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Operating With a Commissionaire Model: An Overview August 12, 2008

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Table of Contents 1.0 1.1 2.0 3.0 COMMISSIONAIRE MODEL AN OVERVIEW ................................................................... 3 Commissionaire Model: Assumptions .................................................................... 4 KEY DRIVERS OF A COMMISSIONAIRE MODEL ............................................................. 6 MAJOR COMMISSIONAIRE BUILDING BLOCKS .............................................................. 7

3.1 Tax and Legal Structure ........................................................................................... 7 3.2 Organizational Entity Structure ............................................................................... 7 3.3 Product Flow Models................................................................................................ 8 3.4 Reporting on Product Flows Intrastat / Extrastat, European Sales Listing, VAT Returns.................................................................................................................................. 9 4.0 4.1 4.2 4.3 5.0 RELATED DISTRIBUTION MODELS ................................................................................... 11 Commissionaire.......................................................................................................11 Buy /Sell ...................................................................................................................11 Flash Buy Sell or Risk Stripped Buy/Sell........................................................12 SUMMARY AND CONCLUSION ............................................................................................ 13

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1.0 Commissionaire Model An Overview A Commissionaire Model is a specific agreement reached on an individual country level, which allows certain tax advantages, usually achieved against the inventory, sale and distribution of finished goods. The model is based upon reducing a tax burden via shifting activities into a lower taxed country. The lower tax environment assumes more of the risk and responsibility, hence reducing the overall tax burden for an organization. A significant presence is required in this lower taxed environment for the model to be accepted by the legal bodies of the countries involved. In its simplest form, the model has two major entity components, a Commissionaire and a Principal. Both the commissionaire and the principal are part of the same overall corporation. They will have different legal entity codes, and hence separate tax identifiers. In most models, the Principal will own the finished goods inventory until the sale to the end customer. The Commissionaire will act as the selling entity, and in the eyes of the end customer will be the only entity that will be recognized. A Commissionaire is a civil law agent who sells in its own name but on behalf of its Principal. A commissionaire earns lower profit than a full fledged distributor because of reduced risks and functions. A summary of the key components that comprise a Commissionaire Model are listed below. 1. A commissionaire is a legal entity who acts in his own name for the account of a principal. The commissionaire typically does not set the price this decision is left to the principal. 2. The principal is contractually bound to the commissionaire to deliver (through the commissionaire) the goods sold to the customer and the commissionaire is contractually bound to the principal to remit the invoice amount received from the customer. The principal is undisclosed and the customer remits to an account designated on the invoice. 3. No relationship is created between the principal and the customer. The customer does not have a delivery claim against the principal, nor can the principal perform any dunning against the end customer. This is the role of the commissionaire and is detailed in the legal agreement between the principal and the commissionaire. 4. The commissionaire is remunerated by a commission paid by the principal. 5. A commissionaire model recognition is more commonly found in civil law jurisdictions (France, Germany), but also know in common law jurisdictions (UK, etc.) Creating a Commissionaire Model for an organization requires significant business input from the Financial, Tax and Logistics organizations. The Tax and Financial organizations will work with multiple country legal and tax authorities to obtain approval for the Commissionaire model being proposed. Implementation of a commissionaire model is subject to approval by these legal governing bodies. A commissionaire model cannot be used without this approval. An organization needs to understand the total impact of implementing a commissionaire model. While there may be significant tax savings in establishing such a model, it could also lead to additional logistics costs for shipping, storage and management of finished goods.

