8 minute read 9 Feb 2018
delicious donut

Collecting VAT and GST is relatively easy; getting refunds isn’t

By

Gijsbert Bulk

EY Global Director of Indirect Tax

Seasoned indirect Tax Partner. Serving clients in Amsterdam and beyond. Litigator. Husband. Father of four boys. Chess player. Runner.

8 minute read 9 Feb 2018
Related topics Tax Tax accounting

Show resources

From overpayments to claiming refunds for tax collected by others, taxpayers face complexities, delays and added costs.

The growing popularity of consumption-based value-added taxes (VAT) and goods and services taxes (GST) in the past half-century has turned businesses around the world into tax collectors. For tax authorities, it’s a great idea in principle.

Relative to income taxation, the generation of more consumption-based taxes enables governments to obtain increased certainty and speed in tax collection. And for the most part, businesses remit what is due on their transactions, absorbing the administrative cost in the process.

Complex compliance requirements are a common but not always wise reaction by tax authorities to what they fear are rampant abuses.
Michael Keen
Deputy Director of the Fiscal Affairs Department, International Monetary Fund

Getting refunds is a different story. From overpayments to claiming credits for VAT collected by others, “taxpayers – large and small – face complexities, delays, added costs and in many instances are completely unable to recover what they are legitimately owed,” says Joachim Englisch, a Professor in Tax Law at the University of Münster in Germany.

For years, many businesses tolerated the situation, figuring the inability to cover refunds to be a cost of doing business and not worth fussing over. Increasingly, however, businesses enabled by technology and better processes are taking steps to get a clearer picture of the actual costs in terms of delays and losses, and are more aggressively pursuing what they’re owed.

A difficult process

In theory, getting a refund is simple, as in this hypothetical example: Take a VAT set at 10%. A barrel maker assembles a wooden barrel and sells it to a maker of fortified wine for $500. The winemaker pays the barrel maker $500 plus the $50 in VAT; the barrel maker collects and sends the VAT directly to the government. So far, so good.

The winemaker lets the wine ferment and age in the barrel, then exports the barrel to a wholesaler for $1,000. The winemaker does not charge VAT on the transaction, because it is an export, and files a refund with the tax authorities for the $50 in VAT it paid to the barrel maker.

And there’s the stumbling block. Because governments are wary of fraud, actually receiving the refund requires navigating complex compliance rules, enduring frequent delays and lengthy review processes, and suffering disallowances. These challenges grow exponentially for businesses operating on a global scale.

“Though insisting on immediate payment of VAT collections denoted by any invoice or return, most host governments in turn throw up all sorts of documentary and process requirements before credits or refunds are verified and granted,” says London-based Kevin MacAuley, our EMEIA Indirect Tax Leader.

Refunds and credits are particularly challenging for taxpayers lacking a physical presence in the jurisdiction issuing them. For one thing, nonresident businesses have little influence over local policy regarding taxation. In fact, many countries make few, if any, provisions for such entities to obtain VAT/GST refunds. Our managing indirect tax refunds report, for example, shows that only 38 of 122 jurisdictions reviewed offer direct VAT/GST refunds to nonresidents.

“Even where available, such companies tend to encounter onerous application and review processes,” says MacAuley.

Joachim Englisch, Professor in Tax Law, University of Münster Image: Andreas Zimmermann

Joachim Englisch, Professor in Tax Law, University of Münster

Image: Andreas Zimmermann

The root causes

So how could something so simple in concept evolve into something so burdensome and complex? Washington, D.C.-based Michael Keen, Deputy Director of the Fiscal Affairs Department at the International Monetary Fund (IMF), believes the primary cause can be found in the various issues that tax administrations repeatedly face in collecting the right amount of tax revenue from businesses.

“Complex compliance requirements are a common but not always wise reaction by tax authorities to what they fear are rampant abuses,” says Keen. “VAT/GST systems have encountered significant instances of fraud over the years – and tax administrations recognize they are still susceptible today.”

Among the simplest means of VAT/GST evasion, and likely the largest contributor to reduced VAT collections worldwide, is the underreporting of sales and therefore underpayment of VAT/GST, says Keen. However, there are many other means for cheating in VAT/GST. For example, forging of invoices claiming taxes paid can be a real problem.

Then, there is “missing trader fraud,” a criminal practice in which a business ships goods into a country (VAT-free) and then sells the goods to other organizations (charging the customers VAT but not paying it to the government) before disappearing. Using buffer operations and other tools to manipulate flaws in the system, this type of fraud can generate VAT refund documentation and payouts where no VAT was ever paid in the first place.

Such goods are often shipped out of the country, then returned for one, two, three or even many more rounds of such false VAT refunds.

