KPMG: Take ownership of indirect tax
New legislation and cross-border disharmony has made VAT compliance increasingly difficult for multinational corporations. Gary Harley, head of indirect tax at KPMG, talks to Finance Director Europe about the dangers of overlooking this latest tax to come under the spotlight.
The present wave of globalisation has permanently changed the political economy of taxation. With individuals, corporations and capital all mobile, states have become market agents themselves, forced to compete with one another over their attitudes to business and their rates of tax.
Nowhere has the 'race to the bottom' been more obvious than in corporation tax. In 1973, Conservative Chancellor Anthony Barber set the top rate of UK tax to 53%. But by 2014, after years of economic integration and so-called 'capital flight', the headline rate will fall to 23%.
The UK's stated aim of improving competitiveness is a political choice with a clear price. Like most developed societies, the state has various social and political programmes to meet. With the reduction in corporation tax, the revenue available to satisfy those obligations has fallen.
"Government needs revenue in order to oil the machinery and fund public expenditure programmes," says Gary Harley, head of indirect tax at KPMG. "If its yield from corporation tax diminishes, you need to make good that difference from other taxes. What we're starting to see is a sharper focus around the VAT component of indirect tax. The UK in particular is moving to the higher end of the EU spectrum at 20% and I don't see that changing."
From the perspective of government, the attractiveness of VAT is relatively simple. As a real-time, easy-to-collect tax on sales, the point of incidence falls on consumers rather than business. That makes it far less dependent on corporate profits and far easier to predict in terms of overall yield.
The government's changing priority from one tax to another doesn't seem to have rubbed off on businesses, however. Neither CFOs nor heads of tax are yet to fully acknowledge the place of VAT in their overall tax liability.
"You have governments shifting their focus on indirect tax," says Harley. "But organisations are typically skewed in terms of their investment and head count towards corporation tax and, increasingly, transfer pricing. Most multinationals have big in-house tax teams headed up by someone with a corporation tax background. Those companies that are investing in global and regional heads of VAT might be rising in number but they remain the exception."
Global integration, local compliance
Viewing tax solely through the lens of corporation tax could prove deeply costly with the regulatory picture so complicated. Global economic integration has been positive for business but compliance with local laws can be time-consuming and expensive.
In the EU, every member state has to implement an indirect tax system that is consistent with the Principal VAT Directive. Within that common framework, member states have discretion in terms of how they interpret the syntax. Their freedom is something of a constraint for multinationals, which have to understand the rules of 27 different member states across Europe.
"Things aren't as harmonised as one would have thought, given the objective of the EU," says Harley. "There are 27 countries now in the EU, and whilst there is a common framework, implementation can vary dramatically in certain areas. Globalisation has, of course, been a good thing, but it does have drawbacks. Companies may have more efficient supply chains but lack the necessary local knowledge on tax, consumer and contract law issues."
Outside the EU, things get even worse. Without an overarching apparatus, huge inconsistencies become apparent in the application of VAT, from compliance requirements such as what goes on a tax invoice and the content of a VAT return, to more complex matters like the place-of-supply rules for goods or services and the ability to obtain a refund of VAT where a local business is in a VAT repayment position.
It is very hard for corporates to comply with their obligations as they move to centralisation, and the lack of standardisation makes this challenge all the more daunting.
"It's a balancing act," Harley says. "The European Commission does have forums and expert groups that allow businesses the opportunity to have their say. The OECD also has equivalent working parties around consumption and indirect taxes. So there is a willingness to listen, learn and make the VAT system easier to comply with. But there's also a degree of nervousness and the pace of change is frustratingly slow. In the EU, there's a significant gap between the tax that governments expect to collect and the tax they do collect. Simplification might be good for business, but it could leave the system open to abuse, which is something that governments and their tax administrations are rightly wary of.
"Tax - be it corporation, payroll or indirect - can have a major impact if you get it wrong," Harley continues. "The penalty regime for honest mistakes with little or no revenue loss can be extreme. It's not unusual for a fine to be disproportionate to the error. That said, at least in Europe, there's a strong judicial process with a right of appeal to the European Court that can ultimately provide some certainty. But in other countries around the world, the legal process is far less certain, which makes doing business a real challenge."
Clear accountability for VAT
Understanding and managing such a complex, fluid landscape might seem like a minefield, but Harley breaks it down into three core areas: governance, compliance and technology.
"At the simplest level, one would hope that an organisation has a strategy of how it manages indirect taxes within its business," he says. "The strategy for indirect tax should be consistent with the wider tax strategy but also complementary to the goals of the wider finance function and indeed the enterprise. It should be absolutely clear on where ownership of indirect tax sits in an organisation. The best organisations will have clarity over who the global process owner is, and that person will ideally be empowered to drive the execution of the governance strategy within the global business. It should be clear in the framework: how accountability for VAT cascades through the organisation.
"But your governance framework isn't just about getting things right by managing risk; it's about creating value, either by reducing the cost of VAT or by trying to implement strategies that minimise the cashflow impact of VAT and GST. For many businesses, VAT is their third-largest cashflow after sales and cost of sales, yet precious little resource is allocated to its effective management at both an operational and strategic level."
Working out a relevant compliance strategy is also important. In the past, compliance was done at a local level, but as organisations shift to shared service centres, things are changing and they face a choice, explains Harley: "Do you want to outsource VAT compliance to a specialist provider, or do you want to keep it in-house and therefore create a tax centre of excellence alongside the shared service centre? Will you recruit tax people into that service centre? Will you get finance people to do it? If you get finance staff to do it, how do you inject expertise into the process? How, if you prepare things centrally, do you remain current to the local rules within the countries you operate?
"I don't think there is a silver bullet. The role of the tax department is to work out what the right model is for them and then to execute it brilliantly."
The final piece of the jigsaw is the role that technology has to play in effective VAT management. This is an area that has come on leaps and bounds over the past five years, with accounting firms and specialist providers all offering practical, enterprise-standard solutions that allow a more automated and preventative approach. For example, there are technology solutions that enable global businesses to have oversight of VAT returns prepared around the world and to act as a repository to support subsequent tax audits. There are solutions to automate VAT return preparation in a tax centre of excellence across multiple jurisdictions and, perhaps most importantly, there is technology that can automate the tax determination on sales and purchases.
Few of the technology solutions are 'plug and play', but a well-considered decision to invest can be transformational in the management of VAT. And technology is likely to have the single biggest impact on VAT management in the years to come.
Finally, as the old adage says, 'what gets measured gets done'. Historically, CFOs have viewed the effectiveness of their tax department through the lens of traditional corporate tax measures such as the effective tax rate and the cash tax rate with little or no focus on VAT. Indeed, in KPMG's 2012 benchmark survey on VAT/GST, only 23% of respondents had key performance indicators that were visible to the CFO. Now, with the increasing focus on fair taxes, CFOs would be wise to think more objectively about how their businesses are managing that real-time tax that governments so desperately crave.