VAT/GST under management: benchmarking
Worldwide VAT under management as % of non-US sales is the same regardless of size
The operational and compliance end-to-end process
Complexity of the taxing systems
Figure 1. MNE X VAT/GST under management — country totals
VAT/GST compliance for most MNE taxpayers seems at best aspirational and at worst an unobtainable dream.
Summary: For MNEs, having and maintaining reliable, detailed, up-to date knowledge of local legislation and compliance requirements for every country where they operate creates the greatest barrier to centralizing their VAT/GST compliance functions.
The tax directors and indirect tax managers we interviewed commented that indirect taxes were well understood and well controlled in the country that houses their global or regional headquarters.
But they were less confident about how well VAT/GST and other sales taxes were being managed around the world in the countries where their branches and subsidiaries operate.
What is "100% VAT/GST compliance?"
For us, full compliance means paying the right amount of tax, at the right time, to the right tax administration.
Reaching for full compliance
The majority of MNE taxpayers strive for full compliance and they incur considerable costs in seeking to meet their VAT/GST obligations around the world.
However, full VAT/GST compliance for most MNE taxpayers seems at best aspirational and at worst an unobtainable dream as opposed to an achievable goal.
Challenges to full VAT/GST compliance include many factors related to reporting taxes on transactions in multiple jurisdictions as well as weaknesses of individual VAT/GST systems, including:
- The demands of "real-time" reporting
- Short deadlines for invoicing and for submitting returns
- High volumes of sales and purchase transactions
- Complex rules
- Complex transactions
- Fast-paced business operations
- Frequent legislative change
- Detailed local formal obligations
- Differences in VAT laws and formal obligations imposed by different countries
- New ways of conducting business
In addition to external challenges to full compliance, MNEs often struggle with internal challenges, which can be equally significant, including:
- Large number of corporate entities
- Complex corporate structure
- Systemic errors
- Problems with ERP systems
- Absence of VAT/GST management processes
- Insufficient in-house resource and/or specialist knowledge related to VAT/GST
- Decentralized responsibility for in-country VAT reporting and split in-house VAT/GST responsibilities(reporting and advising) leading to a lack of oversight
- Lack of local knowledge of detailed VAT/GST rules in shared service centers and of business operations by third-party outsourcers
- Insufficient training about VAT/GST within the finance, accounting and business functions and understanding of the impact of indirect taxes on business decisions and new contracts
- Poor communication concerning future plans (for acquisitions, changes in technology, etc.).
- Poor support from management, budgetary constraints and Internal "politics"
Measuring the impact of VAT/GST risk
To understand the importance of managing indirect taxes in your business, you need to measure their full impact by looking at costs, negative cash flow and the amount of VAT/GST "throughput" or VAT "under management."
VAT/GST under management:
Worldwide VAT under management
as % of non-US sales is the same
regardless of size
VAT and GST represent a business cost
At first glance, VAT/GST does not represent a business cost for most VAT/GST taxpayers because output tax charged on sales is paid by customers and input tax paid on business expenditure is recoverable (either through tax offset or through a refund).
On closer examination, VAT/GST looks far from neutral. VAT/GST-related costs include:
- Input VAT/GST directly related to exempt sales activities
- Input VAT/GST related to "blocked" expenditure
- Input VAT/GST incurred in foreign jurisdictions that do not make refunds to nonresidents or that make recovery very difficult in practice for nonresidents through procedural barriers
- Output VAT/GST related to bad debts
- Output VAT/GST which cannot be passed on to the customer
- Recoverable input VAT/GST which is not identified Recoverable input VAT/GST which is not supported by the correct documentation
- Penalties and interest related to VAT errors
VAT/GST may have a negative effect on cash flow in the following circumstances:
- Financing output VAT/GST paid to the tax administration before customers pay it
- Financing input VAT/GST paid on purchases before VAT/GST credit is taken
- Late-paid refunds
How do you measure "VAT/GST under management"?
In the past, many MNEs have measured their VAT/GST risk by looking at the balance between output VAT and input VAT, as that is the amount payable to or refundable from a tax administration. In these terms, VAT/GST risks have been recognized as important but they have rarely seemed material in terms of the business as a whole.
Complexity of the taxing systems
A more accurate measure of VAT/GST risk is the amount of VAT/GST "under management." When this far larger figure is taken into the equation, VAT/GST issues may take on a very different risk profile.
Calculating VAT/GST under management
To determine the high-level VAT/GST under management calculation:
- Take regional/country revenues from annual report/10K
- Multiply by average regional or country rate = output VAT
- Take cost of sales and SGA (selling, general and administrative expenses)
- Take out employee costs
- Allocate cost of sales and SGA to each region/country
- Multiply by average regional VAT or country rate = input tax
- Add % to allow for intercompany transactions
- Result = a high-level estimate of the total VAT that needs to be managed on an annual basis
Benchmarking VAT/GST under management
The operational and compliance
Our experience of working with MNEs around the world indicates that the VAT/GST under management as a percentage of non-US sales is, regardless of the size of the company, over 30% and in some cases it can be as high as 45%.
The complexity of the VAT/GST supply chain
In considering how to manage VAT/GST transaction flows, it is important to recognize that most MNE VAT/GST supply chains are highly complex, involving multiple suppliers and customers and cross-border transactions.
The complexity of the VAT/GST supply chain increases the level of tax risk. The whole transaction chain must be mapped and understood if it is to be adequately controlled.
Figure 1. MNE X VAT/GST under
management — country totals
Accounting for the end-to-end VAT/GST supply chain
In the past, the management of VAT/GST processes concentrated on the issue and receipt of VAT/GST invoices and filings. But changes to business processes and the lengthening of supply chains mean that MNEs now need to look at managing the whole VAT/GST end-to-end process.
VAT/GST must be managed in each of the sales and purchase phases: record to report, procure to pay, asset management/acquire to retire, order to cash.
In considering the management of VAT/GST issues, it is necessary to identify the relevant transactions and the parts of the organization that have ownership of the information and the process.
Case study: MNE X measures VAT under management
Let's consider a real-life case study, involving a US global company we will refer to as MNE X. VAT/GST should be tax neutral for MNE X, but measuring the company's global VAT under management indicates that VAT/GST is significant in terms of the overall accounts.
In Figure 1, the estimated total VAT/GST charged and incurred by MNE X (including VAT potentially chargeable), in the major countries where it operates, over the three years 2007, 2008 and 2009.
Figure 2 indicates the total VAT throughput for all the countries where MNE X operates for the three years in question. The net VAT/ GST for 2007 was $40 million payable, in 2008 it was $58 million credit and in 2009 $33 million credit. These amounts are low compared with the company's revenue for the same years.
However, the situation looks very different if, instead of netting the tax on purchases and sales, these amounts are added together. In that case, VAT/GST under management represents more than $1.7 billion in 2007, more than $1.8 billion in 2008 and more than $1.1 billion in 2009.
Measured in this way, VAT/GST under management represents a far greater proportion of total revenues, earnings before tax and depreciation (EBITDA) and income tax for these years compared with net VAT/GST.
The company needs robust processes and an adequate control framework to reduce its risk exposure from handling its global VAT/GST liabilities.
Figure 2. MNE X VAT/GST under management — three year comparison
Figure 3. MNE X VAT/GST under management — compared with other key measures
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