Apple’s headquarters are in Cupertino, Calif. By putting an office in Reno, just 200 miles away, to collect and invest the company’s profits, Apple sidesteps state income taxes on some of those gains. California’s corporate tax rate is 8. 84 percent. Nevada’s? Zero. Setting up an office in Reno is just one of many legal methods Apple uses to reduce its worldwide tax bill by billions of dollars each year.
As it has in Nevada, Apple has created subsidiaries in low-tax places like Ireland, the Netherlands, Luxembourg and the British Virgin Islands — some little more than a letterbox or an anonymous office — that help cut the taxes it pays around the world. Almost every major corporation tries to minimize its taxes, of course. For Apple, the savings are especially alluring because the company’s profits are so high. Wall Street analysts predict Apple could earn up to $45. billion in its current fiscal year — which would be a record for any American business. Without such tactics, Apple’s federal tax bill in the United States most likely would have been $2. 4 billion higher last year, according to a recent study by a former Treasury Department economist, Martin A. Sullivan. ” Why indirect taxes pose a growing risk to global companies Managing global indirect taxes is rising up the agenda of the tax function, which is no surprise given the scale of the numbers involved and the fact that it is an above-the-line tax.
We look at leading practices in managing the burden of global indirect taxes and why companies should assess and manage the growing risk of indirect tax controversy. Economists and other public finance experts may differ in their definition of “indirect taxes. ” However, here we refer to them as any taxes not directly imposed on the income of a person or organization. Globally, then, indirect taxes may include value-added taxes (VAT), goods and services taxes (GST), sales and use taxes, withholding taxes on cross-border purchases from suppliers, withholding taxes on business travelers, and customs and excise duties.
Economists often praise indirect taxes as less damaging to the economy than direct taxes on income, while public officials frequently praise them for producing a more reliable revenue stream (1). In the last two decades, governments have become increasingly dependent on the revenue generated by indirect taxes, especially the VAT, or its twin the GST. In the 34 economically advanced countries that belong to the Organization of Economic Cooperation and Development (OECD), consumption taxes now provide 30% of total tax revenue from individuals and businesses, and indirect taxes now account for 75% of total taxes remitted by businesses.
The European Union is so reliant on the VAT that every Member State must maintain a standard rate of at least 15%. Many nations have exceeded this requirement, and in just the first few months of 2011, seven of the 27 EU Member States enacted higher VAT rates, bringing the average rate over 19% (2). The rising importance of global indirect taxes stands in stark contrast to the historic pattern of “benign neglect” of indirect tax management among most global corporations.
Most global companies’ central finance, tax and legal departments had, until recently accepted the idea that they did not have (or need) full global visibility and control over the wide range of indirect taxes, particularly in jurisdictions outside their home country or in emerging markets. From a corporate perspective, indirect taxes have traditionally been administered in a decentralized fashion, often country-by-country and by a wide range of corporate departments, ranging from finance to accounting to logistics.
This is in stark contrast to the centralized approach that corporations typically take when administering corporate income taxes. Managing the multiple burdens of indirect taxes However, the corporate approach to managing indirect taxes is changing now, thanks to pressure from multiple sources. As in so many other fields of management, globalization is also coming to indirect tax management, challenging multinational corporations to deploy technology and people and processes globally that will bring more control, efficiency and value in the area of indirect tax management.
With governments ratcheting up indirect tax enforcement, corporate taxpayers are ratcheting up their risk management efforts. All evidence points to the conclusion that we are entering an era in which indirect taxes will become more contentious and important. That is why it is essential for companies to take a new, global approach to indirect tax management. According to a recent survey of 100 multinationals by the Institute for Professionals in Taxation (IPT), three-quarters of the companies responded that management or oversight of global indirect taxes now resides in the US.
However, the same survey found that the management and oversight of indirect taxes are characterized by weaknesses in governance, controls and processes. Two-thirds of the companies surveyed indicated that their company is either just beginning to implement global transaction tax processes and controls, or has processes established in a few key countries but recognize that more work is necessary to effectively manage indirect taxes. What global trends are making indirect taxes more prone to controversy?
