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Business Model Optimisation: Finding the Substance
Business Model Optimisation (BMO) is a process whereby value is created through business transformation. It is essentially a methodology which seeks to integrate both the operational and tax planning aspects of an organisation. Taxand South Africa explores the issue of 'substance' for a multinational choosing to establish a presence in a low tax jursidiction.
A particular jurisdiction will generally be chosen by virtue of its ability to generate both operational and tax savings for an organisation. In practice, however, activities are sometimes located in low tax jurisdictions with the aim of securing the latter benefit, and sometimes without justifying the existence of the former ie operational savings.
In order to create a sustainable benefit for an organisation, merely shifting or relocating risks to another jurisdiction is unlikely to be sufficient. Instead, the functions and the people performing those functions must be relocated to a principal company (PC) in the tax efficient jurisdiction as well. Substance is therefore created by shifting "significant people functions". What remains in the local jurisdiction are typically limited risk manufacturing and / or distributing activities which should now be geared towards an execution role under the decisive guidance of the PC. The PC therefore assumes the role of a central entrepreneur for the organisation's global business model.
A potential problem which organisations often face when implementing this type of structure, is where some of the "significant people functions" are still performed by the PC in the local jurisdiction where the manufacturing and / or distributing activities are undertaken. In so doing, a taxable presence is retained in the local jurisdiction in the form of a permanent establishment meaning that they would have partially defeated the purpose of the BMO exercise. Care should therefore be taken to ensure that all significant people functions are properly relocated to the jurisdiction of the PC and that no unwanted residual activity remains in the local jurisdiction.
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For BMO to be successful, careful planning and subsequent monitoring must occur to determine that the PC has the appropriate level of substance to be recognised as the sole entity that manages all relevant strategic functions for the organisation's global business model and, therefore, to be treated as the entrepreneur earning the residual return from a transfer pricing perspective. To this end, BMO requires a functional and risk profile analysis to be undertaken to justify to the relevant tax authority that genuine substance has been created.