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1.1

Commissionaire Model: Assumptions

Some Basic assumptions of Commissionaire Model are listed below. As stated previously, each model is unique to an organization and hence all assumptions should be reviewed at the time a specific model is created and put in place. 1. The model is not a one size fits all structure; it will depend not only on the countries of residence of the principal and the commissionaires, but also on the type of industry, the legal agreements, and the ruling obtained by the principal from the competent authority. 2. Due diligence on a country by country basis must be performed and documented for tax, regulatory and other aspects that can affect the sustainability of the model. This means that knowledge of prior years may be obsolete in current and future years. 3. Much of the issues related to the model pertain to transfer pricing and permanent establishment. The Organization for Economic and Co-operation and Development (OECD) can provide guidance in this area. 4. The commissionaire model does not equate to the agent model. The commissionaire is an affiliate in the same corporation as the principal; the agent is not; an agent can be an independent distributor, for example. 5. Commissionaire is not limited to the EU zone. This is a known model even in Japan. There are many different ways to set up the Commissionaire model. However, there are common features that will apply to the main components of the model, the Commissionaire and the Principal. Some of the common features include: Features of a Commissionaire 1. The commissionaire sells on behalf of the principal. 2. Prices and key terms of the sale are fixed by the principal. 3. The commissionaire does not take title to goods. 4. The commissionaire assumes low commercial risk; inventory and A/R are the main exposures. 5. The commissionaire is compensated by a commission of the sale. 6. Selling and invoicing is performed in the commissionaires name. 7. Contracts are directly between the commissionaire and the end customers. 8. The commissionaire is bound to any tax return obligation stated by his country of residence (see deemed invoice). Features of the Principal 1. The principal owns all finished goods inventory in a specific geography (if more than one principal for a given corporation). 2. The principal typically owns all accounts receivables for a specific geography; there are exceptions where the commissionaire will own and manage the A/R but pass write-offs back to the principal. 3. The principal enters into legal agreements with each commissionaire, distribution or manufacturing entity. 4. The principal reports all trade revenue and cost-of-goods-sold (COGS) on its books. 5. The principal pays a commission to the commissionaire.
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Each model must have at least 1 Commissionaire and 1 Principal. However, a common model will have multiple commissionaires (also referred to as commission agents, one per country is typical) and one principal (per region). There also are more complex models that involve more than one principal. In these complex models, any commissionaire would be unique to only one principal. The introduction of finished goods transfers between the principals would add further complexities to any model.

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2.0 Key Drivers of a Commissionaire Model As stated above, the decision on implementing a Commissionaire Model is driven by various departments within an organization. Typically the Tax and Financial departments champion the decision. The internal and external tax and audit organizations for a corporation must provide the guidance and final verification on the use of a specific commissionaire model within that corporation. Some key drivers that are taken into account in determining whether or not to establish a Commissionaire model include: The number of countries and geographies in which an organization operates. If a company sells product only in a single country or has minimal volume in given countries, the cost versus the benefit of establishing the model may not be justified. If expansion into new geographies is being considered, the introduction of a commissionaire could provide benefits. The type of product sold. Many of the benefits of implementing a commissionaire model are derived from tax advantages. While there are other considerations that need to be considered, the tax advantages will depend upon the location of the principal and the type of product. The transfer and mark-up prices of the finished goods between the principal and the commissionaire are major characteristics to focus on. Most companies that implement a commissionaire model have high cost products with significant mark-ups. Companies with low cost and high volume finished goods simply may not realize the tax advantages necessary to justify a commissionaire. Companies within the oil industry, chemical and pharmaceutical companies and medical device manufacturers are prime examples of organizations that have implemented this model and realized significant benefits. The tax advantage and long term impact. The major benefit of implementing a commissionaire model is derived from the tax advantages achieved. Many corporations opt to incorporate their Principal in a country where they can negotiate favorable rulings for tax on profit. These are not necessarily low tax countries. In many countries where this model is used, the taxes on profit are in the 30%-40% range; in Japan they tend to be at the higher end. The numbers can vary due to the existence of treaties between the various countries. Favorable rulings can push this percentage as low as 9%. The ruling is not all about the taxes: it also discusses the transfer price, the management fees, the existing intellectual property licenses, etc. Hence highly priced products with high mark-ups tend to yield the greatest tax savings. Timing the tax savings. All commissionaire agreements are bound by set terms and will expire and need to be re-instated at some point. Some agreements also offer increased tax advantages at the onset of the agreement as finished goods inventory transfers ownership from the commission agents to the principal. When the major advantage is achieved at the beginning of the agreement, the ability to implement a timely solution often influences the decision on whether or not Commissionaire is deployed.

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3.0

Major Commissionaire Building Blocks

Once it has been decided that a Commissionaire Model will be used, decisions on how to build the model for actual implementation must be made. The major building blocks for actually putting a commissionaire into operation include the following: The Tax and Legal structure Organizational Entity Structure Product Flow Models Reporting on Product Flows VAT and Intrastat / Extrastat

3.1

Tax and Legal Structure

For purposes of this discussion, the tax and legal structure of the commissionaire model will be identified as the legal entity and tax identifiers for the Principal and Commissionaires involved. This includes the tax identifier for each company that is part of the model, including participating subsidiaries. It also includes VAT numbers for those countries that will have VAT postings. This may include multiple VAT numbers for an organization depending upon whether or not a Commissionaire maintains a fiscal presence or not within a country. VAT groups, if used would also be part of this structure. The VAT percentages, based upon the country and product type, should be known. Lastly, specific statutory and reporting requirements will be required for different countries as well as for larger governing bodies, such as the EU. Many of these requirements should be well known as they are standard for nonCommissionaire models as well. The Commissionaire Model could add additional legal identifiers, both for company entity and VAT.

