By Karen Lynch
The stakes are high for businesses today as governments around the world use technology to accelerate the collection of trillions of dollars a year in value-added tax (VAT) and other consumption taxes.
Taxes on both general and specific goods and services are a big source of revenue for governments. Over the years, VAT, sales, excise, customs and other consumption taxes have accounted, on average, for about 10% of gross domestic product (GDP) for the 35 countries in the Organisation for Economic Co-operation and Development (OECD).
Businesses are charged with collecting most of the vast sums that are generated through transactions with consumers and corporate customers, and must then transfer them to tax administrations.
"The systems will get better, but don’t ask how long it will take."
Dr. Christian Kaeser, Chairman, International Chamber of Commerce Tax Commission; VP and Global Head of Tax, Siemens AG
While governments aren’t typically the first movers in today’s increasingly digital economy, indirect taxation is proving to be an exception, and businesses often have a hard time keeping up. Manual and semi-automated procedures for assessing, collecting and auditing consumption taxes are currently being overhauled by tax administrations worldwide — all of which vary somewhat in their timing and approach. Providing a glimpse of the future, some administrations are also venturing into innovations such as the blockchain distributed ledger technology.
Today’s digital tax automation initiatives are not half-hearted. “Once these governments get going, they have the deep pockets to invest in automation and the power to realize their objectives,” says Gijsbert Bulk, EY Global Director of Indirect Tax, in Amsterdam.
Out with the old, in with the new
The goal is to collect more tax dollars, more quickly, and to make sure it’s the correct amount. In doing so, governments hope to close shortfalls such as the “VAT gap” between what they expect in taxes and what they actually collect (with the 2015 VAT gap estimated at 151.5 billion euros in the European Union alone).
The old practice of monthly or quarterly VAT filings is fading fast. There are several reasons for governments to digitalize indirect taxes first. For starters, consumption taxes generate a lot of money for governments, accounting on average for 31% of total tax revenue among OECD members.
In general, indirect taxes are easier to assess than corporate taxes, despite complications like cross-border transactions, returns and exemptions. And, as the relatively straightforward product of multiplying transaction value times tax rate, they are more objective and less prone to controversy than direct income tax.
There is another fundamental driver, according to Channing Flynn, EY Global Digital Tax Leader in San Francisco. “In the global digital economy, governments are finding it increasingly hard to tax income,” he says. Tax authorities have seen certain technology businesses operating globally for years without making a (taxable) profit. More industries are digitalizing their business models, in areas such as FinTech and autotech, with hard-to-define tax profiles based on virtual global networks and intellectual property. “So policymakers are saying, let’s go for the low-hanging fruit of indirect tax,” says Flynn.
Among the earliest to automate, beginning a decade ago, have been governments considered most exposed to tax fraud, such as Brazil, Mexico and Russia. As these innovators began to report sharp increases in indirect tax revenue, more governments started stepping up.
Development of Brazil’s Public Digital Bookkeeping System (SPED)
Meanwhile, such major jurisdictions as India and the Gulf Cooperation Council of six Middle Eastern states are now introducing VAT-type taxation for the first time, using systems that are highly automated from the start. Usually, tax administrations’ new systems and procedures tend to evolve (though not always linearly) through five levels, as described in our framework, below:
1. E-filing requirements for traditional tax returns and forms
2. E-accounting, with businesses required to digitally submit source data such as invoices — often in real time or close to it
3. E-matching, when administrations map data across tax types and, potentially, across buyers and sellers
4. E-audit, which is digitally-enabled tax auditing — often with a limited window for businesses to respond.
5. E-assessment, in which tax administrations forgo tax filings altogether. Instead, they analyze the data businesses have transmitted, determine the tax rate and take the money out of corporate bank accounts, unless their findings are contested.
Some of the world’s largest economies, such as Japan, the UK and the US, still rank on the first level of this scale, according to Carolyn Bailey, EY Americas Digital Tax Administration Services Leader. Thirty-plus countries around the world are at level two, she says. Brazil, Mexico and Russia have reached level four. Many more administrations are likely to move from level 1–2 to level 4–5 within 5 to 10 years, with advances such as blockchain, says Bailey.
To date, however, the transition has proved difficult for businesses. One issue is timing. As governments speed their collection of tax information and cross-check that data between buyers and sellers, mismatches can occur — for example, if one side of a transaction books an invoice in May and the other books it in June.
“Siemens has more than 600 litigation cases in Brazil alone, and most are related to automated assessments,” says Christian Kaeser, Chairman of the Tax Commission of the International Chamber of Commerce (ICC) and Global Head of Tax at Siemens AG, in Munich, Germany. Other businesses are in the same situation in Brazil, says Kaeser, who expects to see similar patterns — to a greater or lesser extent — in other jurisdictions that automate their indirect tax systems.
“There will always be cases where the timing will not match 100% in any given period,” says Kaeser. “And the shorter the period of time, the greater the chance of a timing mismatch.” When mismatches result in official notices from tax authorities, businesses find themselves having to explain and litigate over and over. “That is simply multiplying the workload for us,” he says.
Dr. Christian Kaeser, Chairman, International Chamber of Commerce Tax Commission; VP and Global Head of Tax, Siemens AG
Image: Thomas Dashuber
Kaeser expects the situation to improve as, for example, tax administrations’ algorithms adapt. “Logically, the systems will get better, but don’t ask how long it will take,” he says.
Some businesses that have filed for refunds in Mexico have faced another challenge. Better equipped tax authorities have applied greater scrutiny, causing delays and tying up cash flow, according to Teresa Rodríguez, Indirect Tax Partner at Mancera, SC, an EY affiliate in Mexico City.
