Although topics such as U.S. tax reform and the taxing of digital transactions are rarely out of the news lately, there is another kind of tax that governments are using increasingly, and companies would do well to pay more attention to it. These are the indirect taxes that are levied on most transactions as value-added tax (VAT) and general sales tax (GST) or as customs and excise duties. The speed and scale at which countries around the world are announcing changes to their indirect tax systems is giving even the biggest and best-resourced businesses a serious headache. And each year more countries are introducing real-time or near-real-time systems (pdf) that match VAT collected by suppliers with VAT refunds claimed by businesses. Poor control or lack of information about indirect tax changes can lead to lengthy disputes, higher bills, and weak strategic decisions.
Why You Need to Pay More Attention to Indirect Taxes in 2019
Managing the effects of indirect taxes on business performance requires both an understanding of the emerging global trends and a clear strategy. Here we highlight three significant global trends that are changing the way these taxes are levied, and three key steps that companies can take to ensure that they have the right strategy in place to keep up with the pace of change.
The Paying Taxes 2019 report, a collaboration between PwC and the World Bank that tracks tax systems across the globe, highlights just how difficult things can be when authorities introduce new VAT systems into countries. For example, Spain and Poland recently put in place new reporting systems with significantly different results. In Spain, the new system reduced the time it took to comply by four hours — but in Poland, the change increased compliance time for an average business by a whopping 76 hours.
Trend One: The Growing Importance of Indirect Taxes
VAT, GST, customs, excise duties can make up more than half of the tax revenue many governments raise. According to the Organisation for Economic Co-operation and Development’s (OECD’s) tax revenue data, Chile raised (pdf) 54 percent of its tax revenue from indirect taxes in 2014 and 41 percent in 2017; the current average in the OECD member countries sits at 20 percent. France was the first country in Europe to introduce VAT/GST systems, in the 1950s, and today they can be found in more than 165 countries. Angola and Bahrain are set to join the club in 2019; in Brazil, India, and China, VAT/GST reform is underway with the intent of improving enforcement, effectiveness, and efficiency. In the U.K., Brexit could have a significant impact on the VAT landscape in the years to come.
Although the world spotlight tends to focus on direct taxes, such as corporate income tax, destination-based indirect taxes are being used more and more to generate additional revenue.
Trend Two: Additional Taxation of the Digital Economy
How to collect the correct VAT/GST in the context of modern supply chains, cross-border trade, and the Internet remains unclear. The European Union and the OECD are putting forward plans that, in addition to looking at income tax, are focusing on business-to-consumer VAT/GST levied on low-value goods bought over the Internet. As of July 1, 2018, Australia has imposed an import GST on low-value goods, and New Zealand is proposing a similar regime.
As online marketplaces and intermediaries are increasingly being held jointly responsible for the VAT/GST due on transactions on their platforms, companies need to be able to track their customers’ sales or risk getting caught out. This isn’t easy. Businesses may lack structured data as to the exact nature of the items sold, the value of the items, and any subsequent price adjustments. They also may not be able to identify where products come from if the platform is not responsible for distribution and delivery.
A U.S. court decision in June 2018 ruled that retailers must now collect and remit sales tax on sales made to customers in the U.S. state where the customer lives, irrespective of where the retailer is based. This historic ruling changes the landscape of sales tax collection for remote sellers and has potentially far-reaching implications. In effect, it makes doing business costlier for the out-of-state seller.
Trend Three: Increased Emphasis on VAT/GST Compliance and Reporting
The speed and magnitude of business development has exposed glaring holes in some VAT/GST systems that governments are desperately trying to close. In addition, VAT/GST systems are susceptible to instances of fraud, owing to the fact that suppliers are in a position to collect tax from customers and then disappear without having delivered the customers’ tax to the relevant authorities. As a result, many governments around the world are taking unilateral administrative measures to assert greater control over their national VAT/GST systems, while exchanging more data more often between governments. It’s happening in Italy, Spain, and Portugal; meanwhile, in China, India, and Mexico, governments are using VAT invoicing control systems to reduce the size of the shadow economy.
A lengthening roll call of different compliance obligations is becoming familiar to VAT/GST practitioners. Consider real-time reporting, sale and purchase reporting, mandatory e-invoicing, the standard audit file for the tax-control statement, and split payment mechanisms, to mention a few. Every new reporting obligation requires new thinking and resources from businesses as to how to comply. And with greater volumes of information and advanced data analytics at their disposal, governments are better able to identify filing errors and impose significant penalties.
