Indirect taxes include broad-based taxes on consumption, such as value-added tax/goods and services tax (VAT/GST) and sales taxes; taxes on imports, such as customs duties; excise taxes; energy taxes; and environmental levies that apply to the trade or manufacture of a range of products, including alcohol, tobacco and fuel.
For most businesses, indirect taxes are intended to be “tax neutral” because they can be offset against other taxes in the supply chain or can be included in the costs of production, distribution or sale.
But in reality, these levies can create burdensome costs that must be actively managed. Unclaimed tax credits and missed or delayed refunds commonly cause negative cash flow and “tax leakage” that increase business costs and reduce profitability.
Complex local legislation, evolving business models and compliance obligations that vary widely by jurisdiction add to the complexity of making claims — and to the risk of disagreements about the validity of credits, rebates and refunds.
To manage these costs effectively, you need to take action across the organization to gain visibility into the indirect taxes you incur and clarity about how they can be refunded or offset. Ask yourself the following questions:
- Do you know how much duty is trapped in your supply chain?
- Do you know how much VAT/GST is sitting on the balance sheet?
- If you are expecting a refund, how realistic is that receivable?
- Will you receive it in full?
- What will the refund cost to claim, and how long will you wait for reimbursement?
- Can you afford to claim? Can you afford not to?
- Are you missing opportunities to reduce negative balances, obtain rebates and avoid absolute costs?
The answers will help you to design an effective refund strategy that increases recovery, improves cash flow, and reduces costs and risks.
Managing cross-border VAT/GST refunds
Recovering foreign VAT/GST and reducing excess foreign VAT/GST credits are crucial parts of an effective indirect tax strategy. However, recovering foreign VAT/GST is difficult or even impossible in many countries. Even where refunds apply, long delays are common, and claims may be subject to intense audit scrutiny that can tie up corporate resources.
As a result, unclaimed or irrecoverable foreign VAT/GST is a common cause of excess indirect tax credits for many global businesses, leading to negative cash flow and absolute costs. Not all nonresident businesses qualify for direct VAT/GST refunds.
Is it time to review your foreign VAT/GST refund strategy?
Developing an effective strategy for dealing with or mitigating foreign VAT/GST can improve recovery rates and reduce associated costs. However, many organizations assume that the costs and difficulties of recovering foreign taxes will outweigh the benefits.
Now may be the time to review and challenge that assumption. Changes in tax legislation and advances in technology mean that fact patterns, assumptions and decisions made even just a few years ago can be quickly out of date.
Claiming direct refunds of foreign VAT/GST
A successful foreign VAT/GST refund claim depends on complying with all of the conditions imposed by tax administrations — in every jurisdiction where you want to claim. Understanding the detailed rules and thoroughly applying them can improve your chances of success in reclaiming foreign VAT/GST on your business expenses.
Accurate documentation, in particular, is key. Planning ahead and complying with how and when you make your claims and understanding the reciprocity rules are also crucial factors.
Alternatives for recovering foreign VAT/GST
As few countries make direct VAT/GST refunds to nonresident claimants, global businesses must explore other options to reduce and avoid irrecoverable costs and long delays in receiving reimbursement, such as registering for VAT/GST locally or rerouting supplies.
Identifying the key jurisdictions for your business where VAT/GST may be refunded, or where incurring tax should be avoided, is a vital aspect of planning cross-border activities.
Managing domestic VAT/GST credits
Input tax credits are an inevitable part of the VAT/GST system. They arise when the VAT/GST paid on a VAT/GST payer’s purchases (input tax) in a tax period is greater than the VAT/GST charged on its sales (output tax) in that period.
Carrying forward excess input tax is one of the biggest cash flow concerns for VAT/GST payers. Accounting for input VAT/GST correctly and actively managing VAT/GST credits are essential aspects of any effective indirect tax strategy.
These may seem like straightforward tasks, but detailed domestic rules on VAT/GST recovery and differences in how countries handle refunds can complicate the picture, especially for global companies.
VAT/GST — never a cost to business?
As a flow-through tax borne by final consumers, VAT/GST should not be a cost to businesses, but that is not always the case — most VAT/GST payers encounter “sticking tax,” i.e., irrecoverable VAT/GST incurred on legitimate business expenditure. Equally important, for businesses that frequently accumulate excess input tax credits, the impact of negative VAT/GST cash flow on working capital may be significant.
Recovering VAT/GST on business costs
Most tax administrations apply strict rules to the recovery of input tax, but the rules for VAT/GST recovery are not harmonized. Making a successful refund claim depends on knowing and applying the detailed rules in every country where you operate or incur costs.
Where do credits accumulate?
Excess input tax is a common cause of negative cash flow for VAT/GST payers. Different countries treat excess input tax credits in different ways. The excess may, for example, be refunded, carried forward or used to offset other taxes.
