Managing indirect taxes in rapid-growth markets

June 14, 2013

Since 2008, many developed economies have seen flat or negative growth rates. Multinational businesses have responded by transforming their supply chains to reduce production costs and overheads and to pursue growth in new markets.

The emerging markets are not only attracting inward investment, they are also creating a new generation of global traders. As a result, despite the global economic downturn, overall levels of global trade remain high, and the mix of countries involved is constantly evolving.

Business models are also transforming as advances in technology are allowing new goods and services to be designed, manufactured and delivered in new ways.

The shifting balance of world trade

The balance of world trade is rapidly shifting from developed economies toward the rapid-growth markets (RGMs). The 25 RGMs featured in this report currently account for 31% of world GDP and more than 60% of the world’s population.

As the first wave of emerging economies such as Brazil, Russia, India and China mature, new markets are emerging, such as Africa, Colombia, Peru, Thailand, Turkey and Vietnam. Linked to the emergence of these new markets is a marked increase in transactions between developed economies and RGMs but also between RGM countries.

And this trend looks likely to continue.

Why indirect taxes are important to governments in RGMs

Governments in RGMs rely on indirect taxes to bolster revenues and to fund infrastructure projects. Customs duties and local excise taxes in some RGM countries represent a much higher percentage of overall tax revenues than in many developed markets.

However, tariff reductions to meet trade agreement obligations and the growing importance of services in many economies is also putting more emphasis on consumption taxes such as VAT/GST.

Increased global trade means more indirect taxes

Changing patterns of world trade are having a profound effect on where and how materials and products are sourced, manufactured, distributed and sold and on how and where services are supplied.

More companies are confronting the practicalities of doing business in multiple jurisdictions.

As they do, they are encountering indirect taxes such as VAT/GST, customs and excise duties that are inextricably linked to trade flows and transactions. They are finding that indirect tax costs, formal rules, restrictive regulations and bureaucracy can be a barrier to international trade.

Equally, opportunities exist to improve business outcomes, speed up deliveries and reduce costs.

Grants and incentives encourage investment

RGMs offer a variety of tax and business incentives to attract investment in specific regions and areas of industry by offsetting the cost of taxes and other investment activities, or by providing financing at favorable rates. Economic incentives are generally used to encourage job creation, capital expenditure, research and development (R&D), and the sustainable sourcing of energy.

Entering into new markets brings new indirect tax challenges

As companies move into new markets, they often wish to adopt the business models, processes and practices that they have used successfully in other parts of the world. But local indirect tax rules may require them to adapt their plans for operating in unfamiliar territory.

Local compliance in a global world

For many multinationals, the task of keeping up with obligations for VAT/GST, customs duties, export controls and grants and incentives in every country where they operate can represent a heavy burden. These difficulties can be exacerbated by the lack of harmonization between countries’ requirements, a lack of qualified resources in some regions and the use of multiple accounting systems.

In general, the objective is to adopt a cost-effective indirect tax structure to reduce costs and risks, identify opportunities and increase operational effectiveness.

To achieve this, some companies are centralizing their compliance processes to improve standardization and management oversight. Others prefer a decentralized approach to deal with RGMs’ detailed local requirements.

Through interviews conducted with clients, investment agencies and our indirect tax professionals who live and work in these countries, we highlight some of the everyday challenges that businesses encounter and how they tackle them in practice:

Markets for growth

  • Globalization continues, but the players are changing
  • Brazil, Russia, India and China continue to be a strong focus for multinationals and markets such as Indonesia, Mexico, Turkey and Vietnam are catching up fast

Five global indirect tax trends: how do they play out in the RGMs?

  • VAT/GST rates are increasing
  • Excise duties are on the rise again
  • Free trade is increasing but is meeting protectionist challenges
  • Indirect tax systems are becoming more efficient
  • Tax administrations are focusing on compliance and enforcement

Indirect tax issues and opportunities: trading with RGMs

  • Reducing or eliminating customs duties and VAT/ GST on imports can improve cash flow and costs for importing companies
  • Exporters need robust processes to comply with export controls for certain goods or they risk penalties, seizure of the goods, business closure and criminal sanctions
  • Exports are a major risk area for VAT/GST — requiring robust documentation and processes to prove VAT‑free treatment
  • Cross-border electronic services are increasing but VAT/GST systems are struggling to keep pace, which is leading to double taxation and non-taxation

Indirect tax issues and opportunities: investing in RGMs

  • A wide variety of grants and incentives are offered in RGMs for activities such as job creation, capital expenditure, R&D and sustainable energy
  • Trading in most RGMs means registering for VAT/ GST and complying with local rules
  • Registration may allow VAT/GST recovery on costs, but it may increase compliance complexity, costs and risks
  • VAT/GST registration may create wider tax implications, including permanent establishment issues

Indirect tax issues and opportunities: operating in RGMs

  • Companies operating in RGMs face a range of VAT/ GST challenges including unclear rules, detailed local compliance requirements and lack of guidance
  • VAT/GST “leakage,” delays in obtaining refunds and penalties for errors may add to the cost of doing business and have a negative impact on cash flow
  • Reforms to consumption tax systems may be welcome, but rapid changes and delayed legislation create risk and uncertainty for taxpayers
  • RGM tax administrations are increasing their use of technology to collect and audit taxpayer information
  • Free trade agreements, duty-free zones and bonded manufacturing environments help to reduce product costs, but companies must assess the qualifying conditions and compliance burdens
  • Differences between customs valuation and transfer pricing methodologies may cause difficulties for multinationals’ related-party transactions
  • RGM incentives programs and eligibility requirements can change rapidly — decreasing projected savings and increasing compliance costs
  • Companies seeking RGM incentives must develop robust compliance processes

Effective management

  • Full compliance may be hard to achieve across different RGMs, complex corporate structures and multiple IT systems — leading to risks and inefficiencies
  • Multinationals must find the right balance between centralized control and detailed local requirements to meet their multiple obligations efficiently and cost-effectively

Key steps to managing indirect taxes and incentives in RGMs include:

  • Gaining visibility
  • Gaining control
  • Assigning responsibility
  • Measuring and monitoring outcomes
  • Adapting to change

Read more: Managing indirect taxes in rapid-growth markets

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