Tax administration is going digital
The digital age is rapidly transforming the relationship between tax authorities and taxpayers.
Driven by a desire for more revenue, greater efficiency and improved compliance in an atmosphere of shrinking resources, tax authorities are increasingly relying on digital tax data gathering and analysis — using digital platforms to facilitate real-time or near real-time collection and assessment of taxpayer data.
This move toward tax “digitization” is allowing tax authorities to collect tax data in real time or near real time; they can then use the information to respond quickly and in more targeted ways to perceived compliance risks. Digitization is, in some cases, allowing taxpayer information to be cross-referenced and shared among governments and agencies.
Some countries are leading the digital revolution, others are forming a second wave and still others are years away from embracing digitization. Some Latin American countries, such as Brazil, are among the more advanced, while the United States is not as far along in its efforts.
Businesses with dated systems or those that are not able to adapt quickly may face increased risk, unexpected costs and compliance challenges to which they are not prepared to respond.
As countries move toward digitizing their tax administration, their efforts can often follow a similar pattern. Of course, the move to digitization is not necessarily linear, nor should higher levels of digitization be viewed as the ultimate goal of either taxpayers or tax authorities.
*Note that not all governments collect the same information or treat it the same under this model. For example, a country might be at Level 1 for certain data, but at Level 3 for other data. Further, the move to digitization is not necessarily linear, nor should higher levels of digitization be viewed as the ultimate goal of either taxpayers or tax authorities.
Digitization is accelerating the timing of tax reporting and filing obligations for businesses. Many governments are beginning to expect data in real time or near real time, often collecting it directly from taxpayers’ own systems, changing how and how often businesses must collect, format and report tax information.
Value-added taxes (VAT) and goods and services taxes (GST) are often among the first taxes in a country to be fully digitized. Technologies that enable VAT and GST digitization will likely, sooner or later, enable business income tax systems as well.
Automation and process standardization are cornerstones of digitization. The requirement that data be submitted in standard formats facilitates tax authorities’ expanded use of tax, accounting and other source data for compliance purposes.
The increasing reliance on the electronic submission of tax, accounting and other company data has also allowed for the growth of another hallmark of the digital tax age — the use of data analytics and data matching to target compliance and audit initiatives.
Tax authorities are uncovering complex business relationships, reflected in the data companies submit, that they then use to trigger audits or stop the payment of refunds.
Tax authorities’ use of data analytics for audit and compliance purposes is likely to expand, fueled by the increase in the amount of tax data available and the frequency of reporting under tax digitization.
The push for global tax transparency will place a great deal more responsibility on companies, which will soon be required to produce large volumes of data in new formats.
One potential source of taxpayer information will be country-by-country (CbC) reports filed by large multinational corporations (MNCs). The reporting initiative, part of the Organisation for Economic Cooperation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) project, applies to MNCs with aggregate annual revenue of more than €750m.
Under the OECD model, which many countries are adopting, companies use a three-tier framework for providing information on global allocation of income, economic activity and intercompany pricing across all of their global operations.
Companies generally file the CbC report with the tax authority in the home country of the MNC group’s parent company, and the report is automatically shared with tax authorities in other relevant countries under government information exchange mechanisms.
The data businesses are being asked to submit under tax digitization reaches far beyond tax forms, and often includes accounting and sales data. Legacy systems and processes may not be able to support these and other government requirements.
Challenges may include:
- Lack of data available in the required formats
- Difficulty submitting data
- Inefficient processes for transforming data
- Lack of process support for new data requirements
- Outdated tax operating models
- More frequent need for more comprehensive analytics, in advance of submission to tax authorities
- Inability to respond to audit notices in a timely or effective manner
- Inability to respond quickly when there is disagreement with a tax assessment
A detailed review and possible reengineering of the processes companies use to record and report their data may be required. Businesses that outsource these and related functions need to make sure that their third-party solutions are flexible and updated frequently.
Businesses will also experience a financial impact as tax administration is digitized — more complex data requirements, delayed refunds, construction of new systems, retooling of processes and more time spent on compliance could negatively affect cash flow. Data security will also be a major concern as governments share data and BEPS reports.
Meeting the challenge
As tax authorities move at varying speeds toward greater digitization of tax information, businesses need to develop a detailed understanding of digital tax requirements in their markets. Following developments closely and engaging in conversations can help businesses better meet the challenges as governments expand their digital capabilities.
They must also determine whether their 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.
Businesses will need to implement digital solutions that can work within and across countries and that can respond to evolving compliance and controversy requirements. They should explore the use of real-time data analytics for tax planning and compliance purposes, to measure and mitigate risk, to better target controversy interventions and resolve issues as they occur.
Businesses should consider what investment may be needed to respond to the increasing demand for digital tax information and how to manage the risks inherent in the expansion of electronic data submission. Taking the time to understand these issues and explore forward-looking solutions today — and conveying these options to policymakers — may help avoid more costly and time-consuming remedies tomorrow.
For more information, including a snapshot of tax digitization across the Americas, download the full report.