Tanya Duncan’s experiences with global SAP finance implementations in Europe, Mexico, and Singapore have all had one commonality: complex legal entity structures. Designing company codes and plants in an SAP system is not always straightforward and this article presents several considerations in building these structures effectively.
After reading this article, you will learn about:
- Three common legal entity structures
- The corporate tax benefits of these structures
- Design considerations for building these legal entity structures in an SAP system
- Lessons learned in designing these unique requirements
Maquiladora is a factory in Mexico run by a foreign company that exports products to its home country. Contract manufacturing is a form of outsourcing whereby a manufacturer contracts with a firm for components or products. Toll manufacturing is an arrangement in which a company processes raw materials or semifinished goods for another company.
Legal Entity Design Considerations in Global Implementations
Reflecting on my experiences with global SAP implementations, I found a common thread: the majority of my clients had complex legal entity structures that took significant effort to design in an SAP system.
To gain competitive advantages in today’s global business environment, corporations often reorganize into legal entity structures that provide significant tax benefits. These structures frequently take advantage of legally owning assets, revenue, and expenses in different countries where tax rates are more advantageous. Accordingly, SAP company code design is driven by tax and legal requirements, including financial ownership of assets, employee expenses, and facilities.
Three common legal entity structures include contract manufacturing, toll manufacturing, and maquiladora. I outline the characteristics of each of these legal entity structures, how the SAP organizational structure is typically designed for each, and lessons learned from my field experience.
Maquiladora: A maquiladora (or maquila) is a legal entity structure specific to production in Mexico by a non-Mexican parent company. Through this structure, a US parent company, for instance, can import input materials duty-free and tariff-free into Mexico and take advantage of lower cost labor and the devalued peso. The finished goods are then imported back to the US with a duty on the value added by Mexican assembly. Often cities on opposite sides of the border will be used as twin plants to minimize transportation costs and be more efficient.
Toll manufacturing: Under a toll manufacturing (or toll processing) model, a parent company sells input materials to a third party that manufactures the finished goods and sells them back to the parent company. The advantage in this model is that the parent company makes production a variable cost by outsourcing the previously fixed costs of labor, equipment, and facilities.
Contract manufacturing: The contract manufacturing structure is very similar to toll manufacturing, with one main difference: in contract manufacturing, the third party sources the raw materials for production.
SAP Supporting Design
These legal entity structures are reflected in an SAP system by using one or more company codes to represent the contracted legal entities as separate from the parent company. If the contract is with an outside legal entity that is not owned by the parent company, that company code is not created in the SAP system and it is treated as an external supplier.
The following are key areas to consider in the SAP design:
Raw material inventory: In the case of a maquiladora or in a contract manufacturing model, the parent company typically provides the inventory of input materials. In these cases, input materials are extended both to the parent company codes (i.e., where the inventory is originally sourced from external vendors), and the contract company codes (i.e., where the inventory is imported). In a toll manufacturing model, the third-party sources the inventory, so it is only extended to the contract company code. It is important to ensure that raw material inventory is valued in the correct legal entity, and transferred between companies with the appropriate transfer price.