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Monday, 15th April 2024
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VAT: the top global tax risk for business today - how are you managing it? Back  
Research commissioned by KPMG provides further clear evidence of the increasing global importance of VAT, as corporate tax rates decline. It is time for Irish businesses to assess how they are managing this increasing level of VAT risk within their organisation, writes Niall Campbell.
Would it surprise you to hear that 50% of finance directors of global businesses, recently surveyed by KPMG, said that errors in compliance with indirect tax regulations is now their top global tax risk, rather than corporate income tax regulations?
This is just one of the findings in a recently published KPMG survey which demonstrates the increasing global importance of indirect tax, in particular VAT. What is also clear is that there is an increasing level of unease amongst finance and tax directors about the level of VAT risk which is being managed within their organisations on a daily basis.

To avoid significant difficulties in the future, the key issue for business is to quickly recognise what level of VAT risk exists within the organisation and what steps are being taken to adequately manage these risks now and into the future.

The KPMG Survey Results
A worldwide survey of senior finance professionals at over 500 large corporations in 22 countries around the world, commissioned by KPMG International, has revealed some very significant findings, including:
• 75% of global businesses expect governments to rely more on indirect taxation in the next five years.
• 50% of global finance directors rated errors in VAT compliance as the top global tax risk for their organisation, significantly ahead of corporate tax risks (38%).
• 82% of global businesses, prepared to give an estimate, said their total annual VAT Throughput was between US$200m and US$1bn.
• Complex VAT legislation is the number one issue for global businesses in the next five years, concerning two thirds of those interviewed, closely followed by compliance obligations (55% concerned) and the threat of penalties (45% concerned).
• Investment in training and technology are the key priorities for effective VAT management - 66% of global businesses believe that their organisations need to invest in training to raise employee awareness of VAT and 42% believe that investment should be made in improved VAT systems and technology.
• There is still a very low level of awareness of opportunities presented by VAT - only 11% of finance directors identified VAT as a potential source of competitive advantage.

This survey is one of the largest and most comprehensive ever commissioned on large multinationals’ views on indirect tax. The results confirm the trend that VAT professionals have been seeing on the ground in recent years, namely that indirect tax is becoming increasingly important for global businesses as corporate tax rates decline.

The levels of VAT which global businesses are now handling are quite staggering and are clearly causing finance directors and tax directors real concern. While 82% of survey respondents estimated that their annual “VAT Throughput” (i.e. total inputs and outputs) was between US$200m and US$1bn per annum, half of the respondents were unable to estimate this figure. Based on experience on the ground, however, it is clear that the actual level of VAT Throughput for many global organisations is in excess of €10b (yes €10 billion!) per annum - this represents a very significant multiple of the average corporate income tax liability but often does not receive a fraction of the focus.

As the cost of getting VAT wrong is now so material, it makes sense that errors in VAT compliance have now been identified as the biggest tax risk for these businesses - quite a shift in attitudes away from the traditional focus on corporate and income taxes. In many cases, this level of VAT risk has been either invisible or not fully understood – whatever the reason, the key issue now is that finance professionals must quickly get a handle on the level of VAT risk within their organisation and take steps to ensure that this risk is being adequately managed.

The research also indicates that while businesses are becoming increasingly aware of the scale of their global VAT risks and obligations, there is still a gap between awareness and actually investing in effectively managing the issues on a global basis. In particular, investing in areas such as employee VAT awareness training, VAT systems and technology, additional internal resources and relationship building with tax authorities and regulators will be required if VAT is to be managed effectively.

Missed opportunities - don’t let money go down the drain
It is not all bad news, however. With the rise of indirect taxation, there are now significant new opportunities by which more effective global management of VAT can produce real bottom line savings for businesses.
These savings range from improved cash flow to reduced compliance costs to reduced effective VAT rates on income.
However, the research shows that there is currently a very low level of awareness of those opportunities, especially amongst the finance directors.

In simple terms, this may be causing very significant savings to be lost to many organisations, much of which they may not even be aware of.

One of the key factors in dealing with this is to see VAT in a much more external, market focused way. There is a clear competitive advantage to be gained by those businesses that can achieve an optimal VAT position when making a range of business decisions from product pricing, outsourcing and new business locations. As shareholders continually challenge management to improve business performance, finance directors who now engage and invest in managing VAT risks and realising VAT opportunities can deliver real shareholder value.

