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Governments becoming more cutting edge on tax

More and more countries are using technology to review businesses’ financial records directly, and many companies are ill-prepared for the change.

By Dr. Paul Kielstra

The old world of tax planning, provision and compliance, as well as the old tax function that went with it, are being transformed by advanced information technology. Often, it’s governments, such as Brazil’s catalyzing change.

Over the past decade, Brazil has imposed various requirements on companies to provide highly detailed business information, in some cases in real time. Two are particularly noteworthy. First, all billing for goods and services must now take place through one of several electronic processes. Each of these involves, as an early step, communication of the invoice to the government.

Tax authorities must evaluate and approve the information on it before the transaction it covers can proceed. In effect, the authorities now know of every sale before it is legally completed and can block ones where they dispute the level of indirect tax.

“Many companies are surprisingly ill-prepared for the technological requirements governments are imposing and their implications.“

Second, Brazil now requires companies to use a standardized public digital bookkeeping system (SPED) with separate subsystems for accounting and tax. These replace traditional bookkeeping ledgers and, at the end of each year, companies must submit their complete SPED files – a detailed record of every single business transaction – to the authorities.

The result is such a high level of transparency that the ongoing need to file annual indirect or direct tax returns may soon be redundant, or at the very least turn into simple reconciliation events. As Gary Paice, EY Americas Director of Tax Performance Advisory, puts it, in such circumstances “the idea of filing is not relevant per se. If you send an invoice in real time, what opportunity do you have to do anything after the fact?”

Chris DeVito, Sr. Director, International Taxation at Johnson & Johnson, agrees. In a decade or so, he notes “the government will calculate the tax return for you; tax compliance professionals should have very little manual work to perform.”

The nature of the audit is also fundamentally different. Aidan O’Carroll, EY’s Global Compliance and Reporting Leader, explains that “Brazilian tax authorities, by law, can directly interrogate the information in a taxpayer’s financial system and come to a conclusion based on the information they retrieve.”

Governments at the forefront

Argentina and Mexico have developed similar systems for electronic invoicing, and China is doing likewise. Even if not interposing themselves in transactions, numerous governments are extracting data directly from corporate systems as part of VAT and GST audits – at least 69 countries, according to an EY survey in 2014.

As for income tax, Russian authorities have begun putting in place their own system to interrogate company financial records directly. O’Carroll says, “The vision of the Russian tax administration was clear that the need to submit a formal tax return may well become redundant. This may become the case for a number of countries where authorities have the ability to inquire directly into corporate records and come to their own view on what is payable.”

Although most of these examples are from emerging market countries, the trend is visible in developed ones as well. Australia has already expressed interest in developing the ability to interrogate directly corporate records there.

Changes will reach every level: Jim Buttonow, Director of Tax Practice and Procedure at H&R Block and Chairperson of the Internal Revenue Service’s (IRS) Electronic Tax Administration Advisory Committee, expects that the IRS will establish online accounts within seven years for all individual taxpayers and small businesses. These will allow real-time interaction and constant maintenance of a zero balance on taxes payable.

It is not common for governments to be on the leading edge of applying technology, says Ray Imbrogno, Sr. Director, Global Tax at Pfizer. “Today, the interesting stage in the process of greater use of technology is the increasing sophistication on the government side,” he says.

If knowledge is power, tax authorities will have a far greater sway than ever before. As Robert Norton, Chief Income Tax Officer at Vertex, says, these developments may “take a while to become more widespread, but they are coming. They will catch some companies off guard.”

Wanted: tech-savvy tax function

Many companies are surprisingly ill-prepared for the technological requirements governments are imposing and their implications. As Paice puts it, “the drivers in tax are changing enormously, but most tax people are adapting new technology only when the things around them force them to.”

This reflects not hostility to information technology per se; use of tax modules in ERP systems and tax elements in data warehouses has grown more sophisticated over the years. Instead, the particular needs of the tax function in the past, as well as its traditional position within the company, have given it an often justified reputation for slow adoption of technology.

Reliance on complex tools that they do not understand inside-out does not come naturally to tax practitioners. Imbrogno jokes that if “they could do what they do with a calculator and paper, they would probably still be doing it.” The reason, he explains, is that tax people want to verify and confirm data as much as possible because of the potential exposure the company would face if they got it wrong.

Meanwhile, tax has for decades been a notoriously isolated function in many businesses. As a result, company-wide technology decisions have frequently failed to take account of its needs. Paice explains that “data is often not aligned in a way that tax needs, with companies using a business rather than a legal entity analysis. For the tax function, the challenge is not just looking for big data, but good data.”

The result, says Norton, is that “tax people spend most of their time just pushing data around.”

This state of affairs is no longer sustainable, especially in countries which require increasingly granular tax data from companies provided in specific formats.

In the inevitable transition, though, tax functions should embrace new technological opportunities rather than having IT thrust upon them. They provide the tools that companies will need to thrive in the new regulatory environment.

