By Karen Lynch
Disruptive innovation is cutting a wide swath across industries and around the world.
Its impact is felt again and again: as a ride-sharing service completes its 2 billionth trip; as tax officials start targeting their audits via social media; as a venture capital firm gives artificial intelligence (AI) a seat on its board of directors.
Innovative disruption is creating entirely new markets and fundamentally changing the way the world works.
“Technology is enabling tax authorities to become more efficient and robust at assessing and collecting tax, and technology can also help companies get ready for that.“
Channing Flynn, Global Technology Industry Tax Leader, EY
For a decade, the rallying cry of the global digital economy has been to disrupt or be disrupted.
Within another decade, no industry may look the same.
It’s no wonder that tax departments find themselves in the path of disruption as well.
The three biggest disruptors they face are:
- Speed to global market
- Digital authority
- Smart tax
‘A more complete tax system’
Tax teams must keep up with their own organization’s rapidly digitalizing, globalizing business lines and operations.
At the same time, they face myriad governments digitalizing their tax administrations and updating tax policy for a virtualizing, borderless business world.
“In the near term, we will see an increase in tax controversy — and even an uptick in the incidence of double taxation,” says Jay Nibbe, EY Global Vice Chair Tax in London. “But ultimately, we should arrive at a more complete tax system where technology helps improve compliance.”
That’s where digitally advanced smart tax comes into play as the third disruptor, automating the collection and ever-deeper analysis of massive amounts of data.
“The tax function is moving to a just-in-time mode of operations,” says Channing Flynn, EY Global Technology Industry Tax Leader in San Jose, California. “Tax is awfully inefficient today, but as this all settles out over the next 10 years, we should end up with a much shortened tax timeline, greater clarity and less controversy.”
New tax riddles
Innovation, the digitalization of business models and hypercompetitive global markets are propelling business at unprecedented speed.
A good idea, digitalized, can be globalized seemingly overnight, spread via network effects and enhanced with unending improvements.
San Francisco-based Airbnb went from start-up eight years ago to serving over 100 million guests in 192 countries today, while also helping to define a new sharing economy business model that is being replicated across industries worldwide.
And Airbnb continues to innovate and expand from room sharing for the average traveler to providing business accommodations, travel advice, and various booking and business management tools for Airbnb hosts.
Sharing economy businesses, FinTech start-ups such as online lenders and autotech innovators with driverless cars are among the disruptors that are not only moving fast and wide but also upending old ways of doing things through the use of digital technology.
To compete, established businesses are compelled to innovate — and fast — to the point where continuous innovation has become a stated priority in many a corporate strategy.
In turn, innovation challenges corporate tax departments to keep up with borderless, cloud-based transactions and their indirect taxation, or with globally commercialized intellectual property (IP) and its implications for indirect taxation.
For example, when it comes to value-added taxes/goods and services taxes (VAT/GST), the supply chain is becoming longer, more complex and subject to ever-changing rates across multiple borders.
Income tax questions also arise, such as this common riddle: where is taxable value being created during a conference call among various offshore software development centers, the marketing department in the target market and a C-level decision-maker on another continent?
With the prospect of even more disruptive technologies and digital business models on the horizon, there’s a lot at stake.
Tax departments must:
- Control the tax spend
- Avoid litigation, penalties and interest
- Prevent the need for restatements on financial reports
- Protect their organization’s reputation as a good corporate citizen
Beyond avoiding pain, there is the mandate to find value including cost advantage, tax incentives and foreign tax credits.
Missing from the picture
In leading businesses today, employees can turn on their laptop, open up a dashboard and view in real time or near real time what has been happening in the global supply chain.
CFOs are spearheading finance transformations in their organizations, often consolidating decentralized functions into regional centers of excellence and shared services.
Enterprise resource planning (ERP) systems are capturing a wealth of transactional data from operational units and business lines — the source data so valuable to record, analyze and report tax.
What is wrong with these scenarios is that too often the tax team is not in them.
It is still a silo or two away from this near- to real-time data.
For example, only about half of the organizations undergoing finance transformations have been including tax in the scope of that process, according to our analysis.
Collecting internal data and mapping it to government tax data and third-party sources remain a manual exercise in most tax departments.
“Currently, tax executives spend a large part of their time just gathering data,” says Richard Suhr, Global Digital Leader of EY Advisory Services in Wellington, New Zealand. “In the future, if they can obtain tax-ready information, they will be able to devote the bulk of their time to strategic tax analysis.”
The disruptor: artificial intelligence
Greater emphasis on strategy
Arguably, tax analysis now needs to be more strategic than ever.
Given typical corporate margin pressures today, the bar is being lowered on the potential return on investment needed to justify changing a tax position or adjusting tax strategy.
