Three years into his tenure as Mexico’s President, Vicente Fox installed a mechanical engineer turned finance executive as head of the country’s tax authority, the Servicio de Administración Tributaria (SAT).
The move may have seemed unusual, but Fox wanted José María Zubiría Maqueo for a specific purpose: his ability to use technology to boost collections.
Zubiría Maqueo used what he’d learned from his previous role reforming the billing department at a large Brazilian telecommunications company.
“You need to have a sense of what the data is going to convey to authorities — what they are going to see, and you need to be able to talk about it with them and communicate your positions.“
Cathy Koch, Americas Tax Policy Leader, EY
Under his leadership, SAT expanded beyond electronic filing, adding more services online and building databases of information about its taxpayers.
By 2006, Zubiría Maqueo was hiring analysts to mine the databases for insights, and was kept on when Fox stepped down and Felipe Calderón took over the presidency.
By 2012, the tax authorities had collected enough information at hand to justify a more robust approach with multinationals operating within Mexico.
SAT withheld US$384 million in value-added tax (VAT) refunds from international companies that it was examining for the possible avoidance of tax.
‘Send a message’
Mexico today can now use its decade-long digitalization process in two ways: to learn more about taxpayers, and also as a warning shot.
“What they really want is to send a message to taxpayers,” says Calafia Franco Jaramillo, an EY Tax Controversy Leader at the Latin America Business Center in New York. “They want everyone to know that audits can be more efficient and targeted because they have this data.”
Mexico is not alone.
Tax authorities worldwide are in the midst of a golden era of innovation.
They are upgrading old systems or switching to new ones, gleaning insights as they go.
The results have often been immediate
The Canada Revenue Agency used its databases to predict which taxpayers might not comply, and then communicated with them to boost collections, bringing in an additional C$127.6 million in the first tax cycle in which they introduced this new approach.
When Russia digitalized its VAT system, revenue increased within months.
The data hunt
The evolution goes far beyond archiving the information taxpayers provide; the passive approach of waiting for an annual tax return to evaluate is gone.
Tax authorities are now collecting information on a daily basis, and incorporating third-party information rather than just relying on what taxpayers disclose.
In the UK, Her Majesty’s Revenue and Customs (HMRC) pledges that by 2020 there will be no need to file a tax return.
The tax authority will provide one, based on information requested and collected over the reporting period, and taxpayers will have the choice to accept or contest it.
There’s another tangential effect from the current era of innovation underway: it is easier than ever for tax authorities to share data with each other, swap insights on new tax structures and talk about taxpayers they have in common.
“This is an incredibly exciting time to be a tax administrator,” says EY Global Head of Tax Policy Chris Sanger. “They can get to a much greater level of understanding, and much more quickly, than they’ve ever been able to before.”
“This should make taxation more efficient … the authorities can check returns, decide where there are issues and avoid wasting time.”
Charles Rossotti, a former IRS Commissioner, now a Carlyle Group executive
What’s driving the change?
Several factors explain why tax authorities have been so quick to embrace innovation.
Incentives start with the fact that governments are cash-strapped: of the 35 countries in the Organisation for Economic Co-operation and Development (OECD), at least 20 had budget deficits in 2015.
That means tax authorities must do more with less.
The Internal Revenue Service (IRS) in the US estimates it costs US$40 to US$60 for an employee to help a taxpayer in person.
That drops to US$1 if needs are handled online.
“Every tax administration is operating on a reduced budget and reduced head count,” says Rob Thomas, EY EMEIA Tax Digital and Innovation Leader. “Going digital is a potentially expensive investment, but also a solution.”
Another reason to increase collections from corporate taxpayers is growing public support for doing so, spurred on by media coverage of multinationals who are described as paying little or no taxes in a particular country.
Tax authorities now go beyond their traditional focus on illegal tax evasion to include tax avoidance strategies they consider too aggressive.
The bright side
It isn’t all bad news for corporate taxpayers.
The focus on getting them to pay more also comes with some service-oriented reforms — making filing easier, for example, and ending a tradition of overlapping requests for information.
HMRC promises to issue refunds promptly instead of allowing them to build up over a tax cycle, and to keep accounts available online and updated in real time, providing a constant and clear picture of a company’s tax position.
In Russia, the digitalized VAT process comes with a risk-assessment tool for companies: counterparties can be checked in the system to determine if they present risks from a VAT perspective.
“This should make taxation more efficient,” says Charles Rossotti, a Carlyle Group executive and former IRS Commissioner. “This means the authorities can check returns, decide where there are issues and avoid wasting time.”
Tax administration goes digital
The government receives data from business transactions as they occur and performs advanced analytics on that data, along with other data-filing requirements from companies.