There will be a move to consolidate and simplify global indirect tax systems using technology that will transform the collection of tax almost beyond recognition, and allow for even greater exchange of information compared with the current patchwork approach. We’re not there yet. For now, a steady march of new regulations will leave businesses grappling with a proliferation of indirect tax compliance obligations. They will have to find ways to deal with the growing burden, in efficient and cost-effective ways that do not overly influence or inhibit their commercial aims.
It’s probably fair to say that most senior business leaders are still not as engaged with indirect tax concerns as they are with corporate income tax issues. This approach feels increasingly risky given the potential size and scope of exposure in this constantly changing environment. A clearly defined approach to indirect tax should mitigate the risk of costly errors and reputational damage, and ensure that companies have the right tax information at hand to inform their investment decisions.
The following is a three-step practical guide to help businesses control their indirect tax environment more effectively.
1. Understand the impact of indirect tax in real time. Everything a company buys and sells, the way it structures itself and its supply chain, the location and status of its counterparties, and every entry into a new market (whether it’s a new product or a new country) comes loaded with indirect tax implications. If you don’t know the different rules in place for your specific product in each country where you sell, or if you don’t have the right people, processes, and systems in place to manage the different and increasing administrative burdens, controlling your indirect tax landscape is an incredibly daunting and nearly impossible task.
Knowing the rules in your own country does not translate to understanding the rules in another, and although there is growing global convergence regarding the place of taxation for VAT/GST and sales tax purposes (i.e.,it's becoming more destination-based), the same cannot be said for the compliance environment, as set out in Trend Three above.
Subscription services can help companies keep track of indirect tax regulations around the world on a daily basis. Other software can help businesses calculate the total indirect tax under management in each country, model cash flow and actual indirect tax costs, identify areas for improvement or optimization, track the timing and status of filing obligations, and test overnight transactions as they get posted. The key to staying on top is to first map your indirect tax world and its impact, and then commit to understanding immediately what changes are coming your way and when.
2. Establish clean data and processes. The second step requires a more granular level of analysis. As a growing number of governments require businesses to transfer to them more and more indirect tax data with less and less delay, it is becoming a critical requirement for businesses to review and correct their data either before submitting it to the tax authorities, or, failing that, post-submission with a view to quickly correcting errors and prioritizing the resolution of systemic issues. Data analytics can help. More tax authorities are using such analytics, and companies should, too. An effective tool is one that is highly flexible, capable of being tailored precisely to the needs of the business, and focused on genuine errors and outliers rather than offering an excess of possible avenues for investigation.
Most senior business leaders are still not as engaged with indirect tax concerns as they are with corporate income tax issues. This approach feels increasingly risky.
For many years, businesses have employed a just-in-time approach of implementing IT solutions and patches to meet specific national VAT reporting requirements. This is no longer a tenable approach. More sophisticated companies are looking to deal with any immediate issues in parallel with a holistic strategy and vision so that they can adapt more easily to new obligations as they arise.
Some of these efforts can be outsourced, but doing so presents risks — getting it right requires an intimate understanding of the daily functioning of the business. It’s a choice that business leaders will have to assess on a case-by-case basis.
3. Prioritize strategic planning. The third step is to align the map of your indirect tax world with your data in order to make evidence-based decisions. This should be done not only to ensure that the right amount of indirect tax is paid in the right place at the right time, but also in order to inform business decisions regarding where to deploy resources and capital so as to minimize risk and maximize the return on investment. Easier said than done, but if the groundwork of mapping has been done, and the right data dashboards are in place, it makes strategic planning easier.
There are also more opportunities than before to work in partnership with policymakers, because governments are also grappling with rapid change and need help to develop solutions that foster economic growth while safeguarding tax revenue.
Navigating these changes is a significant challenge for multinational businesses, but it will pay dividends for CEOs to ask the right questions about indirect tax. An indirect tax strategy that identifies the true cost of operations can make the difference between the successful execution of a business plan and outright failure. It really does pay to keep tabs on indirect tax.
- Jo Bello is a partner with PwC UK and is based in London. She is the leader of the firm’s global indirect taxes network.