3.2

Organizational Entity Structure

Many official codes go into the tax and legal structure. The organizational entity structure is how a corporation would identify what locations would be identified by specific tax and entity codes. As an example, a typical Commissionaire model does not allow the commissionaire to actually own finished goods inventory. In this model, either all shipments then must be made from the Principals central warehouse location, or the Principal would need to have a location at the Commissionaire site within various countries. The Principal could maintain a plant location at the Commissionaire office. This location would house finished goods but the goods would remain under the ownership of the principal until sale to the end customer. Hence an organizational structure with a selling unit that is legally part of the Commissionaire entity, and a plant at the same physical location but part of the Principal entity. This example is often referred to as Plants Abroad where the principal has legal entity plants abroad in other countries that where the principal is located. Each commissionaire model will have its unique set-up requirements. The key organizational elements usually include:

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Company Codes. Legal entity company code locations would need to be established for the Principal and all Commissionaires. The Principals central location, which typically houses most of the finished goods inventory would be established as a plant or warehouse and would be part of the principals legal company code. The commissionaire(s) sales office. This typically does not store finished goods inventory from a legal ownership perspective. This would be part of the commissionaires legal company entity and would be responsible for the sale to customers. If this location required assets or other items to be owned by the commissionaire, a separate plant could also be established under this commissionaire. The principals plants abroad. If finished goods inventory is actually stored at a commissionaire sales site, a predominant means of establishing this while maintaining ownership by the principal is to establish a plant that is owned by the principal legal entity, but which is physically at the commissionaire site. Purchasing organizations would be established for buying activities. Legal entity restrictions would apply appropriately. Typically each principal and commissionaire would maintain separate legal purchasing units. Product Flow Models

3.3

The flow of finished goods products involves much more than the sale of a product to an end customer. Inventory, planning, allocation, availability checking and distribution must be taken into account. As an example, a commissionaire is typically legally bound in providing goods to a customer only via a pre-established principal. There can be situations where the principal does not have available inventory to fill an order. In this example, the inventory could be provided from a number of other sources, including third parties, manufacturing locations, or other principals within the overall corporation. Depending upon how the commissionaire agreement is structured, there may be restrictions on how the product must be moved in order to fill the requirement. In some cases, a shipment to the Commissionaires principal must first occur before the sale could be shipped. In any organization, there can be untold combinations of product movements between different entities within the organization. Also the type of movement must be taken into account. Examples of the different major product movements include stock transfer orders to perform inventory replenishment, sales to customers, consignment orders which include the fill-up, pick-up and issue, and lastly customer returns. As a recommendation, a product flow matrix to identify these movements between all locations within the commissionaire model should be done to ensure that all these activities are addressed within the correct legal structure. An example of a product flow matrix is shown below. These tables depict the type of analysis that should be incorporated into a successful commissionaire implementation.

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Intercompany Inventory Transactions

ERP <> ERP
Description 1 ERP Flow
IBM
IC Sale whereby financial invoice follows physical flow

ERP <> Non-ERP

Non-ERP <> ERP

Description 2

Sale / Return

Parties involved

Stock Transfer

STO

STO
IC Return whereby financial invoice follows physical flow

SO - PO

SO - PO

STO-R

STO-R
Drop Shipment
IC Sales + EDI purchase

SO-R - PO-R

SO-R - PO-R

STO + STO

DST
IC Return PO + Return SO

DSO - PO

SO - DPO

STO-R + STO-R

DST-R
Credit Rebill
[Option 2] (*)

SO-R - PO-R
+ JE

SO-R - PO-R
+ JE

Administrative Return & Rebill

STO-R + STO

S
Mfg

S
P

S
Mfg

S
P

N
Mfg

STO-R + STO
Administrative Return & Drop shipment

STO-R + SO - PO

- PO

STO-R + DST

S
Mfg

S
P

S
1

S
Mfg

N
Mfg

S
1

STO-R + DST
(*) Credit Rebill options: [Option 0] Direct Shipment/Invoice --> STO / DST [Option 1] Physical Return --> STO-R / DST-R

STO-R + SO - PO

- DPO

[Option 3] Principal to Principal --> STO / DST + Adj, if material financial impact

