Indirect taxation in 2013: tax administrations are focusing on compliance and enforcement

April 18, 2013

The growing importance of indirect taxes to governments places more pressure on tax administrations to enforce compliance. This focus is leading to greater scrutiny of taxpayers’ affairs through more frequent and more effective tax audits and greater consequences for errors.

Audits and exchange of information In Europe, where VAT rates are highest, high-profile cases of missing trader or carousel fraud, involving organized criminal gangs exploiting how VAT applies to cross-border trade, have shown that VAT systems are vulnerable to such attacks and they have alerted governments to the need for vigilance.

As a consequence, tax administrations in all parts of the world are putting a greater focus on indirect tax compliance and enforcement. Our recent survey of Indirect Tax professionals in 39 countries indicates that, in the large majority of countries, the number of tax audits has increased in recent years and is likely to increase further in the future (Figure 4).

Only six countries reported that audits had decreased; even then, in some cases, while the number of audits carried out was said to be lower, the amount of additional tax levied due to tax audits is still increasing. This finding seems contradictory, but it can perhaps be explained by tax administrations carrying out more targeted audits; 24 out of the 39 countries already use specialized IT tools such as audit software to detect irregularities or suspicious patterns in taxpayers’ tax returns.

In our survey 16 countries indicated that the tax administration exchange information about taxpayers’ VAT affairs with other countries. These countries are mainly found in the EU, where the common VAT system requires an extensive information exchange.

On a global scale, the multilateral Convention on Mutual Administrative Assistance in Tax Matters, which is open to all interested countries, facilitates exchange of information on all compulsory payments to the general government except for customs duties. In the last two years, more than 50 countries have either become signatories to the convention or have stated their intention to do so. This will lead, without doubt, to increased international cooperation.

But, even if countries do not (yet) share information, they increasingly exchange information internally, between different authorities and departments (e.g., with customs or social security authorities). Only four out of the 39 countries we surveyed do not share any information at all.

Targeting fraud but hitting “honest” taxpayers too?

There is nothing to be said against stricter compliance enforcement if it actually helps to fight fraud. Fraudulent behavior damages the overall economy and tax compliant businesses, which suffer competitive disadvantages. The other side of the coin, however, is that tax administrations have generally become more wary toward all taxpayers; they are less open to entering into discussion, and it is more difficult to reach mutual agreement on specific issues.

Tax administrations increasingly apply a strictly formal approach not considering specific economic and business issues. This is bad news for all “honest” businesses, which want to be compliant, even more so as our survey shows that formal mistakes (e.g., missing information on invoices) are still by far the most frequent reason for indirect tax adjustments, be it an additional tax charge or the denial of input tax recovery (Figure 5).

In addition, we observe a tendency for tax administrations to pay out input tax surpluses with increasing delay — if at all — or to reject an input tax claim based on bad faith, stating that the claimant should have known that his supplier did not correctly handle the tax. At the same time, many countries are applying stricter penalty regimes in the case of non-compliance and mistakes.

In our survey, 27 of the 39 countries reported that penalties are increasing, and only three saw a decrease (Figure 6). Fines are generally imposed faster and sooner and the fines are higher than in the past. Increasingly, fines are enforced for timing issues, such as late payment, where in the past tax administrations were more lenient on these issues (for example, Austria, Germany, Pakistan and New Zealand).

What should taxpayers do?

Indirect taxes are not easy to manage. For example, excise duties, such as carbon taxes, change quickly and represent a high compliance risk because they typically operate differently in each country.

Taxpayers who collect VAT/ GST from final consumers on behalf of the state run increased risks of carrying the tax burden and eventual penalties themselves if they do not correctly manage the tax. With tax administrations assessing taxes more thoroughly and using powerful and efficient tools, the chance that mistakes will be found has risen considerably and will remain high.

Also, as indirect tax rates increase, the consequences of mistakes become more severe. This is particularly true for businesses that do not recover VAT/GST in full (e.g., because of VAT exempt activity) such as banks and insurance companies.

But higher rates also have an increased cost or cash flow impact on companies that incur VAT/GST in foreign jurisdictions, which is not refunded quickly or, which they do not or cannot recover (e.g., because of an absence of refund schemes for non-residents or because of complicated refund procedures). As indirect tax administrations are turning increased attention to enforcement — including joint audits with other taxes and even other countries — these activities may disrupt business activity.

Large assessments for underpaid tax or penalties for late filings not only have an impact on profitability, they may draw unwanted adverse publicity, even for compliant businesses. More than ever, it pays to proactively manage indirect taxes.

Establishing a clear indirect tax strategy aligned to your overall business strategy will help you keep your business up to date with the rapidly changing tax environment and avoid additional costs and risks of poor compliance or missed opportunities.

Read more: Indirect tax in 2013 – A review of global indirect tax developments and issues

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