensuring their compliance. 3. Taxes are ultimately determined by the respective jurisdiction or even the specific tax auditor who determines the taxes to be paid – not your tax advisor. This includes the judgment of whether the transactional model chosen and the way it  is implemented is  considered a permanent establishment of a foreign legal entity or not. 4. Transactional models should remain in place for several years: Unless you enjoy the conversations with external tax auditors and the respective authorities

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and jurisdiction behind them, the recommendation is to refrain from frequent changes in the transactional model, and also from too much differentiation within one legal entity. 5. Always remember: The tax auditor also asks your customer – not only your enterprise. The key test for initial assessment of presence in the country as one prerequisite for a permanent establishment can be condensed to one sentence: “What will the customer answer if asked by the authorities: Who sold you this product?” If the answer does not fit to the transactional model presented, the auditor will dig deeper. 6. Permanent establishments result in corporate taxes for the legal entity acting from abroad. They also trigger individual income taxes of the employees traveling to the country – a big burden for these employees. Even worse if this the situation arises in several countries: administration and documentation requirements, transactional cost for specialized tax advisors, burden of cash management for prepayment of personal income taxes in these countries and claiming back overpayments based on the DTAs often still after years. 7. Only negotiate, conclude, and sign a contract for the legal entity of your employment or with a proxy of this legal entity – in short: You need to be authorized to act, sign for, and finally thereby oblige the legal entity involved in the transaction. 8. Contracting requires clarity about the legal entities entering into the agreement. This includes the specification of legal entities which will execute, if deviating from the primary contracting parties and a contractual form for their participation. 9. Shipments from or shipments to entities in countries other than those directly involved as parties in the (sales or supply) contract need to be backed up by internal (intercompany) agreements of the vendor or customer, respectively. 10. Be aware that – even within your own company – the words and language used might be associated with different meanings depending on the function using them: Same words used by the tax and legal community often carry another meaning compared to the use in by Marketing, Sales, or Supply Chain Functions. A dialog on transactional models between functions therefore initially often requires very careful listening, asking, and clarifications – and patience.

Appendix: The Bosch Case

At the beginning of the year 2012, Italian and German newspapers reported the German automotive supplier and technology company Bosch to have settled a claim with Italian tax authorities by the payment of 320 Mio. Euro just before Christmas 2011.1 The article of the Milanese newspaper “Corriere della Serra” was confirmed by a spokesperson of Bosch with no further details disclosed, as the parties had agreed non-disclosure of the agreement “accertamento per adesione.”

What Happened? Italian tax authorities had changed their view on a current practice of Bosch operating in Italy and claimed taxes, interest, and fines in the amount of 1.4 bn. Euro dating back to 1997, while Bosch argued that these operations had been taxed in Germany. Settlement was reached with the payment of 320 Mio. Euro, which Bosch was initially hoping to be able to claim back from German tax authorities based on the DTA between Italy and Germany for the double taxation situation. Next to the Italian fiscal authorities, also the office for prosecution of Milan had been involved to investigate potential offenses against criminal law, which could have resulted in personal fines including even prison for the managers involved. In

 See also “Further Reading - The Bosch Case“ at the end of the case study: Sconto ai tedeschi della Bosch: Ma pagano al fisco 300 milioni, Corriere della Sella, Milano, Italy, 2. January 2012 https:// www.corriere.it/economia/12_gennaio_02/sconto-ai-tedeschi-della-bosch-ma-pagano-al-­ fisco-­3 00-milioni-luigi-ferrarella_f68bcd34-3527-11e1-a9e9-f391576f69b4.shtml, 2. November 2022. Bosch zahlt Millionen an Italiens Fiskus, Der Spiegel, Hamburg, Germany, 2. January 2012, https://www.spiegel.de/wirtschaft/unternehmen/steuerstreit-bosch-zahlt-millionen-an-italiensfiskus-a-806762.html 2. November 2022. 1