SOURCE/VENDOR Plant

DESTINATION/BUYER
9900 9901 9902 9903 9904 9905 7700 7701 7702 7703 7704 7705 7706 7708 7715 7717 7720 7731 7756 5000 4300 ABC Netherlands- Sales office ABC Switzerland-Sales Office ABC Germany - Sales Ofiice

ABC Denmark - Sales office

ABC -Portugal -Sales office

ABC Belgium - Sales office

ABC -Norway -Sales office

ABC Finland - Sales office

ABC France - Sales Ofiice

ABC Austria - Sales office

Corporate Headquarters

ABC Distribution Center

9900 9901 9902 9903 9904 9905 7700 7701 7702 7703 7704 7705 7706 7708 7715 7717 7720 7731 7756 5000 4300

S = STO R = Return C = Consignment O= PO / Sales Ord Description Corporate Headquarters Main Division Puerto Rico Main Manufacturing Foreign Distribution Sub Manufacturing ABC Distribution Center ABC Austria - Sales office ABC Belgium - Sales office ABC Denmark - Sales office ABC Finland - Sales office ABC Netherlands- Sales office ABC Switzerland DC ABC Switzerland-Sales Office ABC France - Sales Ofiice ABC Germany - Sales Ofiice ABC - Italia ABC -Norway -Sales office ABC -Portugal -Sales office ABC -Canada Austria Manufacturing

Rel 1,2 1,2 1,2 1,2 1,2 1,2 7 7 7 7 7 7 7 7 7 7 7 7 7 7 5

Business CSD
S,C S S,C S S S S,C C S,C S S S S R

USD

C S

C R R R R R R R R R R R R R O

R R R R R R S, C S, C S, C S, C S, C S, C S, C S, C S, C S, C S, C S, C S, C R R R R R R R R O O O O O O O O O O O O O

S, C S, C S, C S, C S, C S, C S, C S, C S, C S, C S, C S, C S

3.4

Reporting on Product Flows Intrastat / Extrastat, European Sales Listing, VAT Returns

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Austria Manufacturing

ABC Switzerland DC

Main Manufacturing

Foreign Distribution

Sub Manufacturing

ABC -Canada

Main Division

Description

Puerto Rico

ABC - Italia

When establishing a Commissionaire within the European Union (EU), special focus must be paid to a series of reports that revolve around the sale and distribution of finished goods. As stated earlier, there are many components of the Commissionaire model that are required regardless of whether or not this model is used. Any organization that does business within the EU will certainly be aware of requirements for: Intrastat / Extrastat European Community Sales Listing (EC Sales) VAT Returns

A Commissionaire model does not add or reduce the legal requirement for these requirements. It can however, significantly increase the complexity in gathering together the correct information for these filings. Intrastat is the system used for collecting data for the trade of goods between countries within the European Union. Extrastat is similar but includes the data between EU member states and non-EU countries (anywhere in the world). Billing and Purchasing documents make up the data that is used for both these reports. The European Community Sales Listing is a quarterly requirement that is similar to that of the Intrastat. Businesses that supply VAT goods to other business with VAT relevance, within the EC, must supply this listing. The EC Sales List is used to verify proper filing of VAT returns. The VAT return is the return filed with the individual country where a VAT registration exists. It is the detail of all transactions for which VAT was accessed. All three of these reports have inter-dependencies on the data contained within. Every company who is registered for VAT in the EU must submit a number of these VAT related reports. There are slight differences in the requirements from one country to the other due to other local regulations. Combine now, the complexities of tracking and compiling this required data, with the new complexities of the various elements identified above. The complexities of the commissionaire, including the legal and tax structure that determines the owner of the goods and the country that it transacted from, the type of product, the type of movement (sale or transfer), are all items that must be taken into account. The accurate tracking of goods movements can be one of the most complex elements to accomplish in implementing a Commissionaire Model. Establishing a legal and organizational entity hierarchy may address many requirements. However, many times moving products between locations (intra-company) does not generate financial postings since legal ownership does not change. However, if borders are crossed within the EU, the above listings can be impacted. Again, this is certainly independent of a Commissionaire Model, but the Commissionaire structure tends to have an impact of increasing product movements (to achieve that coveted tax savings) and hence increase the complexities in creating these reports. The reports themselves can only be achieved if accurate data is maintained. The true challenge here is creating and maintaining the accurate data associated with the product movements.