Other issues include continual changes in tax rules and inconsistency from one jurisdiction to the next. There is even a lack of consistency in the way jurisdictions are implementing standards — for example, the OECD’s Standard Audit File — Tax (SAF-T) for the export of accounting records in a commonly readable format.
“They’re supposed to all follow one framework, but each one makes it just different enough to drive you nuts,” says Bailey, citing governments’ varying data requirements, scope and frequencies.
Inconsistency doesn’t only add administrative costs, but it also increases the risk of errors and of double taxation, says Kaeser. These and other transitional issues are among the topics being addressed in a new working group of the ICC’s Commission on Taxation.
“The bigger your business, the more systems you have, the more procurement and accounts payable platforms, the more difficult the task of complying,” says Adrian Hextall, Director, Financial Services, Tax Technology & Transformation at EY UK, in London.
Getting businesses on board
For their part, tax authorities realize the challenges taxpayers face. “The tax administration in Mexico doesn’t expect 100% compliance right now from taxpayers because it’s a transitional period,” says Rodríguez. “But they expect taxpayers to accept and incorporate these changes, rather than fight them.”
Governments also point to the benefits businesses can ultimately realize. In Mexico, for example, the tax administration will reward compliant businesses by reducing the standard time it takes for them to receive VAT refunds (from 4 to 6 months down to 5 days), says Rodríguez.
"The technology to administer indirect taxes is going to provide better insights thus enabling companies to more quickly decide important strategic tax items."
Channing Flynn, EY Global Digital Tax Leader
In Brazil, many regular information reporting requirements have been discontinued, says Altemir Linhares de Melo, Advisor to the Cabinet of the Federal Revenue of Brazil. “This means reducing the costs and time to comply with ancillary obligations, significantly improving the country’s business environment and, consequently, increasing the competitiveness of Brazilian companies,” says Linhares de Melo.
Over time, technology should help tax administrations conduct shorter, more focused audits, says Rodríguez. There will be fewer “fishing expeditions,” she says, which should translate into efficiencies for both the tax authority and taxpayer.
The speed of change could further accelerate, as governments continue to experiment with new technologies and share leading practices (as well as cross-border tax data) in such settings as the OECD’s Forum on Tax Administration (FTA). For example, the FTA’s series of publications on the “Tax Administration of the Future” advocates that “big data and blockchain approaches open the possibility of new ways of managing large VAT transactions involving refunds or cross-border transactions.”
Many businesses are upping their own technology game to meet the challenges posed by the digitalization of indirect taxation. Barbara Brogan, a Senior Manager in Pfizer Inc.’s Global Tax Department, recently described the pharmaceutical business’s pilot of robotic process automation for invoice retrieval related to US sales tax and European VAT. The pilot has demonstrated savings of hundreds of hours per year, providing the tax team with more time to devote to other value-added tasks, such as reviews.
“Hopefully it results in some tax rebates for us,” Brogan said on an EY webcast in June. There is also a less tangible benefit. “Who wouldn’t want to take advantage of a technology that has the ability to remove the mundane, manual tasks from your role?” she said.
Along the way to tomorrow’s technologies, tax departments are increasing their use of various tools, such as indirect tax dashboards for specific tasks, while tapping into the enterprise resource planning systems handling their business’s transactional data and upgrading to cloud-hosted environments for recording data across their global organizations.
Advanced analytics, in turn, help businesses validate their tax data at a more granular level. This reduces risk as they move beyond sample-based testing to including all relevant data and then drilling down into the relatively few records that surface as anomalies.
But many are still stuck doing indirect tax the old way. “The internal workings around tax and VAT are very much back-office functions, and back-office functions are the ones that have never received much investment, because they’re not customer-facing,” says Hextall. “That whole infrastructure piece is going to need upgrading, and it’s going to cost a lot of money.”
For some businesses, internal organizational issues prevail. Usually, the tax team’s main source of information is the finance department, which has always prioritized sending earnings and other performance metrics to the board, financial regulators, exchanges and shareholders.
“The idea of reporting your indirect taxes to the government faster than reporting your earnings to the financial market is a complete upheaval of what’s happened for 100 years,” says Flynn. “So you have to get your finance organization in line with these new rules.”
Those businesses that remain in the mode of spreadsheet reporting, manual reviews and informal compliance processes for indirect tax are increasingly vulnerable and inefficient, says Bulk. Those that have created processes where checks and tests have been automated, exceptions and errors are reported, and remediation tasks are managed — all without human intervention — are more in control and can detect and repair mistakes much more quickly.
Benefits extend beyond the tax department, as well. Mining and reporting all transactional data in a real-time environment can provide a lot of information to a business. For example, it can deliver a real-time view of how many products were sold in any particular market at any particular time or, with machine learning, begin to predict sales patterns to refine timing and pricing.
“The technology to administer indirect taxes is going to provide better insights thus enabling companies to more quickly decide important strategic tax items,” says Flynn.
Key action points
Tax teams should analyze their business’s current and prospective indirect profile across four quadrants of our digital tax strategy framework:
- Digital tax administration. Develop a detailed understanding of digital tax requirements in all of your markets and a working knowledge of which jurisdictions are further ahead than others. Keep a look out for new tax rules.
- Digital tax effectiveness. Determine whether your tax function is able to meet digital data and filing obligations in operating jurisdictions and is prepared to defend audits in real time or near-real time. Consider the demands that e-audits could place on your systems and operations.
- Tax technology. Adopt policies and practices — in-house or through outsourcing — for storing, archiving and retrieving data, to prepare for e-audits.
- Tax big data. Explore the use of real-time data analytics for tax planning and compliance, to measure and mitigate risk, better target controversy interventions and resolve issues as they occur.
How we can help: Indirect Tax Services