The impact of tax legislation on lot-sizing and sourcing strategies - PowerPoint PPT Presentation

The impact of tax legislation on lot-sizing and sourcing strategies Hua Jin, Dr Patrick Beullens Southampton Business School, University of Southampton , United Kingdom CMS-MMEI, 29 th March 2019, Chemnitz

Content 1. Introduction – Corporate tax (CT), Value Added Tax (VAT), Import Duties (ID) – Literature & Research questions 2. Economic Order Quantities with CT and VAT – NPV based EOQ – CT and VAT schemes and their impact – CT and VAT Adjusted EOQ – Numerical results 3. Acquisition (Acquire products from EU) with CT and VAT 4. Import (Global sourcing) with CT and VAT 2 5. Conclusion

1. Introduction: Taxes • Corporate Tax (CT) • Import Duties (ID) • Value Added Tax (VAT) As most firms wish to make decisions that maximise future profits after tax , these additional expenses should in principle be accounted for. 3

1. Introduction: Taxes in supply chain Sells 100+VAT(20) manufacturer Raw material producer 20 20 40 Reclaims VAT HM Revenue & customs charged by Producer-Collect 20 producer, sells Manufacturer-collect 20 finished goods to Retailer-collect 40 retailer for 200+VAT(40) 40 80 Customer Retailer Reclaims VAT charged from 40 Input VAT for Retailer upstream, sells finished goods to customer for 400+VAT(80) 80 Output VAT for Retailer 4

1. Introduction: OR literature • There is an increased awareness in the literature of the importance of taxes to the firms and the management of supply chains. • Very few papers in the inventory literature consider taxes – Gurnani (1983) develops EOQ with CT and NPV criterion, but optimal lot- size independent of CT. No VAT. – Michalski (2013) derives a modified “NPV” EOQ model with CT tax benefit on costs to maximise firm value. Optimal lot-size decreases. No VAT. – Hsu and Zhu (2011) & Xiao et al. (2015) analyse production models under Chinese export-oriented VAT policy and CT. Optimal decision depend on purpose of the product of the tax policy. No NPV. No literature has examined impact of timing of taxes 5

1. Introduction: Why CT and VAT are ignored? • CT 𝑁𝑏𝑦 ( 1 − 𝜗 𝑞 − 𝑑 𝑧) = 𝑁𝑏𝑦 (𝑞 − 𝑑)𝑧 • VAT 𝑁𝑏𝑦 ( 1 + 𝜐 𝑞 𝑧 − 1 + 𝜐 𝑑 𝑧 − 𝜐𝑞𝑧 + 𝜐𝑑𝑧) = 𝑁𝑏𝑦 (𝑞 – 𝑑)𝑧 • If lot sizing models are based on average cost, it seems that both CT and VAT would not impact decisions. • This is no longer true when looking at the processes by which most governments collect VAT and CT cash-flows. 6

1. Introduction: Research Question • Based on the NPV criteria, how should the financial parameters in the model to be specified so that its application ensures compatibility with the NPV optimization of profits after tax ? • Is there a rational for embedding taxation rules and processes in inventory control , further for supplier selection based on the Economic order quantity assumptions? As most firms wish to make decisions that maximise the Net Present Value (NPV) of future profits after tax , these additional cash-flows and their timing should in principle be accounted for. 7

1. Introduction: Sourcing Strategy Acquisition 1 Domestic Purchasing 2 Acquisition 3 Import EU supplier Applied UK and EU tax rules that applied EU customer in 2015-2016 as the basis on our Understanding of relevant legislation. Import UK Domestic Buyer UK domestic customer global supplier 8

2. EOQ derived from NPV criterion ∞ 𝑓 (−𝑗𝑏𝑈) - FOC = p y - 𝑏( 𝑡+𝑥𝑧𝑈) AS=p y- ( s + w y T ) σ 𝑗=1 -FOC 1−𝑓 −𝑏𝑈 𝑡 𝑡 𝑧𝑈 ෪ 𝐵𝑇 =( p – w ) y - 𝑈 - a 2 - a w 2 - FOC 2𝑡𝑧 Q* = 9 𝑏𝑥

2. EOQ and CT cash-flows (1) • In general term, CT is charged as a percentage of Operating Profit (OP) in an accounting year. 𝑃𝑄 = 𝐻𝑠𝑝𝑡𝑡 𝑄𝑠𝑝𝑔𝑗𝑢 (𝐻𝑄) − 𝑃𝑞𝑓𝑠𝑏𝑢𝑗𝑜𝑕 𝐹𝑦𝑞𝑓𝑜𝑡𝑓𝑡 (OE) • In operational business function expressed in EOQ model: 𝑃𝑄 = 𝑂𝑓𝑢 𝑇𝑏𝑚𝑓𝑡 − 𝑃𝑞𝑓𝑠𝑏𝑢𝑗𝑜𝑕 𝐹𝑦𝑞𝑓𝑜𝑡𝑓𝑡 −𝐷𝑃𝐻𝑇 𝑡 𝑞𝑧 𝑈 + 𝐺𝑃𝐷 𝑥𝐽 0 + 𝑥 𝑧 − 𝐽 0 + 𝐽 1 − 𝑥𝐽 1 = 𝑥𝑧 In the EOQ model, the amount of products purchased may differ from demand y due to the lot size decision and the times when the accounting year starts and ends relative to the inventory cycle, however, for the constant purchase price w , the effect can cancel out. 𝑡 𝑃𝑄 = 𝑞𝑧 − 𝑈 − 𝐺𝑃𝐷 −𝑥𝑧 10