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4.0 Related Distribution Models This discussion has focused on the Commissionaire Model. However, there are other related models, while not a true Commissionaire, that fit many aspects of the model. And of course, there is the classic Buy / Sell model that most companies operate under. Some countries do not allow commissionaires to be established. Additionally, an organization my find benefits in establishing a commissionaire in one country (of a region) but not in another. Hence, the models described below are not mutually exclusive. In other words, a corporation can establish and operate a commissionaire model for a group of countries and operate a flash buy/sell model for a different group of countries. It would even be possible to operate different models in the same countries if product differentiation were possible. However, care and caution must be used in determining which model to use. The tax and audit authorities should lead the decision on what is legally allowed. The internal tax and financial organizations would decide on what allowable model(s) would yield the highest benefits to an organization. Descriptions of these models follow.

4.1

Commissionaire

The Commissionaire Model, in its absolute form, entails a Principal entity that owns the entire finished goods inventory and all revenue. The sales subsidiary, the Commissionaire, never owns inventory and does not bear any A/R risk. The commissionaire is remunerated with a commission fee. If the principal is an Undisclosed principal then the documents to the customer contains the Commissionaires address. This model is written in the civil law of many countries (France, Spain) and is also known in countries that have common law (UK, South Africa, etc.).As mentioned above, Asia Pacific counties are also familiar with the commissionaire model Variations on this absolute model do exist. In some variations, the Commissionaire actually owns and manages the A/R but does not assume the risk; in other accepted models the Principal will own and manage the A/R. While there are variations, the basic premise of this model involves the finished goods management and selling relationship between the Principal and the Commissionaire(s).

4.2

Buy /Sell

The Buy / Sell is the classical inter-company relationship among affiliates, either manufacturing entities or sales subsidiaries, within the same corporation. The product flow follows the invoice flow. Each entity bears the same risk of inventory and A/R. The main requirement to satisfy here is the Transfer Pricing. A regular sale under this model can involve different types of product flow. One common flow would involve the inter-company procurement of finished goods from a manufacturing company to the selling company. Inventory would be maintained at the selling company and shipments to the end customer would occur from this selling location. A different variation could actually use a drop ship where the goods are shipped directly from the manufacturer to the end customer. The commonality in both
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these examples is that an inter-company transaction occurs to transfer ownership of the goods between the manufacturer and the selling company. This generates an intercompany A/P and A/R at a pre-set transfer price. The selling company also manages the customer relationship, including the invoicing and A/R.

4.3

Flash Buy Sell or Risk Stripped Buy/Sell

In this model, the affiliate, generally the sales subsidiary is stripped of the risk in carrying inventory. Similar to the Commissionaire, the inventory is owned by a Principal. It is sold by the sales subsidiary to the customer either through a Principal or directly from the manufacturing entity. The sales subsidiary buys the inventory at transfer price. The inventory title change occurs only at the time of sale to the customer. The sales subsidiary does not otherwise own any inventory, hence the denotation as a Flash Buy/Sell. An advantage to this model is that the selling entity has minimal exposure to inventory at any given point in time. Many times this model is used where a corporation establishes an overall Commissionaire Model, but a specific country does not accept a commissionaire.

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5.0

Summary and Conclusion

Businesses are providers of goods and services to end customers. Providing finished goods involves the management of inventories, sale, and distribution of the good. There are different models, both from a tax and financial perspective, as well as a logistical perspective. The selection of a given model will ultimately depend upon the organizations product, distribution model, geography of operations, and tax and legal benefits. There is no single model that fits all organizations. A Commissionaire Model is an option that offers tax advantages to certain types of organizations. These advantages need to be weighed against the total impact to an organization, which can include additional labor, inventory, distribution or managerial costs. A Commissionaire Model will need agreement from the tax and financial areas within an organization, and the legal and tax authorities in the country where the model is being implemented. A review by an external audit organization is also a prudent investment. If a Commissionaire Model is undertaken, a review of the finished goods supply chain, as well as tax and finance implications needs to be included. There are many complexities associated with a commissionaire. This overview was directed at some of those complex areas and the specific items for review.

IBM Authors

Robert Kopac is a Partner in IBMs Global Business Services. Bob has led complex ERP engagements that have implemented Commissionaire Models in Europe and Japan. Robert.kopac@us.ibm.com Gopal Chandrasekaran is a Senior Managing Consultant in IBMs Global Business Services. Gopal has led the ERP Commissionaire efforts for numerous global companies. Gopal.Chandrasekaran@us.ibm.com

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