By Gijsbert Bulk, EY Global Director of Indirect Tax
The indirect tax world is experiencing an unprecedented era of expansion and transformation, forcing businesses to prioritize how these levies are managed and paid. We began to see the rise of indirect tax at the turn of the millennium, specifically value-added tax (VAT) and goods and services tax (GST), as well as special consumption taxes on items such as cars, cigarettes and alcohol.
Consumption taxes as a percentage of total tax revenue have remained stable across members of the Organisation for Economic Co-operation and Development (OECD), with an average of 30.5% in 2014 compared with 30% in 2004. But these taxes are being applied to an ever-widening range of products and services. Some of the most recent examples include new levies on sugar, carbon emissions, plastic bags and e-cigarettes, along with goods and services sold online.
“Taxpayers can’t afford to lag behind tax administrations in this digital transformation.“
The compliance burden has expanded in tandem. This represents a significant challenge and risk for the tax function today, considering the wide range of detailed data and technological processes required by each jurisdiction, not to mention the perpetual revisions in indirect tax policies.
All of these developments have led to indirect tax assuming a key role in strategic planning within the tax function. Global businesses need to monitor indirect tax developments closely. And they should be prepared to adapt their transactions, accounting policies and technology to pay and recover the correct amount of tax. (Follow changes to VAT, GST and other indirect taxes with the EY Worldwide Indirect Tax Developments Map at www.ey.com/indirecttax).
While customs duties have been around a long time (in medieval Germany, people paid customs duties to use the roads and bridges), general taxes on goods and services are a modern phenomenon.
France was the first country to introduce a general consumption tax, in this case VAT, in the early 1950s. It took a few decades to catch on — in the late 1960s only 10 countries had introduced a VAT or GST, according to the OECD — but by 2016 some 166 jurisdictions across the world had one.
The OECD calls VAT “among the most important developments in taxation over the last half century.” Governments like VAT/GST for a few reasons: it’s a stable source of revenue, especially in times of recession; it’s efficient to levy in terms of costs and time; and it tends to weigh less on economic growth than other taxes.
Globalization has also boosted the appeal of this tax. As global trade took off in the 1990s and more jurisdictions opened up their borders via free trade agreements, many developing countries introduced a VAT/GST to compensate for lower trade duties and tariffs, according to the OECD.
The adoption of VAT/GST has altered the mix of taxes collected by governments, shifting from specific to general consumption. Excise taxes on specific goods and services declined to 7.6% of total tax revenue, on average, among OECD member countries in 2014 compared with 14.2% in 1965. In contrast, general consumption taxes raised 20.7% of total tax revenue on average among OECD members in 2014, up from 11.9% in 1965.
See how they rise
Recent years have ushered in further changes to indirect tax policies. The 2008 financial crisis and accompanying global recession led to a decline in corporate profits and tax revenue raised by governments. Jurisdictions first responded by addressing corporate tax practices that shrunk their tax revenue. The OECD’s base erosion and profit shifting (BEPS) plan, currently being rolled out across the world, is one such initiative.
But attention soon shifted to indirect tax, which proved to be an important tool for governments battling the aftermath of the global financial crisis.
Some countries increased their VAT/GST rates to raise additional revenue. In the European Union, for example, average VAT rates have increased since 2008. Other jurisdictions extended exemptions and reduced rates for additional goods and services.
The spread of VAT/GST to new jurisdictions continues. India introduced its new GST system in 2017, and Saudi Arabia, the United Arab Emirates and other countries within the Gulf Cooperation Council will introduce a new VAT in 2018.
For now, it appears that VAT/GST rates are unlikely to further increase, but will instead stabilize at current high levels or may even decline in some jurisdictions. The only exception is in the area of online goods and services as governments introduce new measures or clarify existing rules to collect indirect tax revenue that has until now largely slipped through the cracks. For example, some countries are abolishing tax exemptions for small online shipments.
The new excise taxes
Excise taxes on specific goods also remain an important source of tax revenue for governments, although they too are evolving. While excise taxes on alcohol, cigarettes and fuel are applied widely across the world, many others vary from market to market, covering everything from chewing gum to jewelry.
New excise taxes are being used to influence consumer behavior, such as sugar taxes on soft drinks to fight obesity or carbon taxes to address pollution.
By using different tax rates or treatments to encourage consumers to switch to “less harmful” versions of some products, excise tax policies can also play a role in stimulating innovation and creating a market for fledgling technologies.
Along with growing compliance requirements, these changes in excise taxes and VAT/GST influence the business itself. A new sugar tax, for example, could affect prices and demand and ultimately the profitability of the business. Producers and sellers of taxed products may need to innovate or diversify to maintain profitability.
Closing the tax gap
Governments today have other avenues available to collect more indirect tax revenue. When it comes to transactional taxes like VAT/GST and customs duties, vast quantities of data are produced each day. Tax administrations are digitalizing their indirect tax systems to increase transparency and efficiency and reduce errors.
One of the main goals is to narrow the so-called VAT/GST gap — the tax loss to fraud, inefficiencies and other issues. In the UK alone, the VAT gap was estimated at £12.2 billion, or 9.6% of estimated net VAT, in 2015–16.
In some jurisdictions today, taxpayers are expected to submit indirect tax data automatically and electronically. Spain, for example, introduced a new “Immediate Submission of Information” (ISI) system in 2017, requiring businesses that file VAT returns on a monthly basis to keep their VAT books electronically through the new system. China, Russia and Brazil, which are all wrestling with large VAT/GST gaps, are also successfully deploying digital systems to gather more indirect tax revenue.
Software tools provide another way for tax administrations to identify indirect tax errors, uncover issues with taxpayers’ enterprise resource planning (ERP) systems and conduct risk-based audits.
Technology also allows tax and customs administrations to share information, for example through joint risk assessments, which provides them with greater insight and transparency into taxpayer filings.
The right approach
Taxpayers can’t afford to lag behind tax administrations in this digital transformation. Investing in technology, including moving to standardized, automated processes instead of relying on manual spreadsheets, will help businesses handle greater quantities of data and comply with more-demanding indirect tax reporting requirements.
Such efforts will also help businesses respond more effectively if they come under increased scrutiny by tax authorities. And it should help lower costs for headcount, cash flow, consulting, accounting and compliance.
By digitalizing their indirect tax systems, businesses can gain greater visibility over their indirect tax obligations and risks, including outstanding VAT/GST refunds. In some countries, especially those dealing with significant VAT/GST gaps, obtaining such refunds can be extremely difficult. This waiting game can transform VAT/GST recovery into a significant cost for the business — a risk that eventually is brought to the attention of the C-suite.
Digitalization can also lead to less business disruption. Digitalized tax administrations are moving toward a system in which they will be able to identify and certify taxpayers who are compliant. Tax administrations would no longer have to analyze all taxpayers — compliant and noncompliant — in the same manner. Those deemed “good” would face less scrutiny and fewer audits.
In an era when the popularity of indirect tax keeps rising, the onus is clearly on businesses today to pay greater attention to governments’ favorite “child.”
How we can help: Indirect Tax Services