© The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 M. C. Solbach, International Business Transactions and Taxation, Management for Professionals, https://doi.org/10.1007/978-3-031-39240-5

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scope of the investigation were activities of the Turin office of Bosch where about a dozen technicians employed by a German legal entity of Bosch tested prototypes. The argumentation of Bosch and the view of the tax authorities before were that these technicians were providing consulting services specifically to the customer FIAT.  This setup was also practiced in other countries and well-accepted by the authorities there. Furthermore, Bosch argued that there is also no case of tax evasion as taxes had been paid in Germany at about the same tax rate as in Italy. The tax authorities in contrast changed their perspective in 2010 focusing on the fact that the prototypes were marketed also beyond this specific customer – thus to be considered not as a service to a specific customer, but as entrepreneurial activity, thus resulting in a permanent establishment and therefore falling under the tax authority of the Italian government.2 The settlement achieved through the collaboration with authorities not only allowed the fines to be reduced to up to 1/3 of the legal minimum requirement, but could also have reduced potential fines for the responsibility of managers both in Germany and Italy under Italian criminal law.

The Consequences In 2014, Bosch still was in negotiation with German tax authorities for reducing the German tax bill; however, it turns out that the DTA had a gap regarding this situation, and German tax authorities rejected to adopt the Italian view. The situation resulted effectively in a double taxation for Bosch in the amount of 320 Mio. Euro.3 On the side of criminal prosecution, the Italian prosecutors brought the case to court for tax evasion: Fines between 18 months and six years potentially could have been imposed on the managers responsible for the tax declaration and those signing it. The criminal court finally found the managers not guilty for tax evasion confirming that managers acted correctly and taxes were paid in Germany. However, the verdict of the criminal court has no impact on the tax rulings and the previous settlement between Bosch and the Italian tax authorities.4

 Bosch zahlt Steuern doppelt – und erhält nichts zurück, Stuttgarter Zeitung, Stuttgart, Germany, 2. March 2014, Bosch und Italiens Fiskus: Bosch zahlt Steuern doppelt – und erhält nichts zurück Wirtschaft - Stuttgarter Zeitung (stuttgarter-zeitung.de), 5. November 2022. 3  Bosch zahlt Steuern doppelt – und erhält nichts zurück, Stuttgarter Zeitung, Stuttgart, Germany, 2. March 2014, Bosch und Italiens Fiskus: Bosch zahlt Steuern doppelt – und erhält nichts zurück Wirtschaft - Stuttgarter Zeitung (stuttgarter-zeitung.de), 5. November 2022. 4  Il Caso Bosch: quelle tasse che l´agenzia delle entrate non vuole restituire, Panorama, Milano, Italy, 13. March 2014, https://www.panorama.it/news/economia/caso-bosch-tasse-agenzia-entrate-­­ non-vuole-restituire, 2. November 2022. 2

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 hat Can We Learn from Bosch Case for International W Business Transactions? The Bosch Case illustrates the consequences of the consideration of activities in a foreign country as permanent establishment by the local tax authorities. Based on the details published, the is no evidence for sales-related activity or principal–agent transactions. The result, however, remains the same: taxation based on a permanent establishment and the threat of significant double taxation. While courts in France and Scandinavia have ruled principal–agent transactions in specific cases as not harmful for creating a permanent establishment, the OECD explicitely classified them differently as such, resulting in Action 7 BEPS guidelines.5

 http://www.oecd.org/tax/beps/beps-actions/action7/ (2020-Oct-31; 2022-Jan-17).