The promise of analytics and cognitive computing

Data analytics are already transforming companies for the better: a 2013 survey published in the MIT Sloan Management Review found that 67% of executives believed use of analytics improved the company’s competitive advantage significantly. There is no reason why the tax function could not benefit to a similar degree.

The most obvious use for such technology is to catch up where tax authorities have gone ahead. Paice says that “most corporate tax departments are unaware of exactly what capabilities are in place at the government and what is actually being tested. Moreover, they have few mechanisms for examining analytically what the authorities are looking for.” This should not be the case.

Imbrogno believes that “if a government can ask for information and do analytics, chances are the company can do the same thing. Increased reporting requirements will lead to companies doing a lot of internal analytics before data leaves.”

Advanced analytics can help across the entire tax life cycle of planning, accounting, compliance and controversy. This activity is currently more advanced in indirect taxes than elsewhere, but the benefits already have the potential to be substantial.

At one global pharmaceutical company, EY’s analytics not only reduced compliance risk on VAT by improving accuracy, they identified €4.5 million in cash savings and improved the working capital position by €150 million.

Tax does not yet seem to be embracing this brave new world. In a recent EY survey of nearly 1,000 tax and finance executives in 27 countries, only 21% reported that they used any form of custom software – many presumably not analytics-enabled – for tax modeling.

More used spreadsheets, or did the work by hand. Similarly, just 41% used some type of custom tool for data warehousing and roughly 70% believed they would require additional resources for the immediate challenge of collecting information required under BEPS, let alone doing more advanced things with company data.

A new role for the tax function

At most businesses, the tax function needs to learn to walk before it can run when it comes to applying technology. In order to derive the benefits of analytics and cognitive computing, they will require far better data than currently available.

Spending substantial time reshaping and manipulating information gathered for other purposes will not work in a world where real-time compliance is already a requirement in some jurisdictions and companies are looking for rapid insights into data.

Tax functions will have to develop new skills, according to Paice. “The typical tax person is not very technology-savvy (in general). Few departments have any personnel who are ‘power users,’ and most barely have ‘users.’”

O’Carroll adds that at many firms it would represent “a real step change for the tax function to truly understand how an ERP system operates and how to interrogate it for information in real time.” In the future, the tax function will need to understand and use technology far better.

Beyond raising its technology game, engaging with the company in the necessary way will mean a significant cultural change across the company so that tax works in partnership with various functions, in particular finance and IT. For its part, tax will have to become much more familiar with how the rest of the business operates and how it generates data. It can no longer retreat to its silo.

At the same time, tax has to raise its profile so its needs are understood and accommodated. Here, the large number of finance functions currently experiencing data-driven transformations represent a golden opportunity. So will the adoption of cognitive computing systems more generally by businesses in the coming years.

As Imbrogno notes, though, in such situations, “tax organizations have to fight their way to the table to make sure the way information is generated takes into account tax data requirements.”

In practice, other parts of the company are likely to welcome this greater embeddedness once they see its advantages. This can start very early in the process.

Kevin McWilliams, VP Tax at International Paper, recalls that when his department engaged in discussions at the start of his company’s recent financial transformation effort “after people understood what we needed, we found a lot of them saying, ‘Gee, that’s great. We could use that level of detail too.’” He adds that it was therefore possible to create “a coalition of the willing” within finance to design infrastructure that serves the whole organization.

Once such partnerships are set in motion, the benefits will grow because working with trustworthy information will free up substantial time within the function. This will allow it, in Imbrogno’s words, “to focus on the result rather than understanding all of the data.”

By permitting the department to focus on more value-added activities all will gain, adds Norton. As a result “insights will be much more available to business operators to help them understand the tax dynamics of the business.”

Companies, then, in order to keep up with the increasing requirements of regulators have little option but to exploit the latest developments in information technology. Doing this right will benefit the whole business.

Key action points

  • Ensure that the tax function has the technology needed to meet increasingly granular and -real-time information filing and compliance requirements in the near future.
  • Learn what analytic tests tax authorities are likely to apply to company data and proactively assess the data for accuracy.
  • Create a vision of the future tax function, including not just its more exacting data needs but a present and forward-looking culture that works closely with, and provides strategic value to, the whole company.
  • Improve communication. This includes with business partners in the company in order to carry out the new vision, and with tax authorities to address the more pressing requirements of real-time compliance.
  • Make tax-sensitized data at the point of generation the norm throughout the company.
  • Develop the skills within the function to use technology more intensively and work in closer partnership with other parts of the business, especially, but not exclusively, finance and IT.
  • Consider ways that applying analytics and cognitive computing can make new or more effective use of tax-sensitized data.

Read more: To confront today’s challenges, Johnson & Johnson is transforming its decentralized and partly manual approach to tax into a global function equipped with technology.

This article is included in Tax Insights issue 14

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