Sales and Use Tax and VAT: Helping the Recovery Effort?

With the global economic environment still difficult, governments are examining their tax regimes - forcing businesses to re-evaluate their indirect tax operations.

When governments need to raise revenue, they typically cut costs, raise taxes, create new taxes or remove tax exemptions. During the more fragile stages of the recession, government was careful not to obviously raise taxes too quickly for fear of consumer backlash, which would obviously impede recovery. But now that we are in the recovery stage, we are starting to see a more obvious reliance on one the top three revenue sources for government: indirect tax (also known around the world as transaction tax, value added tax, or sales and use tax).¹

Underlying the face of the recovery, most governments - state, local and countrywide - are still facing deep economic troubles. For example, the US is predicted to face shortfalls as big as or bigger than they faced this year in the upcoming 2011 fiscal year.² Government is still in desperate times. And as the saying goes, desperate times call for desperate measures. In regards to indirect tax, desperate measures are coming in the form of new, unprecedented tax laws and are expected to continue with fervour.

New or increased taxes will have an obvious impact on the consumer, but the impact these changes have on businesses is often overlooked. Regardless of whether there is a tax increase, decrease or a new tax altogether, each change represents a significant operational and cash flow outlay for businesses that are burdened with implementing those changes in a timely fashion. As government continues to rely on indirect tax to address their budget shortfalls, the cost of compliance will keep rising, particularly for businesses that manage the process in-house. As such, it behooves businesses have to reevaluate their indirect tax operations to ensure that they are running as efficiently as possible.

New Sales and Use Tax Codes on the Horizon

Even before the recession, indirect tax compliance was identified by corporate tax officers as a top risk area, especially among multinationals who must deal with changing laws in multiple countries. The inherent complexities of indirect tax compliance coupled with government’s continued reliance on indirect tax as a prime revenue generator has made compliance an even bigger concern for global companies.

Across the board, governments are leveraging all avenues in regards to sales and use tax and VAT. Predominantly, the trend has been for governments to increase the rates of indirect taxes as a source of reliable revenue. For example, nine Indian states have increased VAT rates since the beginning of 2010. Indonesia has increased the maximum rate of the luxury tax to 200% and Canada’s province of Nova Scotia increased its provincial component of the HST to 10% on 1 July 2010. Many more are planning increases including Panama, Belize, New Zealand, Quebec, and Canada.

While there is a general trend to increase VAT worldwide, there seems to be disunity in Europe. Some European states are relying on higher VAT rates to shore up its budget deficits. The most notable increase in the VAT rate has been in Greece where the rate has jumped from 19% to 21% and on 1 July 2010 was raised again to 23%. Iceland presently has the highest VAT rate at 25.5% of all existing and aspiring EU Member States after its economy wielded to the global financial crisis. Other European states that saw increases in the VAT rates in the first half of 2010 were Belarus and Moldova. In July 2010, Finland increased its VAT rates with a single percentage. There are calls for VAT rate increases in Spain, Portugal, Latvia, and Switzerland. It is likely that by the end of this year or early 2011, other European countries will increase their VAT rates.

At the same time some European countries are bucking the global trend, choosing to not increase the VAT or even lower some VAT rates as a fiscal stimulus to their economies. In the first half of 2010, Germany, Ireland, Belgium, Hungary, and Slovenia saw targeted decreases of VAT specific to certain product taxability.

Other European countries have gone back and forth on their VAT rate several times. Bulgaria’s government for example has committed to lowering the VAT rate in principal, however due to immediate budgetary constraints may temporarily be forced to increase it, instead. Latvia and Romania seem to be caught in the same dilemma between budgetary deficit constraints and economies that need stimulating.

In the US, of the 131 Q2 2010 state and local sales tax changes, 91.6% were increases or new taxes. In addition, several states have considered legislation that would force retailers to collect the sales tax by claiming that online retailers’ in-state affiliates - such as people who get paid when someone buys a book from Amazon that they’ve linked on their blog - constitute enough of a presence to require tax collection. Colorado passed such a law that came into effect on 1 March 2010.

On the federal level, and in an unprecedented move, the US government, for the first time, is seriously considering implementing VAT. Although it would be new to the US, VAT is in place in about 150 countries worldwide. Like a sales tax, businesses will be burdened with collecting the tax on behalf of the government.

The above-mentioned changes are just a small sample of the dynamic nature of the indirect tax market landscape. However, while governments seem to easily add or change tax law at their whim, the impact these changes have on businesses are rarely considered. Regardless of whether there is a tax increase, decrease or a new tax altogether, each change represents a significant operational and cash flow outlay for businesses that are burdened with implementing those changes in a timely fashion.

The Cost of Indirect Tax for Businesses

Calculation and determination of taxes is not as simple as it might sound. Each transaction has unique characteristics that affect and change the specific tax rates applied depending on who, what, where, when, why and how the exchange was made. A business can face multiple, overlapping tax-collecting jurisdictions - countries, states, counties and cities - and tangled rules in the various tax authorities based on the type of business, location, nexus, or where the products and services will ultimately be used. Even for a small company, this can equate to countless hours updating tax rates tables, calculating tax, filing returns, reporting and auditing.

But just how much does each transaction tax change cost businesses? To give you an example, in the US, the average mid-sized business with presence in all 50 states needs to:

• Research 13,000+ taxing authorities for rates and rules and keep updated every month.
  
• Determine taxable status and rates across 13,000+ tax authorities every time a new product or service is introduced.
  
• Update systems with an average of 1,000 tax rate changes each year - most of them with little advance notice. An onerous month includes 400-500 rate changes.
  
• File around 5400 returns and process 5400 cheques to taxing authorities every year; or 450 returns and 450 cheques each month; or on average prepare 15 returns a day and process 15 cheques a day. Unfortunately, the process can’t be spread out over the month and happens in three required payment periods each month.