14 minute read 10 Feb 2021
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How digital tax reporting is forcing a rethink of sourcing strategies

By EY Global

Multidisciplinary professional services organization

14 minute read 10 Feb 2021

An increase in tax risk and workload from digital tax filing is pushing businesses towards outsourcing. But is that always the best solution?

In brief
  • New digital tax filing requirements put increased pressure on indirect tax functions as demands for transactional reporting and real-time data are introduced.
  • A business’ individual footprint needs to be considered when deciding which approach to adopt. Outsourcing, although attractive, may not be the best solution.
  • Considering what technology the business should buy, build or adapt is a critical factor in devising the appropriate strategic approach.

The emergence of new digital tax filing requirements around the world is putting increased pressure on tax functions that are already stretched. Added to this is a shift towards tax authorities requiring near-real-time or real-time transactional data, which has the potential to stretch them even further.

Two key concerns for tax functions in this new environment are increased tax risk and a likely increase in workload. Indeed, EY 2020 Tax and Finance Operate survey shows that 51% of all respondents expect an increase to their organization’s tax risk profile from complying with emerging digital tax filing requirements, while 84% expect it to increase the workload of the tax and finance function.

EY 2020 Tax and Finance Operate survey

84%

of organizations anticipate an increase in their workload from complying with emerging digital tax filing requirements.

While these pressures exist for all taxes, they have become increasingly acute for indirect taxes, which have been subject to the greatest number of digital tax administration measures in recent years.

This is leading many organizations to reconsider the sourcing models for their tax and finance operations. Research from EY’s report indicates that businesses are more likely to consider outsourcing if they believe that emerging digital tax filing requirements will increase risk and workload.

On first reflection, this shift seems like a natural response to the move towards digital tax filing. As Pierre Arman, Associate Partner, Indirect Tax & Technology, EY LLP, based in the UK, explains: “One of the major risks comes from the tax authorities wanting more data, more often from taxpayers. So, the reporting period shortens and the time that businesses get to format and clean that transactional data to get to a value-added tax (VAT) return becomes less and less. This creates more room for ‘errors’. And outsourcing is typically seen as a de-risking strategy from a compliance standpoint.”

As Arman points out, the landscape is further complicated by the fact that digital tax administration is moving at different rates around the world. “Latin America has been active for a while and Europe has notably kicked off as well, with the introduction of the Immediate Information Supply (SII) in Spain, and Standard Audit File for Tax (SAF-T) in Poland and Norway, and real-time/near-real time reporting in Italy and Hungary,” he says. “What doesn’t help is the lack of a consistent global approach. Every country is going its own way on how they want to tackle it.”

It is a sentiment that is echoed by Maria Hevia Alvarez, EY Americas United States VAT Practice Leader, EY LLP, who explains that this fragmented approach has led to disparate technology which further increases the level of risk. “Historically, businesses with an international presence have used different local solutions depending on each country’s requirements,” she explains. “But as those requirements change, the biggest challenge and risk is how to manage that technology, because they need to make sure it continues to be updated and compliant. Suddenly there becomes a need for clear, standard processes.”

Looking outward for a solution

In order to deal with this increased risk, many businesses are considering outsourcing. Indeed, according to research from EY Tax and Finance Operate survey report, when those surveyed felt that there was going to be just a slight increase in tax risk from digital tax filing requirements, the likelihood to outsource leapt by 20pp.

The picture is slightly different when it comes to workload. A perceived slight increase in workload had no effect on the shift to outsourcing, but when there was an anticipated moderate increase, the likelihood to outsource rises by 10pp. This indicates that tax and finance functions are willing (or able) to handle some additional workload, but when that pressure grows, outsourcing becomes more attractive as a solution.

These responses indicate that the pressure to “get things right” seems to be greater when digital tax requirements are introduced, hence the immediate turn towards outsourcing as a solution. This higher sense of urgency is likely because taxpayer’s have less time to self-audit and correct errors and tax administrations have more opportunities to find errors and challenge tax positions.

