Indirect tax can have a significant bearing on a company’s sales and profitability, but close relationships between tax teams and the rest of the business are rarely found. This needs to change.

By David Bolchover

Indirect tax can have a significant bearing on profits, but business managers often underestimate its importance in the rush to launch new products or expand into new territories, leading to wildly inaccurate sales projections.

A strong relationship between these managers and indirect tax experts, either within or outside the company, can therefore lead to more prudent and measured commercial decision-making. Determining what the indirect tax rate is for a particular product is the first issue businesses have to navigate.

Products can’t be placed neatly into categories; they can have different VAT rates depending on the form in which they are sold, and may have different elements, some of which carry VAT charges and some of which don’t. For example, paper books are zero-rated in the UK, but electronic versions of the same book are not.

International variations in VAT treatments further complicate this. “There is often a conflict between national legislation and EU legislation on VAT treatment for a particular product,” says Richard Teather, Senior Lecturer In Tax Law at the UK’s Bournemouth University.

“And you have to bear in mind that this complexity is replicated for each of the member countries.” Expansion outside the EU becomes tougher still.

Business implications

As the relevant level of indirect tax will influence a customer’s ability to buy a product, it will impact on a company’s sales and profits. Firms have to determine the ideal price to maximize revenue while still complying with legislation.

“If companies don’t factor VAT costs into their pricing, their eventual results are going to look very different from original forecasts,” says Andrew Bailey, a leader at Ernst & Young who specializes in VAT issues in financial services.

Without ongoing specialist advice, misjudgments are inevitable. “Business managers are often operating at great speed in a highly competitive marketplace,” Teather explains.

“The tax department might intervene only after the deal is done. In small companies that don’t have a tax department, external accountants may only review their operations after the year-end when the damage is done. ” Moreover, only the largest companies tend to employ experts focused on indirect tax.

But with the growing quantity and complexity of indirect tax legislation, generalists may find it challenging to keep abreast of developments, leading to potential problems. Bailey warns: “Accountants and general tax advisors should have processes in place so that they know when to seek specialist advice.”

At a high level, ensuring seamless integration of tax issues into the business strategy requires board-level intervention. However, VAT often does not figure in the minds of directors.

Andreas Funke, at Ernst & Young’s indirect tax practice in Germany, says board-level interest is usually only aroused when there is likelihood of a loss.“I’ve seen cases where the sales department entered into a transaction, calculated a margin of 10% but then the VAT wiped out the entire margin,” says Funke.

Increased focus

But there is a growing mindfulness within the corporate world about the dangers of downplaying the importance of indirect tax. One industry that pays particular attention is financial services. Products are generally exempt, and companies therefore need to examine in great detail how to maximize their input tax recovery.

“There is a great deal of awareness in our company,” says Michel Voets, Senior Indirect Tax Adviser at ING, the Dutch bank. “If we incur VAT in a VAT-exempt environment, it’s mainly a cost to us.”

Companies in other industries who are now just beginning to focus more on the VAT implications of their commercial operations can therefore learn from the experience of financial services companies.

According to Bailey, companies in banking and capital markets generally have a committee that will look at new products and ventures into new territories. Various functions, including tax, are represented, and all must give their approval for any launch.

As VAT legislation is constantly evolving, approvals might need to be reassessed further down the line. “As soon as we see new laws, proposed legislation or published case law, we have to assess how different units are impacted, and whether to change an individual product or its pricing,” says Voets.

“If a product goes from exempt to taxable, for example, and we decide that we can’t raise prices because of a competitive market, we have to discuss whether to swallow the cost ourselves.”

ING also pays attention to offshoring and outsourcing projects, as well as major purchases by its procurement division to ensure that they are carried out in a tax-efficient way.

Building relationships

Perhaps an even greater threat to the company than changing legislation comes when business managers decide unilaterally to amend an already approved product or launch it in a new territory without fully understanding the indirect tax consequences.

Advisors must thereby communicate with frontline departments on a constant basis. “Business managers can think, ‘I’ve got a sign-off, so there’s no need to do anything,’ ” says Bailey.

“The onus is on the indirect tax department to find out what’s going on.” To do so, indirect tax experts have to demonstrate they understand their everyday priorities and pressures. “We need people to feel comfortable with us as a fully accepted business partner and trusted and respected advisor,” says Voets.

Voets believes indirect tax advisors can establish credibility by developing their industry knowledge and their understanding of how complex products work so that they can converse fluently in the language of the overall business. ING sends its tax experts on internal courses to learn about particular business areas.

However, even in financial services, where indirect tax specialists are likely to be employed, finding out exactly what is going on in a large organization will always present a challenge.

Indirect tax advisors cannot afford to wait to be invited into discussions that could affect the company’s VAT position. They must constantly be developing contacts and using their instincts to avert problems.

Even if the company has access to the best indirect tax advice available, it may not have the desired impact if it is not fully integrated.

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