|
Graeme Ross |
In the year value-added tax (VAT) celebrates the fiftieth anniversary of its birth in France, it is difficult to imagine that its architects could have envisaged the complex world in which such a seemingly simple tax would have to operate. The demands of increased competitiveness, pressures from the board and the regulators to deliver shareholder confidence and the steady erosion of geographic boundaries mean that today, indirect taxation features much more prominently in the boardrooms of both multinational business and tax administrations than was ever the case in the past.
Taxes on consumption are growing in prominence as tax authorities steadily shift the overall burden from direct to indirect taxes. A tougher attitude from the tax administrations is helping to push indirect tax issues further up the corporate agenda and beginning to remove the cloak of invisibility that previously hid them from view.
New technologies are steadily drawing VAT into the realms of competition between tax regimes and presenting its architects with the problem of how legislation can be redesigned to reflect previously unimagined transactions, while preserving neutrality with the existing ones.
Globalization and EU enlargement are increasingly creating an everyday international aspect to VAT. It is not so long ago that international issues were the exception, managed only by relatively few multinational businesses.
And if the above were not enough, VAT is also being caught up in the debate about corporate social responsibility and tax avoidance.
In this rapidly-changing environment, it is worth standing back for a moment to consider how some of these VAT issues play their part in strengthening - or reducing - the competitiveness of businesses operating in today's international marketplace.
A cloud with a silver lining?
In several jurisdictions, businesses are experiencing a much greater focus on their management of indirect taxes as many tax administrations take a tougher line on promoting better compliance with local VAT requirements.
The assumption (and the apparent expectation of tax authorities) is that regulatory tightening will boost revenue. However, there is at least an equally good chance that it will do the opposite and that after the tougher regime is bedded in, like-for-like tax revenue (assuming no change in effective rates) will emerge significantly diminished.
This has happened before. When the UK's VAT penalty regime was introduced in response to Lord Keith's recommendations in 1985, everyone assumed the new penalties for non-compliance would be the trigger to bring delinquents into line, allowing net VAT revenues to soar. Yet for many years after 1985, VAT revenues consistently disappointed the UK Treasury and the gap between expectations and actual revenue raised proved puzzling to many observers.
A possible explanation for this surprising result is that the improved compliance, which tougher policing is intended to deliver, can in fact be a cloud with a silver lining for business - and a double-edged sword for tax administrations. In the UK, the threat of penalties was successful in increasing the expertise that business applied to their VAT affairs; in turn reducing both kinds of non-compliance: the kind that leads to under-payment and the kind that leads to over-payment (which can be substantial). The net result was better compliance but not more tax.
Overpayment can be particularly substantial in indirect tax, which due to its invisibility is usually managed outside tax departments by billing and purchasing processes. As the management of VAT necessarily involves multiple business functions, in many businesses, there are gaps which have in turn led to an accumulation of flaws and lags in corporate VAT systems.
As tax advisers we may take issue with some of the regulatory details or the approach of some tax administrations, but we support the goals of better compliance and clearer law in principle, because they help us do a better job in what we see as the three basic roles of a tax adviser; helping to protect, release and create value for the businesses for whom we work.
As protectors, the adviser's job is to help establish, test and monitor tax control systems and processes, and to maintain their integrity in a constantly changing business and regulatory environment. This helps to minimize the risk of penalties for non-compliance. A tougher external regulatory regime in this context can be a blessing in disguise because it strengthens the case for establishing more robust and better focused VAT processes.
With better indirect tax systems, processes and controls, there are several tools and techniques that enable business to get a much better picture of the impact of VAT on cash-flow, working capital and absolute cost. With this increased awareness and visibility and the confidence offered by improved VAT processes and controls, VAT drivers can be factored into everyday business considerations such as the shape of supply chains, customer and supplier terms and conditions and sourcing strategies. The prize is of course a reduction in the resources tied up in indirect taxes; in particular, the release of cash, which all too often is consumed unnecessarily by the financing of indirect taxes in many businesses.
Finally, through improved awareness of the obligation on businesses to manage and control their tax processes with the same rigor as other business processes, there are new opportunities to create incremental value by embedding indirect tax considerations early in the process of business change and innovation.
It has long been frustrating for tax directors that all too often they get involved in major decisions, such as outsourcing initiatives, new product strategies and re-structuring programs at the eleventh hour after the important issues have already been determined or flexibility lost. Particularly with indirect taxes however, leading companies are beginning to discover that there are many ways in which additional value can be created by factoring tax drivers into their thinking at an early stage. Whether in the familiar terms of reduced after-tax cost or on a different level, for example by enabling more rapid customer fulfillment, revised supply chains or different business models, the effective management of indirect taxes has an impressive track-record in enhancing the value created through business change.
This factor is becoming increasingly important in a global economy where even close competitors may be operating with very different indirect tax footprints. Although perhaps an unlikely ally, section 404 of the Sarbanes-Oxley Act (S-O) is beginning to tax-sensitize the boards of many corporations, in turn meaning that tax managers have an opportunity to play strategic decision-support roles and help their companies become generally more competitive.
Seen as a catalyst for necessary reform, regulatory tightening offers corporate taxpayers an opportunity to undertake wholesale reviews of their tax systems, processes and policies. The outcome may well be a pleasant surprise, not just sunk cost if the need to focus on tax is taken as an opportunity to protect, release and create value. It is a timely opportunity too, because there is far more than mere regulatory tightening going on.
Technology
The opportunities presented by the capabilities of technology, coupled with an increasing business expectation of operating in multiple geographies mean that businesses are becoming progressively less tied to any particular jurisdiction.