On the surface, this shift to outsourcing in regard to both risk and workload is understandable – to partner with a third-party that has the systems and expertise to manage all the reporting obligations and handle the workload, yet who will be able to flex and adapt as the regulations continue to change. But is there a danger that automatically leaping to outsourcing, especially when it comes to managing risk, is something of a knee-jerk reaction?

Liza Drew, EY Asia-Pacific FSO Indirect Tax Leader, thinks the picture is far more nuanced. “Even without the risk from digital tax filing requirements, there’s been a general increase in terms of the regulatory requirements that tax functions have had to deal with,” she explains. “It’s been accumulating for some time now. When you add in digital requirements – with companies needing to upskill their technology and systems to comply – you can see why it’s a fairly natural reaction for companies to think they’ve reached a tipping point.”

The sourcing dilemma

This begs the questions whether outsourcing is the best solution. Under what circumstances might it be best and when might it not?

As Arman points out: “The real question is whether outsourcing makes sense based on a business’s current set up. If you already have a team in place in-house and you can manage the changes, the move to outsourcing doesn’t make sense from a business and cost standpoint, and also in terms of maintaining control. Secondly, the outsourcing provider can only help you to a certain point. They can’t book transactions in your enterprise resource planning (ERP) system, for instance.”

This latter point is a taken further by Gino Dossche, EY Americas VAT Compliance Leader and US Consumption Tax Leader, EY LLP. “You can effectively put indirect tax submissions into different categories,” he explains. “There’s the periodic reporting of transactions to tax authorities, such as Making Tax Digital in the UK and SAF-T in Poland. Then there’s the near-real-time data that is sent to government through a third-party solution or a direct ERP connection, such as in SII in Spain or e-invoicing in Mexico.

“The periodic reporting is where the shift to outsourcing makes sense, because it is possible to hand this on to a provider. Where the taxpayer must make a direct connection to the tax administration to submit transactional data straight to them, on the other hand, can be harder to outsource.”

All of this points to the fact that the picture is far more complex than simply shifting to outsourcing because the tax risk or workload is increased. Effectively, there are many moving parts to the decision-making process. Companies may not be in a position to outsource or simply choose not to. They may feel that co-sourcing or in-sourcing is a better option – or, indeed, a hybrid of all three approaches may be most appropriate. This may be especially true of companies that have a global footprint.

As Dossche notes: “An organization may choose one approach in one country because of the reporting requirements, but a different approach in another country. You can’t throw a blanket over everything anymore. Strategically you need a more targeted and focused approach to compliance these days.”

The technological imperative

As part of that strategic approach, utilizing technology, perhaps unsurprisingly, is going to be critical. And Kevin MacAuley, EY Global Indirect Tax Deputy Leader, feels that businesses are playing catch-up. “Tax authorities have overtaken businesses,” he says. “Go back five years and businesses were ahead from a technology and a digital perspective, but that’s no longer the case. Organizations have been focused on doing business, only paying attention to the tax function when it raises its hand and asks for resources. The business of tax authorities is collecting tax and so that has been front of mind for them.”

Tax authorities have overtaken businesses. Go back five years and businesses were ahead from a technology and a digital perspective, but that’s no longer the case. Organizations have been focused on doing business, only paying attention to the tax function when it raises its hand and asks for resources. The business of tax authorities is collecting tax and so that has been front of mind for them.
Kevin MacAuley
EY Global Indirect Tax Deputy Leader

Technology is critical to the new reporting landscape, not least because digital administration requires businesses to have an application programming interface (API) to submit the return to the tax authority. As Arman says: “Having less technology capability than the tax authority puts you in a challenging position. Thankfully, the technology out there has rapidly evolved in terms of speed, responsiveness, visibility and analytics – but it needs to work for businesses in a way that makes sense with the journey they are on.”

It is this latter point that is arguably most critical. “Technology is the only way you rise to the challenge,” says MacAuley. “But increased risk and the greater adoption of technology doesn't always require outsourcing compliance to a third party. Some businesses may still want to build their own in-house software, but what we are seeing is businesses increasingly want to buy in the right technology, with some clients asking to procure the same technology that we use ourselves as their compliance adviser.”