What has lead to this increased indirect tax focus and where will it end?
There has been a global spread of indirect taxation in recent years with new regimes or significant reform of existing regimes taking place in many countries (e.g. new EU Member States, India, Gulf States (Dubai, Bahrain), Jersey etc). The total number of countries now applying a VAT system is approx 140 and is increasing steadily. This global spread can be explained by a number of factors:

• Corporate tax competition has caused global corporate tax rates to fall – this has been confirmed by KPMG’s annual tax rate survey in 2007 which showed a continuing downward trend in corporate tax rates due to competition between countries to attract and retain foreign investment. As a result, governments have been forced to look at alternative ways of raising tax revenues, with indirect tax being amongst the most popular.
• In particular, governments have realised the need to move away from relying on taxing corporate profits, which are globally mobile, to taxing domestic consumption.
• Governments have also realised the need to collect taxes on a real-time basis rather than a year or more after the event. As VAT is generally collected within weeks of the underlying transactions, it is more cash flow friendly for governments than corporate taxes, which can take years to collect and are more susceptible to planning and / or deferral strategies.
• VAT systems have proven to be one of the most efficient and cost effective mechanisms for governments to raise large amounts of tax revenues.
• As part of the “green tax” agenda, many governments have used indirect taxation as the means of levying additional tax on things such as carbon emissions, motor vehicles & fuel.

While different jurisdictions will move at different speeds towards increased indirect taxation, the conclusion is that the global trend is irreversible. So much so that the following two points merit consideration by all finance and tax professionals who want to stay ahead and be prepared for what is coming in the next 5 years.

Firstly, the US is currently the only OECD economy without a VAT system. With increased pressure on the US tax take and an increasing budget deficit, policy-makers are now seriously engaged in a review of what the introduction of a VAT system would do for the US. If this were to happen, and many observers predict that it is inevitable, it will change the US (and to some degree the global) tax landscape forever.

Secondly, the Institute for Fiscal Studies, an independent fiscal think-tank, has recently (June 2008) suggested that corporate income taxes be replaced with VAT. They sited the growing mobility of capital and profits which has sparked increased tax competition which, in turn, has created “significant difficulties” in taxing corporate income.

The net effect of the above two points is that the trend towards indirect tax is real and is unlikely to stop while governments continue the race to the bottom in relation to corporate tax rates and as business profits / capital gets more globally mobile.

What do you need to do?
The first thing you need to do is accept that indirect tax, and VAT in particular, will form an increased part of your global tax landscape into the future.

Secondly, you need to convince internal management and stakeholders that this is the case so that sufficient resources are allocated to putting in place an effective VAT management system within the organisation.

Thirdly, you will need to review all aspects of your business to determine the extent to which additional resources, processes and controls are required to effectively manage VAT. This will require engagement with all business functions, including finance, legal, sales and marketing, HR. In fact, all VAT “touchpoints” within the organisation, of which there are many, given the fact that all purchases and sales have some VAT implication, will need to be involved to provide a proper understanding of how VAT is being managed – and how it can change into the future.

This may all seem very time consuming, which it is, in the context of other demands on people’s time. However, consider how much tax department time is often consumed in painstaking review and implementation of one complex transaction from a corporate and withholding tax perspective, for example. An error of judgement could mean a tax cost in relation to that transaction, which although significant, is generally limited in nature. One simple VAT process error however (such as application of an incorrect rate or treatment) could mean that thousands of high value transactions are systematically being treated incorrectly, leading to massive potential exposures and materially incorrect management and financial reporting.

The message?
In summary, the message is clear. VAT is on the rise – all evidence shows this, including the recent KPMG survey. What is important now is how businesses react. Those who anticipate these changes and make the necessary changes will be rewarded in terms of efficient VAT processing and making use of the opportunities presented. Those who don’t will get increasingly bogged down in “fire-fighting” and lurching from one VAT crisis to the next. At best, this would be very inefficient and time consuming. At worst, it could lead to highly material financial costs, reputational damage and significant failures in business processes. This is a choice which has to be made now – by reading this article, I trust that you are already on the way towards making the right decisions.

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