Logistic operations in Free Zones

The Free Zones are areas with the aim of developing the economic activity of a country through tax incentives and stimuli that facilitate commercial exchanges. Many companies seek the Free Zones due to the logistical facilities that normally serve such regions and the reduced costs, mainly taxes. Countries create such Zones to attract companies that want to develop business in the region, developing the local economy and creating jobs. But what would be the main benefits that ZFs provide, and what care should managers take when defining their operations strategy?

Figure 1 – Zona Libre de Colón: the largest Free Zone in America, located in Panama.
Source: Wikimedia Commons

The first point that managers should consider is logistical. In general, the Free Zones are located in port areas, which facilitates the maritime movement of cargo. However, some of them may be in continental areas. The definition of which area is the most advantageous depends a lot on the logistics network that the company has or intends to install. It is important to consider the costs of transporting the flows inbound e outbound. For this, it is essential to know: i) where your current and potential suppliers are, and ii) where current and future demand is located. The intended service level must also enter into the calculation. In addition, there are storage costs. Depending on the fixed and variable costs of maintaining the operation, the decision to position the operation can change a lot. At this point, some Free Zones may provide subsidies on renting areas and other fixed costs, such as utilities, for example.

Knowing the logistical costs, another important aspect of analysis is the tax. There are a number of advantages in tax costs that a company can obtain if it decides to operate in a Free Zone. In the Manaus Free Trade Zone, for example, there are benefits on Import Taxes, Income Tax, IPI, PIS, COFINS and ICMS. In the Free Trade Zone of Cartagena, Colombia, sales tax (VAT) is exempt and the Income Tax rate is reduced.

One of the points of attention for defining tax gains is the type of operation that the company intends to carry out in the Free Zone. For example, a Brazilian company that serves markets in Latin America and North America can install a Logistics Hub in Colombia, as it is a central geographic region between the service areas. Depending on the origin and destination of the products and the Commercial Agreements in force, this Hub could provide a huge tax benefit, specifically in Import Taxes. For example: some product classes have a 10% import tax between Brazil and Mexico. The same products have a zero rate between Brazil and Colombia and a zero rate between Colombia and Mexico. In this case, there is a clear tax benefit, right? Well, not always.

Figure 2 – Tax benefit on import tax when sending products between Brazil-Colombia-Mexico compared to the Brazil-Mexico case.

Source: ILOS 

In the given example, the typical operations of a Logistic Hub, such as storage and labeling, would not verify the Colombian Certificate of Origin. That is, the product brought from Brazil to Colombia would be sent back to Mexico with a Brazilian Certificate of Origin, requiring the payment of a 10% rate. In the Colombian Free Zones, it is necessary to transform the product to obtain the Certificate of Origin, which would not occur for a Logistics Hub, but for an industry or manufacture.

The example presented illustrates the importance of fully understanding the characteristics of the operation and the rules of each operator in the Free Zone of interest. Understanding the Commercial Agreements between countries, understanding the tax benefits that ZF provides and clearly defining the company's service logistics network and its logistics costs is the first step to align the operations strategy with the company's financial objectives.

References:

http://site.suframa.gov.br/assuntos/incentivos-fiscais

http://www.inviertaencolombia.com.co/zonas-francas-y-otros-incentivos/zonas-francas-permanentes.html