2. EOQ and CT cash-flows (2) Firms with a taxable profit of £𝟐. 𝟔 𝒏𝒋𝒑 or less , pay CT 9 months (and one day) after the end of the accounting year. year year year 0 year 9month 9month 9month Amount need to pay at time 0: є 𝑃𝑄 𝑓 − 12+9 𝑏𝑈 𝑤 ∞ NPV = −є 𝑃𝑄 𝑓 − 12+9 𝑏𝑈 𝑤 σ 𝑗=1 𝑓 −𝑗𝑏𝑈𝑏 AS є = −є 𝑃𝑄 𝑓 − 12+9 𝑏𝑈 𝑤 σ 1=1 ∞ 𝑏 𝑓 −𝑗𝑏𝑈𝑏 11

2. EOQ and CT cash-flows (3) Firms with a taxable profit above £𝟐. 𝟔 𝒏𝒋𝒎𝒎𝒋𝒑𝒐 pay CT in quarterly instalment , and these payments are due at times of middle 6; 9; 12; and 15 (in months) from the start of the accounting year. Firms with a taxable profit above £20 million pay CT earlier, so tax due is the third, sixth, ninth and 12 th months of the period. We define the CT effect It is an adjustment of an adopted CT rate and which is account for the 𝑓 −𝑏(12+9)(1/12) time-dependent CT schemes . Є ' = є 1−𝑓 −𝑏𝑈𝑏 12 Corporation Tax-adjusted annuity stream function AS є = Є′ OP

2. EOQ and VAT cash-flows The firm’s expected annual VAT liabilities to the government are net difference: 𝑡 τ NVAT=OVAT-IVAT=p y τ – (w y τ + 𝑈 ) – τ (1- δ ) FOC We define the VAT tax effect : It is adjustment to an adopted VAT tax rate which account for the time- dependent VAT schemes used by firms. Annual VAT accounting scheme Standard VAT accounting scheme Tax-exchange Annunity stream function depend on schemes 13

2. EOQ model with CT and VAT effects (1) • AS version of EOQ model in which the impact of CT and VAT is included, hence, the objective function is given by: Linear approximation of the VAT CT adjusted EOQ: 14

2. EOQ and Tax – Analysis • The effect of taxes significantly increase the opportunity cost of capital to be used in the EOQ formula. 2𝑡𝑧 2𝑡𝑧 TQ* = Q* = 𝞭′𝑥 𝑏𝑥 15

3. Acquisition and Tax AS io = py (1+ τ ) + p on y on (1+ τ ) + p or y or (1+ τ ) 𝑏 ( 1+ τ s ) 1+ τ w 𝑏 − s 1−𝑓 −𝑏𝑈 − wYT P on y on =output VAT 1−𝑓 −𝑏𝑈 P or y or = No output VAT − (1- δ ) FOC ( 1+ τ ) – δ FOC EU supplier EU customer 2𝑡𝑧(1+τ−ϵ′−τ′) Q 1 * = (UK sourcing) 𝑏𝑥(1+τ) UK Domestic Buyer UK domestic customer 2𝑡𝑧(1−ϵ′) Q 4 * = (EU sourcing) 𝑏𝑥 16

3. Acquisition and Tax: sourcing strategy 𝑏 ( 1+ τ s ) 1+ τ w 𝑏 − s 1−𝑓 −𝑏𝑈 − wYT 1−𝑓 −𝑏𝑈 17

3. Acquisition and Tax: Impact of Sales py (1+ τ ) + p on y on (1+ τ ) + p or y or (1+ τ ) 18

4. Import and CT with VAT AS io = py (1+ τ ) + p on y on (1+ τ ) + p or y or (1+ τ ) −[ wYT𝑓 𝑏𝑀 𝐽 + xs 𝑓 𝑏𝑀 𝑡 + (wYT +xs) ϴ𝑓 𝑏𝑀 𝑂 + (wYT+xs) )(1+ ϴ ) τ 1 𝑓 𝑏𝑀 𝑂 ∞ 𝑓 (−𝑗𝑏𝑈) + (1-x) s (1+ τ s ) ] σ 𝑗=1 − (1- δ ) FOC ( 1+ τ ) – δ FOC 19

4. Guide price for global sourcing 20

5. General conclusions • Tax rate & schemes - when the firm pays tax to the government, are both important to the inventory decisions. • Tax adjusted inventory model decreases set up cost, but increases holding cost. Optimal order level is smaller than those arrives at when using the unadjusted values of set up cost s and holding cost aw . • If marginal profit is low, logistics decision are important, and thus also tax considerations. • Impact on order quantity decisions, impact on supplier selection, impact on sale strategy. • Government role is introduced in the logistic decision. 21

Thank you for your attention ! 22