The COVID-19 pandemic has affected many aspects of American business. Mandatory stay-at-home orders transitioned workforces to remote locations, causing employers to rethink office space and real estate footprints. Many businesses have experienced periods of lower demand and fewer customers. In some cases, inventory has dramatically increased, or alternatively, inputs have been difficult to acquire due to supply shortages. Businesses have experienced a level of unpredictability not seen in over a decade.
As businesses look to quickly recover and begin to form 2021 business strategies, inventory management should become a key consideration. A procurement company may provide one solution for a more tax-efficient business operation. However, not all businesses will benefit from such a structure and it is important to consider the benefits of a procurement company as a solution for businesses with large capital expenditures and diffused inventory management. Other equally beneficial strategies may exist for more narrow inventory management concerns.
Procurement companies and sales and use tax savings
As a separate legal entity, a procurement company becomes the central entity for purchasing inventory and supplies exempt for resale to a related operating company. The procurement company can be located in the most favorable jurisdiction weighing sales and use tax, property tax, and income and franchise tax benefits. The operating company no longer holds the inventory or supplies, but can timely purchase those as needed from the procurement company to support its business operations. The procurement company can also help businesses with de-centralized inventory and supply-chain management transition those operations under one centralized function.
Procurement companies can provide broad tax savings for businesses in many different industries. For example, service providers purchase and store supplies used in their contracts, such as a water utility buying pipes and other supplies for use in maintaining waterline infrastructure. It is a common practice to purchase such stock for future, anticipated use. However, a service provider is generally the consumer of items used in providing a service, meaning that the provider will often be paying the sales tax on items purchased for a later use. This dynamic can lead to a lag between the time the sales tax is paid and the time when the income is recognized from the service or final sale of a product. A separate procurement company can help defer the sales tax paid by the provider by purchasing stock and inventory exempt for resale. The provider, the operating company, purchases from the procurement company when necessary, paying the sales tax at that time.
Property tax advantages
Over a dozen states have some form of property tax specifically imposed on business inventory. More inventory stored in one of these states can lead to higher business property tax burdens. Businesses with excess inventory due to pandemic slowdowns may be facing this dilemma more frequently. Compliance with inventory taxes is more complicated than most business managers think. Businesses carrying inventory must determine the tax, the location of inventory, and more importantly, the value of carried inventory within the state. Additionally, some states imposing the tax allow businesses to claim credits for the amount of inventory tax paid against other taxes. Finally, in several states, the tax is assessed and collected locally, adding complexity to the property tax compliance obligation.
Carrying large amounts of inventory for resale, or stock and supplies that will be used at a later date, may be generating significant property taxes. In the service provider example above, stock purchased for use in fulfilling service contracts may not qualify as exempt inventory because it will be used by the provider. Procurement companies can help alleviate these taxes by either holding stock as exempt inventory for resale to the provider, holding inventory in states that exclude inventory from the tax or by holding inventory in states without a property tax. The analysis for any one business may not be so straight-forward, and should be considered in context of an overall procurement company strategy.
Income tax advantages
Holding inventory and supplies may also have substantial impacts on state and local income taxes. Almost half of the states that tax corporate income use a ‘property factor’ to determine income tax apportionment. A procurement company located in a ‘single-sales factor’ state, a state without an income tax or a state with a property factor phasing out in favor of a single-sales factor may provide an opportunity to reduce overall income tax expenses. Reducing or eliminating large quantities of inventory, or aggregating inventory from multiple locations to a single location may provide state income tax benefits. Additionally, a well-designed procurement company may allow for other income tax savings, such as favorable sourcing of certain intangibles. Procurement companies may play a role in reducing income tax base which should be considered when determining whether and where to establish a procurement company.
The advantages of a procurement company should be considered by a holistic approach. Some businesses may find that the savings in one tax are eliminated by an increase in another. Other businesses may find significant savings. Businesses should consider that implementation costs could be high and other logistical and administrative barriers exist such as other taxes, e.g., gross receipts taxes, transfer pricing considerations and choice of entity.
The coronavirus pandemic has shone light on an inventory management optimization strategy that has been utilized for decades by growing businesses. With a highly fragmented sales tax base, ever-changing personal property tax landscape and an increasing adoption of single-sales factor apportionment, procurement companies may be more accessible and provide more tax savings than ever before.