- E-invoices — bank accounts, general ledgers and payroll
- VAT invoices — customs declarations
- Tax return filing reconciliation
02: Business relationships
- Blacklist tests for suppliers and customers
03: Invoice validity
- Canceled and duplicate invoices
- VAT rate validity
04: Accounting records
- Asset - liability-equity balance
- Account mapping to tax authority chart of accounts
05: Certification compliance
- VAT certification
- Import/export trade certification
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The power of data
For many tax authorities, the digital journey starts with a re-evaluation.
The Australian Taxation Office’s Smarter Data Program, established in July 2015, put one office in charge of data management, analytics, intelligence and risk assessment, and serves as a platform to test new technologies and data management techniques.
But authorities also want to quickly get to the first steps in boosting collections, and they do it by using data to improve the audit process.
A database of tax returns can help to quickly spot the atypical ones — a corporation with a significantly higher type or rate of deduction than competitors, for example.
A recent OECD survey found that of 16 member countries participating, 15 use advanced analytics to prioritize audits.
‘A closer look’
“It’s no longer just a person peeling through the paperwork and deciding who to audit,” says EY Americas Tax Policy Leader Cathy Koch. “It’s an electronic review of the data to flag companies outside the norm. Then they’ll take a closer look.”
The next step for tax authorities has typically been to harmonize digital platforms across government agencies, allowing tax authorities to use data from all of them to spot trends and patterns.
This is useful to predict which taxpayers are most likely to underpay, miscalculate or fail to file a return at all.
Tax offices then use these tools to warn potential problem taxpayers through advance communication such as messages through social media, and influence behavior through targeted policy adjustments.
“Most tax administrations are trying to expand or broaden their thinking far beyond what they need to have in place to deal with a taxpayer who hasn’t filed or who hasn’t paid,” says Thomas Brandt, Head of the OECD’s Tax Administration unit.
“They’re thinking about whether a taxpayer would be more likely to respond to a letter or some other type of contact, and they’re thinking about the right timing to do it.”
The Canada Revenue Agency, for example, has moved from a prediction model on the basis of a single tax cycle to a ranking system in which taxpayers are evaluated digitally on an ongoing basis for the risk of noncompliance.
Risk-scoring corporations and high net worth individuals has resulted in a 33% increase in revenue, from C$9.4 billion in the 2012–13 fiscal year to C$12.5 billion in 2015–16, the agency says.
“Countries can come in and share what they’ve uncovered about a particular tax structure. There’s where you get the ‘aha!’ moment.”
Thomas Brandt, Head of the Tax Administration unit at the Organisation for Economic Co-operation and Development
Computer models can also be designed to spot specific types of issues within a tax return and supporting information:
- Ireland uses analytics to spot income declarations that could be too low.
- Sweden tests for unreported income.
- Australia’s “nearest-neighbors model” identifies erroneous deductions.
For corporate taxpayers, it’s important to mimic this process and spot in advance what elements of their tax returns could draw attention, says EY’s Sanger.
Tax authorities can dig deeper into tax returns using artificial intelligence.
In the US, the IRS used the work of researchers at the Massachusetts Institute of Technology and a Washington-based company to boost its oversight of partnerships, one of the more common forms of flow-through tax entities, which corporations have used to avoid paying tax twice on the same income.
The researchers found a mushrooming of this structure from 2005 to 2015, and also an estimated US$91 billion in underreported income as a result.
They designed an algorithm to analyze partnerships and simulate the transactions between them.
They found that specific combinations of partnership structure and transaction type often indicate incorrect deductions, suggesting that any tax return containing them is a good audit candidate.
This information was absorbed into a database managed by the Office of Tax Shelter Analysis, which was created in 2000.
As of late 2015, the team behind this innovation was exploring whether other areas of tax law are suitable for this artificial-intelligence approach.
Corporate tax concerns
For corporate payers, the focus on value-added tax (VAT) is particularly relevant.
Authorities in France, Mexico, the Netherlands, Norway and elsewhere have all reported building analytical models to uncover problem claims.
Singapore, Malaysia and New Zealand use social network analysis — the visual display of connections between entities — to detect VAT carousel fraud, which exploits VAT-free treatment of cross jurisdictional sales.
Social network analysis can spot links between taxpayers and joint bank accounts, or shared telephone numbers.
This data-driven approach is changing the profile of employees in tax administrations.
In October 2015, the Netherlands’ tax authority, Belastingdienst, simultaneously announced 5,000 redundancies along with 1,500 new postings for data scientists.
Alongside this ongoing process of bulking up intelligence and analysis capabilities, tax authorities are increasingly sharing information about specific taxpayers and tactics to understand the data with their peers worldwide.