5

Glossary

As most of the wording is consistently in day-to-day business across different countries, companies, or functions, the following table defines their use throughout this book (Based on the experiences in leading a global project it proves, that most of the frictions between teams are based on the different understanding of the meaning of words. It might therefore also serve as a guidance for practitioners for daily use, but it is not meant as scientific definitions): Business Business model

Business unit

Buyer (vs. seller) Company

Activity of manufacturing, trading, or service delivery, typically but not necessarily conducted in own legal entities often referred to as companies. A business model describes the logic of how an organization creates, delivers, and captures value in an economic, social, cultural, or other context. The process of business model construction and modification is also called business model innovation and forms a part of business strategy (According to Wikipedia https://en.wikipedia.org/ wiki/Business_model. Accessed 27 Dec 2022). A global or regional business unit is defined as a part of the company that can clearly be separated from the rest of the company by its management structure, dedicated resources in Manufacturing and Marketing and Sales, also implied by an separate P&L statement and responsibility. Legal entity of the customer that engages in a transaction in buying goods. Commercial view. Entity of an enterprise or conglomerate, which forms an overarching framework.

© The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 M. C. Solbach, International Business Transactions and Taxation, Management for Professionals, https://doi.org/10.1007/978-3-031-39240-5

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Conglomerate

Corporation

Crossborder agent Customer (vs. vendor) Dual use products Enterprise Functions

MLI

Glossary

A conglomerate is a combination of multiple legal entities connected through common ownership structures, often operating in different industries under one corporate group. Typically, it is structured in one parent company as a holding and several subsidiaries. A conglomerate can also be formed as a network of subsidiaries and holdings with a common governance structure. A corporation is an organization usually consisting of a group of people or a company, which is authorized by the state to act as an entity; it can be used as a synonym for a legal entity (or legal person in legal context). A crossborder agent is defined as an employee of an legal entity of the vendor located in a country that is not involved in the invoicing chain. Enterprise as sum of legal entities acting as requester of goods and services on the market (demand side). Products that can be used in a civil and military way. Enterprise shall be the whole of the business across several legal entities and countries. It refers to the total of legal entities of an organization. Organizational term describing these units of the enterprise that are focused on specific functions, such as Manufacturing, Supply Chain, Procurement, Marketing, Sales, Finance, Tax, Legal, IT, or HR. Supporting functions are often organized as centralized corporate departments. The multilateral convention to implement tax treaty-­ related measures to prevent Base Erosion and Profit Shifting (“multilateral instrument” or “MLI”) offers concrete solutions for governments to close the gaps in existing international tax rules by transposing results from the OECD/G20 BEPS Project into bilateral tax treaties worldwide. The MLI modifies the application of thousands of bilateral tax treaties concluded to eliminate double taxation. It also implements agreed minimum standards to counter treaty abuse and to improve dispute resolution mechanisms while providing flexibility to accommodate specific tax treaty policies. The MLI covers over 90 jurisdictions and entered into force on July 1, 2018. Signatories include jurisdictions from all continents, and all levels of development and other jurisdictions are also actively working toward signature (OECD BEPS (2022) Signatories and parties to the multilateral convention to implement tax treaty-related measures to prevent Base Erosion and Profit Shifting. https://www. oecd.org/tax/beps/beps-­mli-­signatories-­and-­parties.pdf. Accessed 11 Nov 2022).

