Summary: Once a low priority for the C-suite, properly addressing indirect taxes is rising to the top of their agendas.
The spread of VAT/GST worldwide
Since it was first introduced, VAT has been an unstoppable tax success story.
Some form of VAT/GST now applies in more than 150 countries worldwide. The US is the only developed economy that does not currently levy a VAT-type tax.
However, each country has its own system with its own rules about how, when and where tax is charged. Documentation and reporting requirements also vary greatly between different tax jurisdictions.
All MNEs must be aware of and manage multiple VAT/GST obligations around the world, even if no VAT/GST applies in their "home" country.
The shifting tax balance
In a report issued in March 2011, the Organization for Economic Cooperation and Development (OECD) indicated that consumption taxes "now account for 30% of all revenue collected by governments across the OECD.
Value added taxes are the principal form of taxing consumption in 33 of the 34 OECD member countries (the US continues to deploy retail sales taxes, albeit at the sub-federal level) and account for two thirds of consumption tax revenues."2
The report also indicates, "In June 2009, OECD ministers agreed that: ’Growth-oriented tax reforms would generally involve shifting revenue from corporate and personal income taxation or social security contributions onto consumption and property taxes, including housing taxation (OECD, 2009).’"3
As the tax burden shifts, current corporate models of tax management will increasingly be called into question. MNE corporate tax functions must consider whether they have sufficient resources and the necessary skills to respond appropriately to the shifting tax landscape.
Increasing VAT/GST rates
VAT/GST rates are rising worldwide and the tax base is broadening. Governments increasingly look to indirect taxes to balance budgets, fund tax reforms in other areas, promote and regulate trade, and support green policies and other social initiatives.
The upward-rate trend is especially strong in the European Union (EU) where VAT rises have come into effect or been announced in 7 of the 27 Member States in the first months of 2011.
In some countries, such as Greece, Ireland, Portugal and the United Kingdom (UK), these increases follow hard on rises (or on return to previous rates after temporary stimulus-driven reductions) implemented in the previous 12 months.4
Rate rises do not just increase VAT/GST costs for final consumers. They increase costs for all businesses that do not recover VAT/GST in full (e.g., related to VAT-exempt activity) or that pay VAT/GST on disallowable costs (e.g., business entertainment).
Rises also have an increased cost or cash flow impact on companies that incur VAT/GST in foreign jurisdictions which is not refunded quickly or which they do not or cannot recover (e.g., because of an absence of refund schemes for non-residents or because of complicated refund procedures).
Even within a country, the working capital cost of VAT/GST cannot be underestimated, especially where a business has a high days-sales-outstanding (DSO) figure and/or a low days-purchases-outstanding (DPO) figure:
- A high DSO indicates a greater working capital requirement in financing VAT/GST payables
- A low DPO indicates that the benefit of input tax recovery is reduced. Higher VAT/GST rates only exacerbate this cost
Perhaps most significant is the effect of higher VAT/GST rates on "VAT/GST throughput" or "VAT/GST under management" — i.e., the amount of VAT/GST "at risk" that must be actively managed in the business.
More VAT/GST in the system equates to more tax authority scrutiny and higher penalties for errors — the greater the amount of tax in the system, the greater the tax risk.
Increasing tax enforcement
As VAT/GST has increased in importance to balancing government budgets, tax administrations have also been tasked with ensuring that they collect the full amount of tax due. This has led to an increase in audit activity and in VAT/GST assessments for underpaid tax.
Penalties for errors can equal 100% or more of the tax due and may apply even where there is no effective tax loss. Business may be severely disrupted by tax audits and large assessments may draw unwanted adverse publicity.
In some countries, company officials can even be jailed for failure to comply with indirect tax responsibilities.
Increasing corporate scrutiny
Increasingly, problems related to indirect tax management are being elevated to global tax directors and the C-suite. This is because MNEs are facing greater scrutiny from regulators (e.g., Sarbanes-Oxley (SOX) reporting), stakeholders and external commentators than ever before.
VAT/GST management is often seen as an indicator of the strength of corporate tax and financial controls generally.
21st-century business models
Globalization and the spread of advanced technologies have changed significantly the way that MNEs operate in recent decades.
Supply chains are longer and more complicated than in the past, while response times have decreased dramatically.
Business units, sectors and functions are being operated and managed across country boundaries — with technology, ERP systems, standardization and centralization of processes reducing errors and driving efficiencies.
All this, and particularly financial transformation strategies, have an impact on the management of indirect taxes as traditional local responsibilities for compliance are transferred to a central hub or hubs.
Where tax compliance was once a local responsibility, it is now becoming a regional or global function.
However, tax laws and administrations have generally not caught up with these changes — at least not for the benefit of taxpayers. Many administrations remain firmly in the twentieth century (e.g., requiring signed paper returns) and they are focused on local rules.
As we reported in VAT and GST: multiple burdens for multinational companies5, when we surveyed return filing obligations in 90 countries in 2010, although 60 countries permitted electronic submission, 30 required manual returns. Similarly, while 62 countries permitted payment by bank transfer, 28 required payment by check.
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2 Source: OECD 2010 Consumption Tax Trends
3 Source: OECD 2010 Consumption Tax Trends
4 Source: Indirect Tax in 2011, http://www.ey.com/indirecttaxin2011, Ernst & Young