We see six key trends that are contributing to growing controversy between corporate taxpayers and indirect tax administrators; and to an increased focus within companies on the management of global indirect taxes. * Globalization continues to spur increases in global trade, creating the so-called flatter world. Supply chains are longer and more complicated than in the past, with business units often stretching across many countries’ boundaries. All these changes increase the volume and complexity of indirect tax levies, especially the administrative compliance load.
This is especially true in emerging markets in Asia and Latin America where companies have less familiarity or expertise with consumption taxes. * Seeking higher revenue to pay down debt incurred during the Global Financial Crisis of 2008–2009, many governments see indirect consumption taxes as the answer, with support from economists who view them as less damaging than direct income taxes. * Tax authorities under pressure to produce more revenue under existing law are taking advantage of new technologies and information-sharing agreements with other governments to make their audits stricter.
Many corporate finance and tax executives have historically focused on other tax areas, allowing a variety of departments and local offices a free hand to administer the company’s indirect taxes. This leaves them ill equipped to grapple with the surge of indirect tax obligations. The trend toward shared service centers and finance transformations has underscored the absence of global oversight and control over indirect taxes. The impact of the global recession on corporations has caused corporate executives to focus more attention on cash flow, which brings attention to indirect taxes because of the vast sums remitted and refunded each day. * More prominent commentators are calling for enactment of a VAT in the US than have done so since the 1970s. The federal government’s rapidly mounting indebtedness is challenging the US fiscal tradition of reserving broad-based consumption taxes for state and local governments, most of which rely on general sales and use taxes.
Corporations are starting to think about how they would react if the US were to enact a VAT. Which taxes are “indirect” and how big are they? Globally, the VAT or GST is the biggest of the indirect taxes, producing the most revenue for the most governments. In the US, the sales and use tax is the largest consumption tax, and it is administered at the state and local levels. Whichever consumption tax a government uses, it defines which goods and services are taxable, and then it enlists vendors as tax collectors.
In a VAT/GST system, every seller in the value chain is required to collect a percentage of each sale’s price as a tax and remit that amount to the government. Governments have steadily increased their rates over the years, and that trend continues. VAT and GST rates around the world range from 5% to 25%, while retail sales taxes generally range from 5% to 10%. As they deal with VAT, GST and sales tax, corporate managers must also deal with several other indirect taxes. Selective sales taxes, also called excises, are targeted at particular products, including fuel and telecommunications.
The customs duty is a centuries-old indirect tax on goods, historically levied at the border. As if these were not enough for indirect tax mangers to oversee, three other taxes often fall into their domain: * Property taxes * Withholding taxes on purchases from cross-border supplies * Withholding taxes on the wages of roaming employees. The latter two taxes are income taxes to the supplier or employee, but “trustee” or indirect taxes to the purchaser or employer. Altogether, these indirect taxes account for about 75% of all taxes imposed on global businesses, and just the “net” VAT take is approximately $1. trillion a year worldwide. How are companies reacting to the pressure on their indirect taxes? While many companies are rapidly expanding their indirect tax management function, other companies seem to be in denial on the indirect tax issue. A recent Ernst & Young survey of 200 corporate tax executives at global companies found that, even among those who undertake a finance transformation, one of the goals of which is to improve their tax and filing functions, most have not included their indirect taxes.
There are several reasons for shying away from the indirect piece of the tax puzzle. One reason is the personnel problem. Since the people administering indirect taxes are spread around the world and across corporate departments, finance and tax executives can find it daunting to try reforming so many business processes at once, and dealing with all the people in charge of these processes. We have seen indirect tax authority in a shared service center, logistics, IT, corporate control and assurance, and of course tax and finance.
This multiplicity of corporate departments is a problem. So many are involved because indirect tax management extends from “record to report” as well as “order to cash” and “procure to pay. ” That is, because VATs and other indirect taxes affect almost everything a company buys or sells, indirect tax data is spread throughout the company’s recordkeeping operation, unlike most income taxes that can be more readily identified in a company’s financial statements.