These different approaches can have significantly different impacts on affected businesses and should be factored into strategic decisions about managing VAT/GST costs and cash flow. In some jurisdictions, receivables may be outstanding for months or even years. Understanding how and where credits arise and taking action to deal with excessive delays and “crunch points” can greatly improve management of working capital.
Business start-up costs
Setting up a new company, starting a new business venture or entering a new market is a crucial stage in the life of any business — when effective cash management is vital to success. These phases can also be common sources of excess input tax credits because most new businesses pay VAT/GST on setup costs before they start to trade and charge VAT/GST on their sales.
However, only 55 of 120 countries refund input VAT/GST incurred on preregistration costs. Engaging in strategic planning and taking action can greatly improve VAT/GST cash flow and reduce additional VAT/GST costs.
Exploring alternatives may help new businesses to avoid incurring irrecoverable VAT/GST on setup costs or to greatly reduce the financial impact of long delays.
Avoiding or reducing domestic VAT/GST credits
Managing VAT/GST refunds and credits involves looking critically at the VAT/GST you pay and identifying ways to reduce or avoid accumulating sticking tax and excess credits. One of the most effective ways to manage refunds is to avoid incurring excess input tax.
Effective strategies to mitigate excess input tax may include identifying opportunities to buy goods and services VAT/GST-free (e.g., through VAT/GST grouping), to accelerate refunds (e.g., as a frequent exporter) or to use reverse charge accounting (e.g., by purchasing services cross-border).
Managing customs duty refund opportunities
More than ever, effectively managing global trade requirements and costs is crucial to obtaining and maintaining a competitive advantage.
Free trade agreements
Effectively identifying and using free trade agreements (FTAs) can significantly reduce — or even eliminate — duty costs. With more than 400 trade agreements in force, optimizing utilization has become a primary focus of many importers.
While the fullest benefit of FTAs is achieved when claims for preferential treatment are made at the time of entry, importers should remember that many agreements do permit refunds for a certain time after entry. However, in today’s environment, the FTA climate is changing.
This is illustrated by the US withdrawing from the Trans-Pacific Partnership and the potential renegotiation of the North American Free Trade Agreement (NAFTA). Such moves may signal a shift away from large multilateral agreements to more bilateral agreements. Companies should be mindful of how potential changes might affect their overall duty impact.
Duty drawback is a refund mechanism used globally, typically to promote job creation for manufacturing and export activity. The specific drawback opportunities and requirements vary by jurisdiction.
Generally, duty drawback programs permit refunds of customs duties, fees and taxes paid in connection with the importation of products if those goods (or like-kind goods) are later exported or destroyed.
Correct classification of goods is necessary to properly assess customs duties. In most countries, incorrect classification can result not only in penalties for the importer but also in overpayment or underpayment of duties.
With average rates of 2% to 3%, duties are not an insignificant cost, and they can directly affect a company’s bottom line. Compliance objectives aside, correcting classification errors can be worthwhile, particularly in jurisdictions where an importer can obtain a refund for overpaid duties.
Refund opportunities may be available for companies importing from related parties where transfer pricing adjustments occur. These adjustments may change product pricing. A downward adjustment may result in a duty refund, while an upward adjustment will require additional payment of duties.
Managing excise duty refund opportunities
Excise taxes apply to specific goods and services, and they are often seen as an inevitable cost of doing business in industries that produce and sell alcohol, tobacco, fossil fuels and snack foods.
But these taxes apply to different products in different countries, sometimes at different stages of the supply chain; opportunities to reduce the impact of excise duties also vary between countries.
Managing excise taxes and understanding opportunities to mitigate their impact are crucial for all businesses operating in affected industries.
Indirect tax refunds — the future is coming
Nowadays, any discussion on the future of indirect taxes is almost bound to include the terms robotic process automation (RPA), artificial intelligence (AI), the Internet of Things (IoT), machine learning and blockchain.
Relatively obscure concepts only a few years ago, these technologies are increasingly providing solutions to a range of challenges facing governments and global businesses. They have the potential to streamline and accelerate business processes, increase cybersecurity, and reduce or eliminate the roles of trusted intermediaries and centralized authorities.
From review to renew: adopting a strategy for indirect tax refunds
Actively managing indirect tax costs should be a central part of any corporation’s taxation strategy. Even if your business chooses not to claim VAT/GST refunds or to reduce customs duty costs, those decisions should be based on deliberation and knowledge of your options and the likely outcomes.
You need to identify the indirect costs you incur and related financing, recognize your options for reducing or avoiding excess costs, and apply an effective process for recovering or mitigating them. And this process should be kept under constant review.
Many of the methods for driving indirect taxes out of the business and improving working capital are not new, but change is constant: the approaches and decisions of today may no longer be appropriate tomorrow based on developments in tax, business and technology. Taking a fresh look at how you deal with the fundamentals can bring surprising rewards.
Read more: Managing indirect tax refunds