2013-Issue 49—In most organizations, indirect taxes touch multiple business functions, such as purchasing, sales and inventory management. For U.S. sales and use tax and value-added tax (VAT), the consumer ultimately bears the burden of payment of the tax. The burden of compliance, however, rests with the business, and the cost of non-compliance can be substantial — customer dissatisfaction and, in some cases, direct costs to the business for interest, penalties and where taxes are not appropriately recovered.
To ensure that businesses remain compliant, it is essential that companies consider indirect taxes when engaging in business process changes and other corporate initiatives. We have seen a number of corporate change programs where this has not been the case, and the negative impact it has on day-to-day transactional compliance often results in a significant amount of additional work and resources to complete the sales and use tax and VAT returns.
This edition of Tax Advisor Weekly discusses some key corporate initiatives that have indirect tax implications and outlines the importance of ensuring that these taxes are taken into account from the start. Apart from ensuring that unnecessary cost and disruption are avoided, these projects also provide an opportunity to tidy up sales and use tax and VAT determination and reporting. In some cases, these projects may even yield substantial tax refunds. The ROI on projects can substantially improve if tax is taken into account at the onset and if the tax department remains a stakeholder throughout the project.
VAT and Sales and Use Taxes Affect Many Functions Within a Business
As mentioned above, U.S. sales and use tax and VAT are both consumer-based taxes. However, the manner in which businesses pass this burden on to consumers varies greatly
Under a U.S. regime, as goods flow through a supply chain, they are considered exempt resale sales. Tax is only collected on the final sale to the end consumer and is then remitted by the seller/vendor to the appropriate tax authorities. Use tax is complementary to sales tax, not duplicative, and only comes into play when goods, for whatever reason, are purchased by the end user without the appropriate tax being charged. In this instance, the user must self-assess use tax on those goods and remit the tax to the appropriate tax authorities.
In a typical VAT regime, vendors must also collect and remit taxes on sales; however, this is required for all sales taking place in the supply chain, not just the final sale to the end customer. In addition, businesses must pay tax on their purchases and recover this tax in their periodic VAT filings with tax authorities. There is also a use tax concept known as the “reverse charge,” which applies to importations of services; as with use tax, the customer is liable for the reverse charge, not the vendor.
Under either regime, a broad range of business functions within an organization affect, and are affected by, the indirect tax processes and function. Each one of the areas listed below plays a key role in the management of indirect tax function and the related risks.
Corporate Initiatives That Affect Indirect Tax
IT initiatives, such as enterprise resource planning (ERP) roll-outs or upgrades, have a significant impact on an organization. As tax compliance is not at the forefront of these projects, but instead is indirectly represented through the functions listed in Table 1, it is essential that the tax department provides significant and specific input and guidance about the indirect tax issues that need to be considered to the IT project representative in each of these functional areas.
ERP and financial systems projects can deliver great benefits to an organization. With the proper focus, improved indirect tax compliance can be one of those benefits. The tax department needs to play a key role in deciding:
- The scope of VAT and sales and use tax requirements within the overall project;
- Whether native functionality or a tax engine addresses the organization’s compliance requirements; and
- How the individual project work streams align with the tax department in order to realize the objectives driving the ERP roll-out.
Other IT initiatives that may affect indirect tax compliance include e-commerce projects, reporting initiatives and the deployment of workflow tools.
It is most efficient to pick up these types of tax issues as part of the bigger IT project, as opposed to a separate tax project after the fact. In fact, outside the U.S., we are beginning to see CFOs demand the involvement of the tax department in these projects on a more regular basis.
The outsourcing of functions such as accounts payable (AP) can deliver significant savings to organizations. However, the identification of, and accounting for, indirect taxes on purchase invoices is a key element to the success of such outsourcing initiatives.
When the AP function is performed in-house, AP clerks often have an intimate knowledge of the organization’s supply chain and historical indirect treatment of AP invoices. It is, therefore, crucial that an effective knowledge transfer, support system and monitoring model are put in place in order to ensure that indirect tax compliance standards are maintained or improved as part of the AP outsourcing initiative.
It is often the case that tax-sensitized supply chain documentation has never been created or is out-of-date and that there is limited validation of the tax treatment of transactions posted in an ERP system. While this may not always cause compliance issues, with an outsourced model in which tax is not adequately considered, an increased risk to indirect tax compliance will result.
Shared Service Centers (SSCs)
The creation of an SSC also involves a shift of local knowledge to resources that may not be familiar with an organization’s local indirect tax compliance requirements.
SSCs often house functions such as AP but, increasingly, also include other functions such as end-of-month financial reporting and the preparation of indirect tax filings. These SSCs are often located in non-English speaking countries, making the knowledge transfer and ongoing support of the indirect tax function an even greater challenge. Similar to an outsourcing initiative, effective transition and knowledge transfer plans related to the indirect tax function and requirements need to be realized when creating an SSC.
Electronic Invoicing/AP Automation
An increasing number of companies are assessing electronic invoicing and AP automation as a means to deliver efficiencies in non-core business processes. The opportunity (and potential threat) is that the projects can enable the automation of VAT and sales and use tax accounting on purchases.
Under a paper-based invoicing process, AP clerks manually code invoices for VAT treatment, something that can lead to errors. E-invoicing and AP automation present an opportunity to automate these processes to deliver increased accuracy and efficiency. However, as with any automation project, it is the upfront investment and effort in deploying the solution that will dictate the overall success of the initiative. Tax determination is based on multiple data sets and complex determination logic. Thus, if a business fails to provide adequate resources to ensure that the tax requirements are properly implemented as part of the overall project, tax determination accuracy rates may actually decrease and the efficiency of the reporting function may actually suffer.
Therefore, it is imperative that indirect tax leadership be involved in early-stage discussions to ensure that the appropriate data is being captured and used for determination and that the e-invoicing solution is compliant with all applicable local country e-invoicing legislation and requirements.
Mergers & Acquisitions
M&A activity can also present challenges from a compliance standpoint, especially in cases where companies are expanding internationally into new jurisdictions. Aside from the usual tax due diligence and advisory activities that a tax department will perform to support M&A activities, there will also be a need to work with migration teams to ensure that VAT and sales and use tax compliance is managed effectively as part of any transition arrangements.
Alvarez & Marsal Taxand Says:
As a number of these initiatives are driven by the C-suite, it is essential that the tax department identifies and is vocal about any indirect tax risk associated with these initiatives to ensure that they are considered as enhancing, not inhibiting, these initiatives.
A key challenge is that the tax department is often brought in very late or is not appropriately represented in the teams that support these initiatives. Historically, tax teams have not been as well connected as they should be with other teams within the business, and in large organizations this can even extend to the finance and IT departments.
On the bright side, there have been significant advances in technology around indirect tax management over the last 5-10 years. Organizations are deploying tax engines, reporting solutions and enhanced ERP configurations in increasingly innovative ways to support these types of initiatives. Organizations will also seek to augment existing resources through leveraging the experience of external resources to perform a solutions-architect-type role to ensure such initiatives adequately consider indirect tax compliance.
The key to a successful project is to ensure that the tax department is identified (or identifies itself!) as a key stakeholder from the outset, leverages the developments in tools and technology to support these initiatives and gets the buy-in of higher-level executives to make sure the job is done in the best long-term interests of the business.
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John Curry, Senior Director, contributed to this article.
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