Managing the dynamic landscape of indirect taxJune 4, 2012
Indirect taxes have risen to become the largest category of tax that businesses deal with today, especially those operating globally. Although often a hidden burden, the impact on the bottom line is very real.
By Gerri Chanel
Indirect tax amounts are huge. They make up 75% of all taxes remitted by businesses globally, by far the largest type of tax under management by businesses.
They include a wide range of taxes imposed on consumption rather than profits or income; thus the term “indirect.” Some apply to a broad range of transactions, such as VAT/GST and sales and business taxes; others are assessed on specific transactions, such as excise taxes and customs duties.
What is it about VAT and other indirect taxes that makes them so appealing to governments?
Dr Philip Robinson, Ernst & Young’s Global Director of Indirect Tax, says: “They are a more secure source of revenue – consumption tends to be more stable than profits, even in a weak economy, so revenue streams from consumption taxes are not as volatile as those of income taxes.”
Another advantage of indirect taxes, at least from a government perspective, notes Gijsbert Bulk, EMEIA Indirect Tax Leader for Ernst & Young, is that rates are generally easier to increase than for direct taxes.
Economists also favor broad-based consumption taxes. They are considered more neutral compared to other taxes in terms of affecting spending habits, investment decisions and the natural allocation of resources.
There’s a downside, however: Consumption taxes tend to have a greater impact on lower-income individuals, who spend a bigger share of their income, though this is mitgated where basic goods and services are exempt or subject to reduced rates.
As indirect taxes have boomed, so too has their impact on businesses. “That impact is often underestimated since most companies look at indirect taxes simply as flow-through taxes,” says Robert Langham, Director of Indirect Taxation at Philip Morris International, a global tobacco company.
With VAT, a company typically pays input tax on purchases, then simply subtracts it from the output taxes it collects from customers before remitting the difference to the tax authorities. “In reality, though, there is a huge administrative burden, much more so than for corporate income tax,“ Langham explains.
“The management of indirect taxes has changed fundamentally in recent years,” says Tamara Berger, Global Head of Indirect Taxes and Tax Technology at Agilent Technologies, a manufacturer of measurement tools. “Just keeping up with all these changes has been a challenge in itself.”
New types of services and the internet are also complicating factors, particularly in countries within the EU, where VAT frameworks were developed many years ago, says Claudio Fischer, of Ernst & Young’s EMEIA Tax Policy Development team. The issue is that online transactions, among others, were not contemplated in the original legislation. “And all these tasks become even more challenging in emerging markets, whether in Asia or Latin America or elsewhere,” Robinson adds.
Complexity also arises internally. In many companies, a variety of departments and local offices spread around the world administer the company’s indirect taxes. Even in one location, indirect tax authority may exist across logistics, IT, corporate control and assurance, as well as tax and finance.
Moreover, compliance often depends on disparate enterprise resource planning (ERP) systems, many of which are ill-equipped to generate the data required for today’s surge of indirect tax obligations. Tax engines are available to bridge these gaps, but require substantial investments.
As multinational companies move increasingly to shared service center models, the responsibility for indirect taxes migrates with them. But when indirect tax functions are transferred to a faraway service center, the company loses the on-the-ground talent that was familiar with local compliance requirements.
In recent years, the global financial crisis has accelerated a worldwide trend toward higher indirect tax rates and an extension of the range of goods and services subject to indirect tax. This is propelled in part by the ongoing struggle of many countries to balance budgets, but also the desire to fund social initiatives and tax reform in other areas.
This trend has been particularly strong in Europe. The VAT rate across the members of the EU hovered for many years around 19.5%, then started to increase after 2008. The average EU VAT rate has now passed 21%, and this trend looks set to continue in 2012. Hungary’s new standard rate of 27% has broken the “magic barrier” for the top EU rate, which for a long time was believed to be 25%.
Many countries are in the process of refining and/or expanding their indirect tax systems, some in fundamental ways, says Robinson. These range from India’s proposed introduction of a new nationwide GST to a VAT pilot program in Shanghai. In the EU, reform is also on the horizon: the European Commission is currently drafting new VAT legislation, due to be published in 2012, with the intention of simplifying the system and cutting down on fraud.
There has been progress already: several countries have recently modified their rules to take modern technologies into account, for example. Iceland and Luxembourg have aligned the VAT treatment of electronic and print media to reduce the distortions caused when, for example, a printed newspaper is taxed at a reduced rate but buying the same newspaper online is taxed at the standard rate.
But given the increasing scope of indirect taxes, tax administrations around the world are putting a greater focus on indirect tax compliance. “We’re seeing a much more aggressive approach from tax authorities,” says Berger.
Dealing with reality
Governments around the world are looking to indirect taxes to balance budgets, fund tax reforms in other areas, promote and regulate trade, and support green policies and other social initiatives. This movement is being supported by the World Bank, the OECD and the International Monetary Fund (IMF), all of which favor indirect taxes, rather than direct taxes on income.
The landscape for indirect tax has clearly shifted and that shift appears to be a long-term one. In response, tax and financial executives will need to increase visibility over how the company’s indirect taxes are managed.
These taxes may be “hidden” but their impact on the bottom line is quite real.