Should a Multinational Firm Place Part of its Supply Chain in a Tax Haven?: Strategies to Enable International Tax Arbitrage

Abstract

What motivates the geographic footprint of the supply chains that multinational firms (MNFs) deploy? Traditional prescriptive research in the operations and supply chain management literature tends to recommend locations primarily based on differentials in production costs and the ramifications of physical distance. The role of taxation has received much less attention.MNFs that strategically position parts of their supply chains in low-tax locations can allocate the profits across the different pieces of the firm so as to improve post-tax profits. For the profit allocation to be defensible to tax authorities, the operations in tax havens must possess real decision authority and bear meaningful risks such as the consequences of uncertainty in market demand. Generally speaking, the greater the transfer of risk and control, the larger the allowable allocation of profit. These transfers may also create inefficiencies due to misalignment of business goals and attitudes towards risk. We model these tradeoffs in the context of placing in a low-tax region a subsidiary that oversees product distribution (as a Commissionaire, Limited-Risk Distributor, or Fully-Fledged Distributor). Our analysis ultimately informs the questions of motive for the MNF: whether and when to use these tax-aware supply chain strategies.