Glossary

OECD BEPS

OECD BEPS Article 7

Payment terms

127

The Inclusive Framework on Base Erosion and Profit Shifting (BEPS) was established in June 2016 and brings together over 135 countries and jurisdictions to collaborate on the implementation of the OECD/G20 BEPS Package. At its inaugural meeting in Kyoto, Japan, in July 2016, there were 82 members of the OECD/G20 Inclusive Framework on BEPS.  Today (December 2019), there are over 140 members and 14 observer organizations. Members of the Inclusive Framework commit to the comprehensive BEPS Package, including the consistent implementation of the four minimum standards, noting that the timing of implementation may vary to reflect the level of development of countries and jurisdictions. Members also commit to have their compliance with the minimum standards reviewed and monitored by their peers. All members participate on an equal footing (OECD (2015) Guideline on Base Erosion and Profit Shifting. https://www.oecd.org/tax/beps/. Accessed 17 Jan 2022). The 15 actions of the BEPS Project equip governments with rules and instruments to address tax avoidance, ensuring that profits are taxed where economic activities generating the profits are performed and where value is created. The BEPS Action Plan called for a review of the definition of a permanent establishment to prevent the use of certain common tax avoidance strategies used to circumvent the former model permanent establishment definition. Article 7 deals with arrangements through which taxpayers replace subsidiaries that traditionally acted as distributors by commissionaire arrangements, with a resulting shift of profits out of the jurisdiction where the sales took place without a substantive change in the functions performed in that jurisdiction (OECD (2013), Action Plan on Base Erosion and Profit Shifting, OECD Publishing, Paris, https://doi.org/10.1787/9789264202719-­en, specifically on Action 7: http://www.oecd.org/tax/beps/beps-­actions/ action7/. Accessed 31 Oct 2020). Key element of the payment terms is the timeframe in which a customer has to pay for the goods and services received. Usually, the timeframe starts at the issuance of the invoice when the goods ship (commercial transfer of ownership of goods) and ends with the receipt of money at the vendors account (legal transfer of ownership of goods). Variations of this are possible, e.g., customers

128

Seller (vs. buyer) Supplier

Transactional model

Vendor (vs. customer)

1 

Glossary

favor to set the starting point at the point of receipt of goods, thereby excluding time for shipment from the time accounted for in the payment terms. Other elements include cash discounts, early payment discounts, or allowances. Legal entity of the vendor that engages in a transaction in selling goods. Commercial view. Legal entities that physically provide the goods typically as part of the vendor’s enterprise, potentially also as a third party. Supply chain view. Transactional models are part of the implementation of the distribution strategy, describing the invoicing chains along with the flow of goods or service delivery, respectively. Enterprise as sum of legal entities acting as provider of goods and services to the market (supply side).

References and Further Reading

Bretschger L, Hettich F (2000) Globalisation, capital mobility and tax competition: theory and evidence for OECD countries, Wirtschaftswissenschaftliche Diskussionspapiere, No. 07/2000, Universität Greifswald. Accessed 11 Nov 2022 Brück M (2015) Konzern startet globales IT-Großprojekt, WirtschaftsWoche. https://www. wiwo.de/unternehmen/industrie/henkel-­konzern-­startet-­globales-­it-­grossprojekt/12610772. html#:~:text=Henkel%20Konzern%20startet%20globales%20IT%2DGro%C3%9Fproj ekt&text=Henkel%2DVorstandschef%20Kasper%20Rorsted%20hat,einheitliche%20SAP%2DPlattform%20steuern%20will. Accessed 7 Nov 2022 Chandler AD (1962) Strategy and structure – chapters in the history of the industrial enterprise. MIT Press, Cambridge. ISBN 0262530090 Day GS (1990) The market driven strategy: processes for creating value. Free Press, New York. ISBN 9780029072110 Day GS (1999) The market driven organization: understanding, attracting, and keeping valuable customers. Free Press, New York. ISBN 0684864673 FAZ.net (2016) Singapur als wichtiges globales “Center of Excellence” für Henkel. https://www. faz.net/asv/wandel-­chancen-­zukunft/singapur-­als-­wichtiges-­globales-­center-­of-­excellence-­ fuer-­henkel-­17093076.html. Accessed 7 Nov 2022 Fenton EM, Pettigrew AM (2000) The innovating organization. Sage, London. ISBN 0761964339 Haufe (2019) Beha S: Wir können Steuerberatung auf einem ganz anderen Level anbieten. Interview with Hans Maier, Senior Vice President Corporate Taxes and Tariffs of Robert Bosch GmbH. https://www.haufe.de/taxulting/wandel-­in-­der-­steuerabteilung-­vom-­tax-­expert-­zum-­ manager_484580_489002.html. Accessed 2 Nov 2022 Henkel Life (2015) ONE!GSC – start in Amsterdam, p. 9. https://henkel-­pensionaere.de/mediathek/ dokumentenpool/henkel-­life/henkel-­life-­ausgaben-­2015/471-­henkel-­life-­ausgabe-­02-­2015/ file. Accessed 11 Nov 2022 Herhausen D, Schögel M (2016) Customer-driving marketing: Neue Kundenbedürfnisse wecken. In: Business innovation: Das St. Galler Modell. Springer Fachmedien Hubbard B, Abi-Habib M (2020) Deadly explosions Shatter Beirut, Lebanon. New York Times. https://www.nytimes.com/2020/08/04/world/middleeast/beirut-­explosion-­blast.html. Accessed 9 Nov 2022 ICC International Chamber of Commerce: Incoterms (2020). https://iccwbo.org/resources-­for-­ business/incoterms-­rules/incoterms-­2020/. Accessed 8 Nov 2022 Kouvelis P, Xu F (2021) A supply chain theory of factoring and reverse factoring. Management Science 67(10):6071–6088

