Compliance Challenges to Grow as Tax Authorities Get Tough

It’s no secret that the cost to businesses of value added tax (VAT) compliance is steadily rising worldwide. A 2010 PricewaterhouseCoopers (PwC) survey analysed VAT and equivalent tax systems in 145 different countries and found that, on average, it now takes companies longer to comply with VAT than with corporate income tax. EU companies were possibly surprised to find that the cost and time typically involved for them in VAT compliance compares quite favourably with other regions of the world; the average of 73 hours was well below the global average of 125 hours and a figure of 192 hours for companies in Latin America and the Caribbean.

The data was highlighted at this week’s breakfast seminar, jointly presented by accountancy firm Grant Thornton and cloud computing business software group NetSuite, which looked at the compliance challenges faced by financial professionals. Also cited at the session was a February 2012 survey by Aberdeen Group, which found that audit penalties and fines resulting from non-compliance have doubled in the past two years, while 44% of companies reported difficulties in gaining access to regional and jurisdictional tax requirements – in other words knowing exactly what is needed in order to comply.

Across many EU countries, the VAT rate applicable is between 20% and 25% and the assumption that the latter rate represented the upper limit was dented last year by Hungary’s decision to increase its rate to 27%. This means that VAT typically represents one fifth to one quarter of a company’s turnover, and compliance is increasingly important as tax authorities focus more on it and regular tax changes make it harder for companies to keep pace. In the UK, the task of compliance has been complicated in recent years as the rate was reduced from 17.5% to 15%, and then returned to 17.5% before increasing to 20% in January 2011. In Italy, the rate rose from 20% to 21% in September 2011 with little prior notification and is due to rise again in July 2013 to 22%.

Compliance is also a difficult task for companies that are enjoying dynamic growth and whose business is expanding and growing more complex; for those with multiple locations and many separate systems that makes operational consistency difficult; and from legislation changes, with the EU’s applying changes to VAT in both 2010 and 2011 and further amendments scheduled for 2015, while the EU’s new VAT invoicing directive comes into force at the start of next year.

As Karen Robb, partner, indirect tax at Grant Thornton, noted, the demands of being VAT compliant have grown over the past decade. The task originally consisted of reporting the correct data and paying the right tax in the right jurisdiction at the right time. However, transparency and a clear audit trail have become increasingly important in recent years. “You also have to prove that you’re taking all reasonable steps to be compliant,” she said.

The pressure has been increased by a number of external factors, which include:

  • The introduction of Sarbanes-Oxley (SOX).
  • Application of Senior Accounting Officer (SAO) rules.
  • Increased mutual cooperation between tax authorities in different countries.
  • More sophisticated audits.
  • A more aggressive attitude from tax authorities.
  • The pace and quantum of tax changes.

For many companies, these will be added to by internal challenges such as: multiple corporate entities for larger organisations; increasing complexities in the corporate structure, supply chain and/or transactions; problems in the enterprise resource planning (ERP) system; and insufficient VAT knowledge and/or other in-house resources.

Non-compliance is Costly

Robb said that the UK’s HM Revenue & Customs (HMRC) has stated it will support companies that seek to comply fully on VAT but “come down hard” on those that seek to gain advantage through non-compliance. All newly VAT-registered businesses can expect to be visited by an assessment officer within 18 months of inception and both HMRC and its peers in other EU countries will seek confirmation that the figures submitted on VAT returns are correct. This task may involve reviewing all VAT accounts, general ledgers, purchase and sales ledgers, invoices (which should be sequentially numbered), import and export documents and bank statements. Any apparent gaps in invoice sequential numbers will cause HMRC to assume that invoices have gone missing.

While they may not necessarily be automatically entitled to access, HMRC may additionally ask for the annual accounts, management accounts, data files and any correspondence between the company and its tax advisers. Increasingly it is also requesting downloads of accounts payable (A/P) and accounts receivable (A/R). However, businesses whose tax affairs are relatively straightforward will generally find that a correspondingly simple but regularly updated recording system for tax is sufficient for requirements.

The UK’s current penalty regime for non-compliance dates back to April 2009 and is based on three categories of behaviour:

  1. Careless (the failure to take ‘reasonable care’, which is determined by a number of tests).
  2. Deliberate.
  3. Deliberate and concealed.

The corresponding charges, depending on the seriousness of the offence, range from nil to a figure comprising the assessment plus penalties (up to 100% of tax), multiplied by the statute of limitations (currently four years in the UK) plus interest.

Robb’s colleague, Alex Baulf, suggested that a one-off major error in compliance is likely to be regarded as less serious that multiple small errors occurring frequently as it will generally be easier to identify the error and quantify the liability, notify HRMC and take remedial action.

Baulf agreed that ERP systems are vulnerable to several potential weaknesses that can lead to errors occurring. “The company’s IT infrastructure may not provide the level of detail necessary, or the level of detail may reside in part of the system not easily accessible. Legacy systems and the limitations of native VAT functionality can also result in errors.

“In addition, SAP and other treasury management systems [TMSs] have been slow in updating their tax capability in response to the VAT changes of 2010 and 2011. In addition, while they had good built-in logic for dealing with companies that manufacture there has been slowness in adapting to the shift towards a more services-based economy.”

Baulf also cited the example of a company that completed several merger and acquisition (M&A) deals, resulting in four different ERP systems and no common processes. Compiling VAT returns was still a manual process which, combined with its continuing use of Excel spreadsheets, resulted in transposition errors and, in turn, prevented it from meeting its obligations to transmit error-free files to HMRC’s Intrasat online system and the EC Sales List.

The concluding message was that HMRC and other European tax authorities are likely to increase their focus on non-compliant taxpayers as the new age of austerity continues. So it is both good compliance and good practice for businesses to identify areas of potential non-compliance risk, including a review of the adequacy of ERP systems, and to develop and document processes that will address them.

“A heavy volume of documentation is needed for UK companies to get their VAT returns right,” said Robb. “However, in many countries the burden is even heavier.”

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