Properly understood, indirect tax compliance should be part of a global compliance and reporting effort by global corporations (see graphic). What makes executives reconsider global indirect tax management? Because of the complexity of the end-to-end business processes and the fact that dozens or even hundreds of autonomous indirect tax management operations coexist within one global company, we have observed that an external or internal trigger is often required to get the process started.
One is finance function transformation, which refers to a web of interlocking process improvements, usually including an overhaul of a global company’s financial accounting. As part of that, the company centralizes its financial and tax data in regional or global databases, often in a shared service center. However, even companies executing a finance transformation often leave the indirect tax piece out. In fact, a recent Ernst & Young survey found that only 17% of companies currently overhauling their finance function included indirect tax management.
However, other triggers can set off alarms about indirect tax management, which may be lucky or unlucky for the company, depending on which trigger is pulled. An ERP implementation or upgrade (e. g. , SAP or Oracle), a global indirect tax compliance outsourcing, an internal audit compliance review, a merger or acquisition, an audit surprise, a major business restructuring: any one of these can trigger a reassessment of indirect tax management. Even just a question from the executive suite or audit committee could suffice, asking, “What is considered best practice in managing indirect taxes? Reforming indirect taxes the hard way, spurred by controversy The most unpleasant of the events that trigger reassessment of indirect tax management is clearly a major underpayment revealed by audit that brings penalties and interest or possibly even consequences that are more serious. Such errors are more likely with each passing year as the volume of transactions rises and the pressure from tax authorities grows. VAT controversies can erupt in any one of the various departments or functions administering them.
In accounts payable, we have seen VAT charged by and paid to suppliers but not reported on the VAT return and therefore not recovered. In accounts receivable, we have seen many sales invoices or credit notes that are adequate for business purposes but not for VAT documentation which results in authorities imposing assessments and penalties. Similarly in data processing, we have seen many systems with insufficient tax codes, or even systems that do not adequately support VAT compliance, leaving personnel to process them manually. (See box below for a longer but still partial list of indirect tax controversies).
VAT controversies are on the rise, but other indirect tax risks merit attention. Unlike VAT, which is recoverable, at least in theory, customs duties and several other indirect taxes are not. The lengthening of the corporate supply chain across many countries aggravates customs risks such as import classification errors or undervaluation. Similarly, withholding on payments made to foreign suppliers is taking on increasing importance as global supply chains result in more cross-border transactions and more risk in not properly withholding payments to suppliers in accordance with an individual country’s tax requirements.
In our experience of assisting businesses all over the world, we see a wide range of approaches to indirect tax management. On one end are the low-risk/high-automation companies. They have probably executed a finance transformation in the last few years and included at least some aspects of indirect tax management in their overhaul. A senior tax person leads global indirect tax management at the head of a team of indirect tax specialists, and this leader has received executive support when submitting requests for the resources necessary to put central reporting and processes in place.
At the other end, we see companies taking a high-risk/low-automation approach. For whatever reason, they cannot come to a decision voluntarily to move toward global management of indirect taxes. It is a decision that circumstances may force upon them later. In general, these companies have not named a senior person in tax or finance who is responsible for indirect taxes, they have little or no established budget for indirect tax management, and they are making less use of technology and automated processes. For many such companies, a starting point is to perform an indirect tax diagnostic or assessment.
A first step is to measure the amount of VAT that is being managed by a company or purchases, sales and intercompany transactions. Add that to the rest of the indirect tax burden and the amounts are staggering enough to break through most resistance. Even though excises, customs duties and other indirect taxes are substantial, the VAT usually dominates the discussion. Executives frequently conclude that VAT, and therefore indirect taxes generally, are not a large problem because the flow of taxes is akin to a “cash in and cash out. However, this analysis ignores the fact that, with a significant amount of VAT under management, modest errors or timing differences on either the sales or purchasing sides can result in very large audit assessments, overlooked input VAT refunds and working capital impairment. Based on our experience working with a variety of global companies, a process improvement assessment aimed at improving the global management of indirect taxes typically follows a five-phase approach: * Identify.