© The Editor(s) (if applicable) and The Author(s), under exclusive license to Springer Nature Switzerland AG 2023 M. C. Solbach, International Business Transactions and Taxation, Management for Professionals, https://doi.org/10.1007/978-3-031-39240-5

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Mintzberg H (1983) Structure in fives: designing effective organizations. Prentice Hall, New York. ISBN 013855479X Mintzberg H (1978) The structuring of organizations. Prentice Hall, New York. ISBN 0138552703 Nagarajan KV (2011) The code of Hammurabi: an economic interpretation. International Journal of Business and Social Science, 2(8), 108–117 OECD (2014) Model tax convention on income and capital: condensed version 2014. ISBN 9789264211155 OECD (2015a) Guideline on base erosion and profit shifting. https://www.oecd.org/tax/beps/. Accessed 17 Jan 2022 OECD (2015b) Base erosion and profit shifting article 7. http://www.oecd.org/tax/beps/beps-­ actions/action7/. Accessed 17 Jan 2022, 31 Oct 2022 OECD (2015c) Preventing the artificial avoidance of permanent establishment status, action 7 – 2015 final report, OECD/G20 base erosion and profit shifting project. OECD Publishing, Paris. https://doi.org/10.1787/9789264241220-­en. Accessed 11 Nov 2022 OECD (2017) Base erosion and profit shifting, 2015 final reports. OECD Publishing, Paris. https:// www.oecd-­ilibrary.org/docserver/9789264241220-­en.pdf?expires=1642423060&id=id&acc name=guest&checksum=B0B58489E16953A43F496B433D418181. Accessed 11 Nov 2022 OECD (2020) OECD/G20 inclusive framework on BEPS: progress report July 2019-July 2020. OECD Publishing, Paris OECD (2022) Transfer pricing guidelines for multinational enterprises and tax administrations 2022. OECD Publishing, Paris. ISBN 978-92-64-52691-4 OECD BEPS (2022) Signatories and parties to the multilateral convention to implement tax treaty related measures to prevent base erosion and profit shifting.https://www.oecd.org/tax/beps/ beps-­mli-­signatories-­and-­parties.pdf. Accessed 11 Nov 2022 OECD (2013), Action plan on base erosion and profit shifting. OECD Publishing, Paris. https:// doi.org/10.1787/9789264202719-­en. Accessed 31 Oct 2020 Rumelt RP (1974) Strategy, structure, and economic performance. Harvard Business School Press. ISBN 978-0875841267 Spanish Government (2004) Law on payment terms between Spanish Companies, (based on EU Directives 2000/35/CE and 2011/7/UE). https://cms.law/en/int/expert-­guides/cms-­expert-­ guide-­to-­payment-­term-­legislation/spain. Accessed 8 Nov 2022 Statista (2022) Google, Amazon, Meta, Apple, and Microsoft (GAMAM)  – Statistics & facts. https://www.statista.com/topics/4213/google-­a pple-­f acebook-­a mazon-­a nd-­m icrosoft-­ gafam/#dossierKeyfigures. Accessed 5 Nov 2022 Supply Chain Movement (2016) Henkel’s Dirk Holbach: “Success depends to a large extent on people”. https://www.supplychainmovement.com/category/trends/. Accessed 11 Nov 2022 United Nations (2012) Model double taxation convention between developed and developing countries. United Nations, New York. ISBN 978-92-1-159102-6 United Nations (1969) Vienna convention on the law of treaties 1969. https://legal.un.org/ilc/texts/ instruments/english/conventions/1_1_1969.pdf. Accessed 16 Nov 2022 Wilson JD (2014) Tax havens in a world of competing countries, CESifo DICE report 4/2014 (December), pp 32–37 Worldbank (2021a) Exports of goods and services (constant 2015 US$). https://data.worldbank. org/indicator/NE.EXP.GNFS.KD. Accessed 7 Nov 2022 Worldbank (2021b) Exports of goods and services (% of GDP). https://data.worldbank.org/indicator/NE.EXP.GNFS.ZS. Accessed 7 Nov 2022 Wikipedia (2019a) Permanent establishment. https://en.wikipedia.org/wiki/Permanent_establishment. Accessed 25 Oct 2019 Wikipedia (2019b) Business model. https://en.wikipedia.org/wiki/Business_model. Accessed 25 Oct 2019 Wikipedia (2019c) John D.  Rockefeller. https://en.wikipedia.org/wiki/John_D._Rockefeller. Accessed 25 Oct 2019 Wikipedia (2019d) Incoterms. https://en.wikipedia.org/wiki/Incoterms. Accessed 25 Oct 2019

