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The customer has changed and this is changing value creation for tax

The changing customer

As technology and automation bring new levels of choice, customers have the power to shape and define the business strategies of their suppliers.

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Erica Perry

Partner, Transfer Pricing

KPMG in the UK

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Today’s customers are more empowered than ever before. As technology and automation bring new levels of choice, access and service, customers call the shots and have the power to shape and define the business strategies of those serving and supplying them.

We need only look at the turnover of companies in the S&P 500 to see this – in 1965, the average lifespan of companies on the S&P 500 was 33 years, by 1990 it was 20 years, and by 2026 it is forecast to be 14 years. Companies cannot endure in the long term without understanding the shifting needs of their customer base and reinventing their business models.

Customer evolution

Customer centricity is a prerequisite for survival. In consumer driven industries this means engaging with customers in a more personalised and hyperconnected manner, anticipating the needs and expectations of customers.

However this change is not confined to the B2C sector - the changing demands and expectations of enterprise customers are also impacting B2B models. Businesses expect suppliers to be ever more responsive and indeed predictive of their needs. AI, the Internet of Things, data analytics and manufacturing innovation all mean that customers are demanding greater involvement in the development roadmap and customisation to their requirements.  In product based businesses, customers are demanding more agile and flexible supply chains. Service and subscription models are becoming increasingly widespread, even in more traditional sectors such as automotive and industrial manufacturing.  There is also a move towards more direct-to-customer models, eliminating distributors and intermediaries.

At the same time, the need for greater flexibility and adaptability to respond to customer demands, together with cost-cutting pressures, is leading to changes in organisational structures. Decisions often need to be made in real time at a more operational level closer to the customer, pushing greater autonomy and responsibility down the organisation’s hierarchy.

Whilst the customer has changed, some organisations are still playing catch up – especially the established players in certain sectors. Most of these have significant amounts of historical infrastructure and assets, as well as people – but these need to be configured differently if they are to become more customer-centric, agile and responsive.

Taxing customer value

As much as this is a business model challenge, it also poses significant questions for tax. The changing nature of the customer is sharpening the focus on the correct mechanism for taxing value. This means further revisions to international tax principles, including ddigital taxation, increasing risk of Permanent Establishment challenge, and a shift in where taxable profits are expected to accrue under transfer pricing rules.

Under the OECD’s Base Erosion and Profit Shifting (BEPS) initiative, we have already seen increased scrutiny by tax authorities on taxing businesses according to where key decisions are made and value is created – rather than where legal ownership of assets resides or the contractual allocation of risk.

In this age of the customer, there is a potential shift from a tax perspective in the relative value contributions of certain business functions, such as R&D, supply chain and marketing. Tax authorities are already beginning to ask more detailed questions about how and where value is created in customer centric organisations. In particular, we are seeing an increase in challenges around local marketing intangibles, the role of in-market teams in developing, not just executing, commercial strategy, and arguments that position customer relationships as more valuable than other intangible assets, such as technology or brand. As companies look to take costs out of the business and push decision making further down the organisation, this is also placing greater pressure on more traditional distribution models which have been characterised as limited risk for transfer pricing purposes.

Whilst many businesses are still grappling with the demands of BEPS, the tax agenda continues to develop with the digital taxation proposals being discussed at the OECD, as well as at the European Commission and unilaterally.

Since the publication of the OECD consultation paper in January 2019, concerns have been raised about how far the proposals go and how they would likely impact all taxpayers, not least given the evolution of business models and blurring of traditional sector lines. The current “user participation” proposal indicates that the existing tax framework ignores the value that certain business models derive from user participation.  The “marketing intangibles” proposal is even broader in scope, potentially attributing value to marketing intangibles regardless of legal ownership or “DEMPE” analysis of the functions relating to those intangibles.

All of this means that businesses must be able to evidence and defend where and how value is created in their organisations – in particular the value derived from winning with customers in a customer centric business.

Tax must be in the conversation

A perfect storm of business change and international tax developments is taking place.

It is vital that tax is part of the conversation around business model changes, now and in the future, to avoid tax authority challenge.

With the customer moving the dial, has value creation shifted in your organisation and are you ready to defend your tax model?

Contact:

Erica Perry
Director
Email: erica.perry@kpmg.co.uk
T: +44 (0)20 76944891

Sinead Murdock
Senior Manager
Email: sinead.murdock@kpmg.co.uk
T: +44 (0)20 73112242

 

 

 

 

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