“Governments often find themselves placing onerous conditions on others simply because they’re concerned by their own inability to adequately manage VAT/GST processes,” Keen says.

Indirect tax neutrality

Indirect tax neutrality

Making matters worse

Nevertheless, taxpayers can be their own worst enemy in terms of making matters worse, according to MacAuley. Consider consolidated invoicing and billing, a move aimed at increasing efficiency. Customs data, payments for specific services, and other documentation needed as evidence for refunds and credits often get truncated if businesses carry out such improvements without paying heed to VAT/GST compliance, according to MacAuley.

“All too often, businesses put people in charge of processes that have an impact on VAT and GST and yet, those executives either aren’t aware of the implications or simply face too many competing priorities,” says MacAuley.

Or consider planning, warehousing, shipping and location decisions. Ideally, a business will want to be able to offset the VAT/GST it pays on its inputs against the amount it collects from domestic sales, according to Gijsbert Bulk, our Amsterdam-based Global Director of Indirect Tax.

But what if the business meanwhile is making large investments in property or equipment? Or if the vast majority of its sales are exports? Now the VAT it is remitting vastly exceeds its sales, which places the organization in chronic need of refunds, Bulk says.

At best, “this can have a negative impact on cash flow,” says Bulk. But worst case, “if the operation is in a high-risk market, delays or denials could potentially kill their entire business.”

Michael Keen, Deputy Director of the Fiscal Affairs Department, International Monetary Fund Image: Stephen Voss

Michael Keen, Deputy Director of the Fiscal Affairs Department, International Monetary Fund

Image: Stephen Voss

Impact of automation

Complex processes and rules are often an ideal candidate for automation, and this includes the digitalization of tax administration around the world. This will have consequences for VAT/GST compliance.

“Tax authorities are capturing the details of purchase orders, invoices, payments and the like – if not in real time, then something close to it,” says Tracey Kuuskoski, our Leader of APAC Digital Indirect Taxes, who is based in Singapore. “They will have a clear window into VAT/GST collections, payments and refunds.”

While higher degrees of automation would be a win for taxpayers, lowering their VAT/GST compliance costs and streamlining the VAT refund process, in many cases, result in refund benefits being slow to arise, according to Kuuskoski. That’s because many of the countries that are moving the most rapidly from archaic to fully automated systems are emerging markets. Such nations will tend to have priorities other than paying VAT/GST claims, says Kuuskoski.

For example, in many cases, jurisdictions have been unable to resist holding on to such revenue, according to Keen. Closely related, he says many jurisdictions “are still developing the resources, skills and structures needed for their budget systems to properly manage VAT refunds.”

“Rather than set aside a portion of VAT/GST collections for eventual refunds, the risk is that the money gets spent as it rolls in,” Keen says.

For now, rather than use newfound automation to accelerate and streamline VAT/GST claims, these nations will instead use all the new data they have at their fingertips to look for ever more sophisticated ways to initiate new reasons for audits, says Kuuskoski.

“Delays will continue – at least until we reach some kind of new equilibrium,” says Kuuskoski. Keen notes there will never be an era of perfect compliance and the elimination of fraud. Even greater automation is no cure-all.

“There are loads of creative people out there looking for the next chink in the armor,” says Keen. No matter how much technology is in use, there will be new weaknesses, and they will be exploited.

But progress is being made. Keen says that the IMF and others are doing their best to help national tax authorities the world over to improve their budgeting and planning processes and show how that makes them more attractive centers for business, thus improving their economies. This in turn will lead such countries to be more open, fair and fast in dealing with VAT/GST credits and refunds.

“Hopefully, it’s a compelling enough argument,” says Keen.

Key action points

  • Review VAT/GST regulations in all nations where your business has significant operations to confirm up-to-date understanding
  • Review internal processes for identifying and documenting VAT/GST credits from purchases and VAT/GST payments from sales
  • Review compliance with documentation requirements and credit/refund procedures. Make certain all of those who might have an impact on VAT/GST processes – particularly suppliers and various internal groups – are able to supply the tax team with the needed documentation in a timely manner
  • Apprise key executives responsible for decisions involving location, shipping, invoicing, etc., of the key issues for VAT/GST optimization
  • Where VAT/GST credits/refunds are not significant enough to warrant investment in upgraded processes, consider hiring a third-party specialist agent

Summary

From overpayments to claiming refunds for tax collected by others, taxpayers face complexities, delays and added costs.

About this article

By

Gijsbert Bulk

EY Global Director of Indirect Tax

Seasoned indirect Tax Partner. Serving clients in Amsterdam and beyond. Litigator. Husband. Father of four boys. Chess player. Runner.

Related topics Tax Tax accounting