And even as their own businesses globalize at top speed, tax departments must repeatedly pivot to evolving rules in the wake of the base erosion and profit shifting (BEPS) project by the Organisation for Economic Co-operation and Development (OECD).
Well into 2016, authorities have been dealing with unfinished work on the BEPS project’s multilateral tax rewrite, published in October 2015.
Meanwhile, governments around the world have been implementing their own, at times inconsistent national interpretations of the guidelines into domestic tax law.
In tandem, tax administrations are not only digitalizing their operations but also setting up information exchanges with their peers in other countries to keep up with digitalizing businesses.
As rules change, for example, the location of a networked server can suddenly raise the risk of a taxable permanent establishment in a new jurisdiction.
Shifting VAT/GST rules and rates in one jurisdiction after the next can throw off pricing strategies, undercut profit assumptions and mangle complex global supply chain calculations.
For Airbnb, creating a new way of transacting business has led to entirely new tax strategies.
“We needed to think about how we should engage and help our hosts with taxes,” says Airbnb Global Tax Director Beth Adair.
On its transaction platform, for example, Airbnb has now begun collecting and remitting tourist taxes, also known as hotel or occupancy taxes, for people hosting guests in their homes in 200 jurisdictions (and counting).
As Adair points out, “It’s unusual for corporations to voluntarily wade in and handle other people’s tax responsibilities.”
In the driver’s seat
Global digital economy dynamics have presented the world’s tax authorities with an essential challenge: how to levy taxes, collect them and preserve their national treasuries in this new business environment.
Governments worldwide have become preoccupied with:
- Setting digital economy tax policy
- Expanding tax transparency
- Modernizing tax administration
Policy issues may have dominated the headlines over the past five years, as the BEPS project tackled perceptions of cross-border tax avoidance and promoted greater transparency about exactly who is paying how much tax and where.
In the background, however, tax authorities have been digitalizing their information technology (IT) systems in ways that could revolutionize taxation.
Those administrations on the vanguard, such as Brazil, Mexico and Russia, are said to be well ahead of even some of the biggest global businesses in digitalizing their operations.
Almost every government in the world has achieved at least some level of digitalization, albeit to varying degrees and across different types of taxes and taxpayers.
Indirect taxes such as VAT and customs duties have been first in line, with direct income taxes falling subject to similar treatment over time.
“Advanced governments are beginning to look at your data in a way that I’d say 99% of corporations do not,” says Carolyn Bailey, EY Americas Digital Government Tax Transformation Leader in Houston. “If tax departments wait to catch up, it’s going to be really hard, and the tax authorities are going to be in the driver’s seat.”
The disruptor: global players
The upshot may come as a surprise.
“Sometimes, governments may know more about you than you know about yourself,” says Michael Heldebrand, EY West Region Leader Global Trade in San Jose.
The upside for governments could be increased tax collections.
Russia’s Federal Tax Service has reported that its tax digitalization efforts led to a 12.2% increase in VAT collection in 2015.
With these kinds of results, and with tax administrations across the world sharing leading practice and capacity building in addition to tax information, the momentum behind digital taxation is growing.
However, many tax authorities face steep challenges.
“Such transformations are highly complex and come with massive challenges, requiring the intersection of multiple, multijurisdiction datasets,” says EY’s Suhr. “Dealing with these issues takes capabilities, skills and experience that many government administrations don’t have.”
In more established tax administrations, such as the United States, complex legacy systems, multiple jurisdictions and entrenched bureaucratic processes have also proved a hindrance.
What about the business world?
The road ahead will not be smooth for the business world, either.
Corporate tax departments are beginning to face challenges as well, including:
- The multiplicity of data formats required by different jurisdictions
- Shorter time frames for digital defense of tax positions
- The need to test data at the source for quality, because transactional information is going straight out the door to tax administrations
Approaching these challenges one country at a time is becoming unsustainable; regional and global strategies are required.
And adjusting for tax considerations after the fact can be far more expensive than getting it right the first time.
In the long run, however, the intent of digital taxation is to make tax compliance less burdensome and more collaborative, according to documents from a recent meeting of the OECD’s Forum on Tax Administration (FTA), which also emphasized consideration to issues of privacy and security where data is shared across borders.
The future of smart
The third disruptor to the tax department is framed by one of our identified megatrends for 2016, “the future of smart.”
As defined by EY, “smart takes a transaction, ensures it is connected, analyzes its data and makes it more autonomous and effective.”
It is changing the way both business and taxation are conducted.
The sea change for taxation is that smart tax is real-time and even forward-looking — where tax has traditionally been historical.
Multiple smart technologies are colliding and hitting their critical inflection point at the same time.
- Business process robotics will help automate data collection.
