This is the third in a series of Tax News Highlights articles covering international taxes and what companies need to consider during and after the current global pandemic.
From a tax perspective, many multinational enterprises (MNEs) structure their operations using a three-party arrangement: an entrepreneur owner, a contract manufacturer (CM), and a limited risk distributor (LRD). Under this structure, the entrepreneur economically owns the nonroutine intellectual property and assumes certain risks, which allows it to claim the residual profit or loss in the supply chain. The CMs and LRDs (collectively, limited risk entities, or LREs) earn normal (or routine) returns and should not normally share in the residual profits or losses earned by the entrepreneur.
COVID-19-induced social and business restrictions have limited or completely shut down sales, production, and services for many MNEs. As a result, MNEs and their tax advisers need to examine the implications of any three-party arrangements. A central question to be resolved is whether LREs should continue to earn a profit while possibly forcing the entrepreneur into a ruinous residual loss. Depending on the length of the global pandemic and the adverse economic consequences, many MNEs could earn consolidated losses but still owe taxes in many of the jurisdictions in which their LREs operate.
LREs typically earn normal returns because they generally do not own nonroutine intellectual property. Their business is about providing manufacturing capacity (labor and property, plants, and equipment). Given the lack of significant barriers to entry, they operate in a highly competitive environment, and competition extends to location, delivery, and price. LREs continuously are moving operations from one low-cost jurisdiction to another to maintain their competitive advantage.