Analyze the “current state” of a company’s global indirect tax management — with a focus on people, process and technology. Many tax and finance executives have little idea who is doing what in indirect tax management, or even how much is being paid in a particular tax. * Diagnose. Identify how the current state differs from leading practices (“gap analysis”). Scope the project — including business needs and the taxes, entities, countries and systems involved, and the initial project deliverables. Design. Develop a plan for remediation of “gaps” and process improvement, building toward a more efficient “future state. ” Analyze the organization’s people, process and technology to identify and prioritize risks and opportunities and possible options. * Deliver. Implementation of the developed plan, including testing, training and change management. * Sustain. Post-implementation review of the action plan and evaluation of whether the plan has yielded the expected benefits.
This also includes a plan for continuous improvement and updates. Final thoughts One former US Secretary of State, John Foster Dulles, had a good line about tough problems, “The measure of success is not whether you have a tough problem to deal with, but whether it is the same problem you had last year. ” Indirect tax management is one of the toughest tax problems global companies face, and leading companies are taking steps to make sure they’re not in the exact same situation a year from now.
Drawing on all that we have heard from global companies, it is apparent that large multinational companies are increasingly aware of indirect taxes’ considerable impact on their business, not only in potential penalties, interest and lost refunds if poorly administered, but also on their working capital. Corporate managers are beginning to understand that it is not the net calculation — payments minus potential refunds — that is important; it is the total amount of indirect taxes that has to be managed in the business.
As businesses come to grips with the pervasive nature of indirect taxes — transaction taxes like VATs and GSTs, excise taxes, customs duties and retail sales taxes, plus other indirect taxes such as property taxes, withholding on cross-border business purchases, and withholding on business travelers — businesses are taking steps to manage indirect taxes more globally. However, almost all of them are still far from the level of efficient, global control or oversight that they need. Moving to effective indirect tax management is a major undertaking.
From manual processes, fragmented responsibilities and little oversight, a global company standardizes and automates its processes, establishing clear responsibility and centralized control. Each company’s strategies will veer in a slightly different direction, depending on its tax situation, personnel, resources and technologies. But no matter what exact path is followed, we are clearly at the dawn of a new era in which global indirect tax is rising to the forefront of corporate tax roles and responsibilities.
Where VAT controversies are prompting corporations to consider a global approach Accounts payable * VAT charged by and paid to suppliers is not reported and recovered on the VAT return * Accounts payable clerks assign incorrect tax codes when posting purchases * Recovery of input VAT is blocked by tax authorities because the supplier’s VAT invoice is invalid * VAT is recovered by the business when it is not entitled to do so * VAT is not correctly accounted for on cross-border purchases Accounts receivable VAT charged to and collected from customers is not reported and paid to the tax authorities on the VAT return * Sales invoices or credit notes issued are not valid for VAT purposes * The incorrect VAT treatment is applied to supplies * The appropriate documentation is not retained to support the tax treatment applied to sales * The appropriate tax treatment is not applied when samples, gifts or other free-of-charge items are given to customers Systems Tax code logic is incorrectly configured or there are insufficient tax codes * There is no indirect tax-relevant input into master data setup and management
* Indirect tax-relevant areas in customer and supplier master data (for example, customer VAT registration numbers) are incorrect * The VAT treatment applied to supplies is not correct (in the case where automation in the system determines the tax treatment) * Systems reporting does not support the VAT compliance process, and there is heavy reliance on manual processes Recent examples of tax controversies regarding customs duties Import classification errors — Application of incorrect product specific rate over five years of imports resulted in $8m payment and potential for $16m penalty * Undervaluation of imports — Separate payments for royalties that should have been part of the piece price and the declared value resulted in an assessment of $2m * Free Trade Agreement eligibility — Conditionally duty-free goods that did not qualify resulted in a $10m repayment of duties * Comprehensive civil penalty laws — Penalties not only on underpayments, but also on errors that do not result in underpayments The Tax Function has to contribute value to the company’s business strategy.