- The Internet of Things will minimize paperwork.
- AI, which is becoming more prevalent in such day-to-day settings as web searches, weather forecasting and voice recognition applications, will enable data mining and deep learning.
- Blockchain technology, most simply described as a secure, distributed ledger software, is not only poised to break into the world of business and finance but also tipped to merge its transactional capabilities with AI’s cognitive capabilities for autonomous transactions that can self-initiate, self-manage and self-retire.
- Big data analytics, AI’s forerunner, is already enabling better decision-making through data storage, aggregation, cleansing, integration, consolidation and analysis — including predictive analytics.
The disruptor: digital governments
How tax authorities will use it
Some tax authorities are taking advantage of recent rapid advances in data analytics and machine-learning technologies to develop risk profiles, analyze trends, flag potential audit issues and identify higher-risk cases for deeper investigation.
For example, administrations in Ireland, Malaysia, the Netherlands, New Zealand and Singapore are even carrying out social network analysis, assembling connected individuals into easily visualized networks and scoring them for risk.
According to the OECD’s FTA, administrations’ digital techniques are evolving.
High-level supervised models are giving way to more granular models and unsupervised machine-learning techniques that learn from historical data to identify patterns.
Tax administrations are also integrating predictive methods, to anticipate such problems as inaccurate tax returns or late payments, as well as prescriptive methods, to influence taxpayer behavior.
“Don’t think that this isn’t going to disrupt your business,” says David Jensen, EY Disruptive Innovation Leader in Los Angeles. “You need to be engaged now.”
What’s ahead with audits?
In a best-case scenario, tax administrations’ development of a more analytical approach could mean that audits are fewer and better targeted, reducing compliance burdens on businesses.
A more nuanced view is suggested by Christoph Huber, Head of Group Tax at OC Oerlikon Management AG, a Swiss industrial group that operates in 37 countries.
“On the one hand, tax authorities could get more efficient and ask the right questions,” Huber says.
Among the efficiencies he would welcome: fewer audits on years-old filings, which the passage of time can make so burdensome that tax adjustments are sometimes simply accepted.
“On the other hand,” he adds, “the authorities could just ask more questions, because it takes them less time to identify potential issues — many of which turn out to be nonissues.”
Watson on the case
IBM’s Watson, a cognitive business platform, may be best known for beating human contestants on the Jeopardy! television game show in 2011.
But Kanthi Srikanta, Vice President Tax Operations for IBM in Armonk, New York, prizes its potential for minimizing tax risk.
“This is all still a few years off,” Srikanta told EY for an upcoming edition of Digital tax developments review. “But if, for instance, we have the right amount of tax information fed into Watson to profile different countries, Watson would be very good at identifying our top-risk countries and where we should pay close attention in terms of our existing tax structure.”
In the future, traditional accounting, finance and tax functions will be revolutionized by robotic process automation and new systems that offer real-time collaborations, scenario planning, cost modeling and risk simulation tools.
Repetitive, high-volume tasks will be performed by a virtual workforce of software robots that can work faster, more inexpensively and more accurately than a human being.
AI will be loaded with such information as tax code, case law and administrative guidelines, and AI will make certain decisions on this basis.
“Tax professionals will be redeployed to higher-value activities that require subjective judgment and strategic decisions,” says EY’s Suhr. They will be supported by real-time data aggregation, data visualization and predictive forecasting — allowing people to focus on unlocking value within accounting, finance and tax, rather than being burdened by their compliance or reporting function.
Clearly, the tax world is going through a daunting transition.
But EY’s Flynn summarizes the situation simply: “Technology is enabling tax authorities to become more efficient and robust at assessing and collecting tax, and technology can also help companies get ready for that.”
The five levels of digital taxation
- E-file: Traditional tax returns and forms must be digitally filed, within a well-established yearly or quarterly time frame.
- E-accounting: Companies must digitally submit source data to support filings with a defined time frame.
- E-match: Governments build in analytic capabilities, matching data across tax types, and potentially across taxpayers and jurisdictions in real time.
- E-audit: Governments analyze and cross-check filings in real time, and companies have limited time to respond.
- E-assess: Tax administrations plug directly into corporate systems, analyzing the data, determining the tax rate and then taking the money out of corporate bank accounts — pending any response to the contrary.
Key action points
- Put tax departments in a position to know of any significant business change and its tax implications.
- Confirm that the department is involved early and integrated deeply in corporate finance transformation initiatives.
- Map the global footprint of tax administration digitalization wherever you do business.
- Move from single-country compliance fixes to regional and global strategies.
- Be prepared with a digital audit defense strategy.
- Inject digital capabilities into the tax department.
This article is included in Tax Insights issue 17 – Transformation and innovation (pdf)