How businesses can prioritize ways to pay indirect tax

Consumption taxes as a percentage of total tax revenue have remained stable across members of the Organisation for Economic Co-operation and Development.

The indirect tax world is experiencing an unprecedented era of expansion and transformation, forcing businesses to prioritize how these levies are managed and paid. We began to see the rise of indirect tax at the turn of the millennium, specifically value-added tax (VAT) and goods and services tax (GST), as well as special consumption taxes on items such as cars, cigarettes and alcohol. 

Consumption taxes as a percentage of total tax revenue have remained stable across members of the Organisation for Economic Co-operation and Development (OECD), with an average of 30.5% in 2014 compared with 30% in 2004. But these taxes are being applied to an ever-widening range of products and services. Some of the most recent examples include new levies on sugar, carbon emissions, plastic bags and e-cigarettes, along with goods and services sold online.

The compliance burden has expanded in tandem. This represents a significant challenge and risk for the tax function today, considering the wide range of detailed data and technological processes required by each jurisdiction, not to mention the perpetual revisions in indirect tax policies. 

These developments have led to indirect tax assuming a key role in strategic planning within the tax function. Global businesses need to monitor indirect tax developments closely. And they should be prepared to adapt their transactions, accounting policies and technology to pay and recover the correct amount of tax. (Follow changes to VAT, GST and other indirect taxes with the EY Worldwide Indirect Tax Developments Map at www.ey.com/indirecttax).

Globetrotting tax

While customs duties have been around a long time (in medieval Germany, people paid customs duties to use the roads and bridges), general taxes on goods and services are a modern phenomenon.  

France was the first country to introduce a general consumption tax, in this case VAT, in the early 1950s. It took a few decades to catch on — in the late 1960s only 10 countries had introduced a VAT or GST, according to the OECD — but by 2016 some 166 jurisdictions across the world had one. 

The OECD calls VAT “among the most important developments in taxation over the last half century.” Governments like VAT/GST for a few reasons: it’s a stable source of revenue, especially in times of recession; it’s efficient to levy in terms of costs and time; and it tends to weigh less on economic growth than other taxes.

Globalization has also boosted the appeal of this tax. As global trade took off in the 1990s and more jurisdictions opened their borders via free trade agreements, many developing countries introduced a VAT/GST to compensate for lower trade duties and tariffs, according to the OECD. 

The adoption of VAT/GST has altered the mix of taxes collected by governments, shifting from specific to general consumption. Excise taxes on specific goods and services declined to 7.6% of total tax revenue, on average, among OECD member countries in 2014 compared with 14.2% in 1965. In contrast, general consumption taxes raised 20.7% of total tax revenue on average among OECD members in 2014, up from 11.9% in 1965.

The right approach

Taxpayers can’t afford to lag tax administrations in this digital transformation. Investing in technology, including moving to standardized, automated processes instead of relying on manual spreadsheets, will help businesses handle greater quantities of data and comply with more-demanding indirect tax reporting requirements. 

Such efforts will also help businesses respond more effectively if they come under increased scrutiny by tax authorities. And it should help lower costs for headcount, cash flow, consulting, accounting and compliance.  

By digitalizing their indirect tax systems, businesses can gain greater visibility over their indirect tax obligations and risks, including outstanding VAT/GST refunds. In some countries, especially those dealing with significant VAT/GST gaps, obtaining such refunds can be extremely difficult. This waiting game can transform VAT/GST recovery into a significant cost for the business — a risk that eventually is brought to the attention of the C-suite. 

Digitalization can also lead to less business disruption. Digitalized tax administrations are moving toward a system in which they will be able to identify and certify taxpayers who are compliant. Tax administrations would no longer have to analyze all taxpayers — compliant and noncompliant — in the same manner. Those deemed “good” would face less scrutiny and fewer audits. 

In an era when the popularity of indirect tax keeps rising, the onus is clearly on businesses today to pay greater attention to governments’ favorite “child.”

This article was originally published in Tax Insights on 1 Feb 2018.