References and Further Reading

131

Further Reading Corriere della sera economia (2012) Sconto ai tedeschi della Bosch: Ma pagano al fisco 300 milioni. https://www.corriere.it/economia/12_gennaio_02/sconto-­ai-­tedeschi-­della-­bosch-­ma-­ pagano-­al-­fisco-­300-­milioni-­luigi-­ferrarella_f68bcd34-­3527-­11e1-­a9e9-­f391576f69b4.shtml. Accessed 2 Nov 2022 Handelsblatt (2012) Bosch legt Steuerstreit mit Italien bei. https://app.handelsblatt.com/economy-­ business-­und-­finance-­bosch-­legt-­steuerstreit-­mit-­fiskus-­in-­italien-­bei/6012274.html. Accessed 5 Nov 2022 Il Post (2012) Bosch paga 300 milioni di euro al fisco italiano. https://www.ilpost.it/2012/01/02/ bosch-­paga-­300-­milioni-­di-­euro-­al-­fisco-­italiano/. Accessed 2 Nov 2022 Manager Magazin (2012) Bosch legt Steuerstreit mit Italien bei. https://www.manager-­magazin. de/unternehmen/artikel/a-­806702.html. Accessed 5 Nov 2022 Panorama (2014) Il Caso Bosch: quelle tasse che l’agenzia delle entrate non vuole restituire. https:// www.panorama.it/news/economia/caso-­bosch-­tasse-­agenzia-­entrate-­non-­vuole-­restituire. Accessed 5 Nov 2022 Spiegel Wirtschaft (2012) Bosch zahlt Millionen an Italiens Fiskus. https://www.spiegel.de/ wirtschaft/unternehmen/steuerstreit-­bosch-­zahlt-­millionen-­an-­italiens-­fiskus-­a-­806762.html. Accessed 2 Nov 2022 Stuttgarter Zeitung (2014) Bosch zahlt Steuern doppelt – und erhält nichts zurück. https://www. stuttgarter-zeitung.de/inhalt.bosch-und-italiens-fiskus-bosch-zahlt-steuern-doppelt-und-­ erhaelt-nichts-zurueck.20501d3d-875e-489b-84a2-2959acfc60cf.html#:~:text=Global%20 agierende%20Konzerne%20nutzen%20gerne,zu%20viel%20gezahlte%20Geld%20 zur%C3%BCckzuerhalten. Accessed 5 Nov 2022