This may include an upgrade in ERP system, such as a migration to SAP S4/HANA, which is broadly being seen as a potentially transformative ERP for the tax and finance function. As Hevia Alvarez points out: “It may prove to be the perfect opportunity to get rid of all the local solutions and processes that a business might have and put in place a common global solution that helps them operate in a centralized way.”

Disparity amongst the C-suite

So, the shift to digital tax filing requirements is creating a general perceived increase in tax risk and workload. And central to that is the critical need to utilize technology in a way that suits each individual business best, and address the question of whether outsourcing, insourcing or co-sourcing their compliance function is the most appropriate solution.

However, the picture is not quite that simple. EY research shows that there is a distinct disconnect between finance, tax and compliance leaders with regard to how exactly the business will be impacted by and how prepared they are for the new digital requirements.

As part of EY 2020 Tax and Finance Operate survey, participants were asked: Does your organization have adequate resources in place to identify, evaluate and respond to legislative and regulatory change (e.g., BEPS 2.0 and emerging digital tax filing requirements)? While 65% of CFOs and 66% of Heads of Tax said yes, only 18% of Heads of Compliance felt they were adequately prepared.

What's more, when it comes to complying with emerging digital tax filing requirements and other electronic transactional government filings, 73% of Heads of Compliance felt it would increase their organization’s tax risk profile, compared with only 54% of Heads of Tax. And only 36% of Heads of Compliance felt the organization was adequately prepared to comply with the requirements, against 60% of Heads of Tax and 65% of CFOs.

So why is there this disconnect and what are the implications, if any, for how businesses implement a sourcing model?

Drew believes there are a number of key factors at play here. “Firstly, I don’t think the CFO goes into the granular level of detail that the Head of Compliance does,” she says. “So, compliance has better visibility of the challenges. Also, Heads of Tax don't always have the responsibility for filing the tax return. In Asia-Pacific where I am based, tax filing has typically been done by local finance functions.

This points towards an often-cited issue that indirect tax sometimes sits under the tax function, while in other cases it sits under finance – again adding to challenges around visibility. Drew believes this has the potential to create a lag in the decision-making process around sourcing. “Any decision will always require consensus from a number of stakeholders – it will never be just one department,” she says. “Thinking about whether technology should be outsourced, in-sourced or co-sourced, for example, can’t be a unilateral decision.”

This points to the need for a collaborative approach and the breaking down of potential silos within an organization – allowing a far more effective and responsive approach to meeting challenges that arise.

Conclusion

The technology “arms race” between tax administrations and taxpayers is accelerating and bringing decisions about outsourcing in tax higher up the C-suite agenda. This has only been made more urgent by resource challenges and budget constraints following the Covid-19 pandemic.

Digital tax filing is only heading in one direction and is clearly the way of the future. As Dossche says: “Tax authorities around the world have a VAT gap to fill. They have been focused on implementing measures to enhance compliance, which is where digital tax filing comes into play – this is all about new ways to collect the VAT revenue without increasing the rate.”

For Hevia Alvarez, this inevitability means adopting a structured approach to sourcing. “Tax and compliance leaders need to be having conversations,” she says. “The first step is to make sure businesses are compliant and to identify any gaps right now – are there any countries not being covered properly, for instance. Once this has happened, they need to address the use of technology and the establishment of robust processes, which means analyzing which is the best solution for them.”

The pressure from digital tax requirements is only going to increase in the years ahead. Businesses that take a strategic approach to sourcing are the ones that will mitigate the associated risks.

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Summary

Digital tax administration measures – especially demands for real-time data – have added to tax functions’ workload in recent years and increased costs and risks for many taxpayers. In the longer term, the Covid-19 pandemic seems likely to accelerate these trends. While adopting an effective indirect tax operating model may not seem a priority in the current environment, it should be. The right mix of resources will vary from business to business, but making the best use of technology, processes and people is crucial – not only in meeting obligations but also in boosting business performance.

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By EY Global

Multidisciplinary professional services organization