There is not a long history of sharing at this level between tax authorities, in part because hard copy data is not as easily shared as electronic versions.
Going digital makes it possible.
“If you submit something electronically, it will be shared in real time with many other governments,” EY’s Thomas says.
While countries can act on their own initiative — the Canada Revenue Agency reports sharing based on its double-taxation treaties — the OECD is also a leading facilitator of exchange.
Its Forum on Tax Administration was created in 2002, and the 46 current member countries account for more than 85% of global economic output.
A members’ meeting on advanced analytics in Dublin in 2011 increased existing demand for the regular trading of information, experiences and innovations.
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That led to the repurposing of another OECD body, the Joint International Tax Shelter Information and Collaboration Network (JITSIC).
Formed in 2004 by four OECD member countries, it has since broadened its purpose and been renamed the Joint International Taskforce on Shared Intelligence and Collaboration.
Membership has jumped to 36 countries.
JITSIC helps to foster relationships among tax officials through meetings in which they can talk about the tax structures and other mechanisms taxpayers use to avoid or evade tax.
At a meeting in early July, for example, members discussed the Panama Papers data leak and how best to use that information.
Tax officials do not discuss specific taxpayers or returns in these settings — that must be done through the tax treaties and exchange agreements countries sign with each other.
But sharing the techniques they are using to spot compliance issues often helps officials spot opportunities to meet separately to address specific taxpayers and returns, outside the JITSIC process.
“Countries can come in and share what they’ve uncovered about a particular tax structure,” Brandt says. “There’s where you get the ‘aha!’ moment. Then everybody can go back and apply those insights.”
Searching for stateless income
With digital innovation rolling out on a larger scale, the future is likely to include even more data to absorb into systems and mine for insights.
Another OECD effort, the project on base erosion and profit shifting (BEPS), will present new opportunities for sharing as well as potential challenges to the international co-operation fostered at JITSIC.
In October 2015, the OECD unveiled its 15-point BEPS action plan that, if adopted by governments, would amount to the biggest global tax rewrite in history.
It is based on the argument that reforms are necessary as multinational company now have global footprints that transcend the scope of country-level tax authorities, and can use legal structures in low-tax jurisdictions and countries that facilitate secrecy to reduce their taxes and generate “stateless income.”
One of the main BEPS actions requires companies to share a complete global picture of sales, operations, employees, profits and other key figures using a country-by-country report with all tax inspectors, in each of the jurisdictions in which they operate.
The first of these reports are to be filed at the end of 2016.
Tax inspectors will be looking for that stateless income and determining to which country it should belong.
This suggests the need for even more collaboration with peers from other countries.
Headed for the cross hairs?
It also means that tax authorities will be soon able to compare the revenue they derive from a multinational company with what it pays elsewhere, and they might not always agree on what’s proper or appropriate.
As the BEPS process evolves, countries have already developed differences of opinion on how to implement its reforms, which could put corporate taxpayers in the cross hairs of a debate between tax authorities.
American multinationals in particular could find themselves in this position thanks to a unique feature of the country’s tax system — that US corporations’ profits are not taxed until repatriated.
While there is no formal requirement that tax authorities share the country-by-country reports with others in the original BEPS plan, many countries have since signed up to do so.
In May 2016, Canada, China, Iceland, India, Israel and New Zealand signed the Multilateral Competent Authority Agreement.
Signatories to this treaty, which now number 39, pledge to automatically exchange taxpayers’ country-by-country reports.
With excitement building around tax authorities’ new tools, corporate taxpayers are being forced to keep up with these changes and prepare for a future with myriad new compliance requirements.
“You need to have a sense of what the data is going to convey to authorities — what they are going to see, and you need to be able to talk about it with them and communicate your positions,” EY’s Koch says.
“If you can’t consistently explain why your taxes look like they do, you could be in for a difficult time.”
Key action points
- Staying in compliance across multiple jurisdictions means regular checks with tax authorities and close monitoring of their communications, as new requests for digital submissions are frequent.
- With tax authorities better able to evaluate tax returns for outlier numbers, organizations should look at what they are submitting and anticipate which elements are most likely to raise questions at tax authorities. Responses to potential questions can be prepared as a precaution.
- The ability to compare tax returns quickly means that organizations should know more about how their peers approach common deductions and declarations. It’s important to have a sense of how your organization’s tax return differs from those of similar organizations.
- Organizations should be aware and prepared for the fact that data they submit will be shared with other tax authorities worldwide.
- As tax authorities move closer to real-time access to corporate tax systems and e-audits, verify that data reporting delivers the correct tax treatment.
This article is included in Tax Insights issue 17 – Transformation and innovation (pdf)