Technology is therefore bringing about change in the fiscal environment and obliging taxpayers and the tax authorities to revisit long-held assumptions. As we have seen, countries hungry for extra foreign investment have been shifting their tax burdens from direct to indirect taxation. The assumption is that VAT regimes are effectively isolated within national borders and foreign investors have no reason to favour low indirect tax regimes. But digital technology transcends national boundaries and turns this rationale on its head, since digital products may be capable of being supplied in one country but consumed in another. This potentially leaves a tax director with more options than previously thought, when deciding on the right location - both in terms of cost and competitiveness.
The European Commission has ring-fenced the EU from the external digital threat to tax revenues, by obliging companies providing products and services which are delivered electronically to EU consumers to become VAT-registered in one or more member states. This might confine the problem, but does not eliminate it since in a highly competitive business environment, there is more than enough variation in European VAT regimes to provide an incentive for tax-influenced business structuring.
The growth of broadband internet access, in the last year alone, has triggered an e-commerce explosion and rekindled the anticipated migration of services from hard to soft media. The proportion of software sales delivered through the net is growing fast with no better illustration than the huge success of the music industry web subscription sites following, which some pundits now expect the whole of the recorded music distribution industry to migrate to the web. The evolution of supply and distribution channels is attracting the attention of the tax authorities who cannot risk treating indirect tax as a catch-all for domestic consumption in a world where consumption need not be domestic. A redesign of indirect tax law in this area is always on the horizon but workable policies are proving elusive.
Globalization and EU enlargement
In this environment, the tax authorities are becoming obliged to confront the implications of globalization in general and the expansion of the EU in particular. Both are leading to an intensification of competition between tax jurisdictions for foreign investment. Indirect taxes will play a leading role in this drama, because they appear less vulnerable to these competitive pressures than direct taxes. There are even those that say corporation tax is dying and that before long all corporate taxation will be indirect, perhaps this is not surprising when in the UK indirect taxes raise more than three times as much tax revenue from companies as UK corporation tax according to treasury's UK Financial Statement and Budget Report 2004.
The growing complexity of the management of indirect and direct taxes across multiple jurisdictions is one reason why the Australian, Canadian, UK and US tax authorities have recently decided to talk to each other outside the normal OECD channels and develop a joint approach to information sharing in relation to the taxation of corporates.
Multinational corporate taxpayers should also take the opportunity to look at the implications of the recent expansion of the EU and the quasi-harmonization of VAT regimes, as new members states comply with EU VAT directives. They might well find that decisions they made years ago about what business models to employ when trading with eastern European countries have been invalidated.
Take for example, the so-called commissionaire model, where suppliers pay commissions on sales arranged by local associate companies. Commissionaire arrangements have proved popular as low-cost market entry strategies, but were rarely if ever viable in the central and eastern European countries because the local direct and indirect tax regimes often made them unviable. Following the enlargement of the EU however, indirect taxes have been aligned with the EU VAT Directive, meaning that the feasibility of commissionaire models should be reconsidered, along with other business models that may previously have been rejected.
These new possibilities and the digital problem described above illustrate the central dilemma for the tax authorities as they try to adapt their revenue raising systems to the rapidly evolving global economy. That is, it makes sense for various reasons to shift the balance from direct to indirect tax. However, if you were designing an internationally competitive indirect tax scheme from scratch it is unlikely that you would start from here.
VAT regimes have remained largely unchanged since they were introduced half a century ago, long before today's focus on shareholder value and the responsibility of companies to their investors, and long before digital products and services were even dreamed of.
Moreover, the limited redesign that has occurred has been in response to changes in local environments and taken relatively little account of the globalization of business and the emergence of internationally mobile companies.
VAT and other consumption taxes have not been subject to the long process of refining and codification in international treaties that has shaped corporate income tax systems. They are immature, in an international sense, and still have a lot of growing up to do before they can effectively accommodate the additional burden that tax authorities the world over are placing on them.
The regulatory tightening and the emergence of new, de facto international standards, such as S-O 404, are accelerating the process of maturation and yielding benefits to tax payers that extend way beyond more effective risk management processes which can be measured in monetary terms. As large multinational companies move towards global contracts for services such as telecommunications, specific knowledge in consumption tax management is growing. More sophisticated contracting arrangements are being developed and, as experience and best practice models accumulate in central tax departments, they are also being disseminated globally to countries and tax jurisdictions where the details may vary, but the foundations and basic principles of indirect taxation are the same.
Avoidance
Indirect tax is also caught up in the important philosophical debate about tax and corporate social responsibility, the outcome of which, although not yet clear, is likely to set the tone for developments in tax regimes for decades to come.
The closer scrutiny of tax caused by the tougher regulatory environment is helping to ensure the debate is well-informed and the exposure of national indirect tax regimes to international comparisons adds an interesting new dimension to it.
What is clear is that in a business environment that is changing rapidly and continuously, there will be escalating pressures on national administrations to develop and evolve their indirect tax policies and legislation to cope with the effects of technology, globalization and competition, both amongst taxpayers and tax jurisdictions.
In today's climate, what businesses want, besides competitive rates, is certainty and clarity. They want to know what the right tax is and the right time to pay it, and they would much rather be taxed by a well-designed, dynamic and evolving statute, than be subjected to the lottery of trying to apply rules which were designed for a different world and where polarized interpretations are the inevitable outcome.
In this age of portable business and virtual architecture, it is worth bearing in mind that increasingly, companies may be becoming the ultimate architects of corporate indirect tax systems, quite simply because they have the final choice as to where they do business. National policymakers have an interesting challenge ahead in balancing their revenue objectives with the need to reduce compliance burdens and in creating an environment that achieves neutrality and is sufficiently agile to support the evolution of business.
For further information contact:
Graeme Ross - KPMG LLP (UK)
Tel: +44 20 7311 3372
Email: graeme.ross@kpmg.co.uk
