Written by Richard Cornelisse
Manage risks, disputes and litigation Tax audits could be very time consuming and have a huge impact on resources or external advisors.
Be therefore prepared and minimize the risk that extensive resources have to be allocated when a audit is held by getting already a clear understanding of the material tax risks (risk based approach), visibility of the related processes and controls, its weaknesses and strengths (for example: zero measurement as simulation of a tax audit), identify the evidence supporting tax positions taken and document in such a way that will be easy accessable again when actually needed (audit trail / workflow management).
A transparent relationship with tax authorities might resolve any disputes faster.
Define and outline a tax audit strategy and set a protocol for:
- company's code of conduct respectively rules of engagement during an audit (the do's and don'ts)
- project plan and resources needed (roles & responsibilities)
- preliminary audit findings (amount of assessment and fines)
- voluntary disclosure for example to avoid prosecution for tax fraud or joint liability
- exchange of information such as answering queries and provide information respectively data
- holding the final meeting
- litigate and how and when to settle
- managing essential deadlines (e.g. objection procedures, appeals to District Courts, Courts of Appeal and Supreme Court, etc.)
- implementing audit findings in new processes and controls
- document audit findings from prelimary to final audit findings (gap and explain the gap)
Avoid disputes and manage risk
Tax positions are properly disclosed, presented and documented Tax controversy considerations and requirements should be built into the preparation of the indirect tax return and those responsible for indirect tax controversy review indirect tax returns to verify that indirect tax positions are properly disclosed, presented and documented. It is also about 'being tax audit ready' such as simulation tax audit analysis to anticipate on any actual tax audits. It is something you could - in a proactive manner - actually prepare for.
Prepare IT systems for e-audits
Tax audits via data analytics Not only finance and tax but also the tax authorities might request access to systems and data analysis tools that shows how transactions are processed and how IT systems are set up. Data integrity is therefore becoming a greater risk factor when transactions are booked in any given country and are not properly evaluated for tax purposes.
It could be that the financial data in the system does not reflect the business model design or that any change of the business is not properly managed.
A new trend: tax authorities and standard audit files for tax purposes
Tax Authorities, due to technological innovations, have become increasingly better in executing their tax audit. The probability that the Tax Authorities will issue additional assessments and penalties in the near future because errors in indirect tax are detected, increases by the day.’
The OECD has issued in May 2005 a guidance note on the development of Standard Audit File –Tax (SAF-T) and recommends the use of SAF-T as a means of exporting accurate tax accounting data to tax authorities in such way that can it can be analyzed easily.
Portugal has now implemented this guidance per January 1, 2013. On monthly basis, companies are obliged to submit the SAF-T (PT) reports for sales invoices to the tax authorities.
From a risk management perspective mandatory data filing should give food for thought. The submission of the SAF-T file means that a taxpayer has to provide specific data to the tax authorities every month.
It is best practice that before information is provided to the authorities, a company performs a risk assessment and determines the worst case scenario to avoid unforeseen tax risks and makes copies of any information provided.
What if there are glitches in your data, input errors, empty fields, awkward descriptions in fields or apparent inconsistencies?
A non exhaustive checklist re submitting data to the tax authorities
- Has data been analyzed and a tax risk assessment performed?
- What are the tax authorities doing with this data: perform data analysis?
- Does not meeting the requirement result in a higher risk of a tax audit?
- If not impacting the present does the company show a audit trail that can be retroactively be investigated and backfire to tax position taken (ammunition for contra arguments, increase of penalties)?
- If the data provided does not meet the required data format could this result in a higher risk of a tax audit
- To avoid unanticipated risks or mitigate this risk is it not necessary to perform a data analysis prior to submitting data, as an internal pre-audit?
Some questions to answer relating SAF-T and audit defense objectives
- Is the mandatory data request approach of the Portuguese tax authorities incidental or will this become a future trend?
- Is it not likely in the downturn economy that more countries will follow this in order to maximize tax revenues?
- What is the current status in the European Union or beyond?
From 1st July 2016 onwards it is required to provide SAFT-PL files in XML format on request of the Polish tax authorities. In Austria it is also mandatory to provide data in electronic format. In France this is in force. In Luxembourg, Norway, Singapore and Canada providing data is still on a voluntary basis and only mandatory upon request by the tax inspector.
See chapter: Filing electronic audit files
- Is likely that tax data analysis is or will be the standard tax audit methodology?
- Does this impact your company's audit defense objectives?
Dutch tax authorities focus on IT: tax authority approaches are changing
Recruiting IT skillset The Dutch tax authorities announced on May 19, 2015 that 5,000 of its 30,000 employees will lose their current job, while at the same time 1,500 specialized data analysts will be hired as tax returns will be automatically assessed via data analysis. The world how we know it is changing fast.
Processes and controls
How to act Roles and responsibilities have been determined who deals with the tax authorities during an audit (announcement) and tax authorities questions and procedures “how to act” (e.g. appoint one contact person, never provide documents without first making copies) have been documented and rolled out.
Strategic objectives per role
Roles and responsibilities have been determined who deals with the tax authorities during an audit (announcement) and tax authorities questions and procedures “how to act” (e.g. never provide documents without first making copies) have been documented and rolled out.
Increased audit risk due to fraud priorities?
Combat VAT fraud A recent European Union study (2013) says the bloc's 28 member nations may be losing almost 200 billion euros ($267 billion) annually in value-added tax revenues due to tax evasion and a lack of enforcement.
EU Tax Commissioner Algirdas Semeta said the amount of revenues slipping through the governments' nets is "unacceptable, particularly given the impact such sums could have in bolstering public finances."
The study for the European Commission, the bloc's executive arm, found member states lost an estimated 193 billion euros ($258 billion) in VAT revenues in 2011, or 1.5 percent of the EU's economic output. European Commission - Press Release - Fight against fraud: new study confirms billions lost in VAT Gap
Actively combating VAT fraud is a priority for the European commission and local governments. New measures are being taken such as the introduction of individual liability for not remitting VAT if the buyer knew or should have known that he was buying from a fraud.
To prevent such a condition of liability, the ability to demonstrate that sufficient control measures have been taken is essential.
Is it not realistic to state that the risk of a tax audit increases in those countries that have lost substantial tax revenue because of VAT fraud?
Something to consider from an audit defense strategy perspective and could be a reason to challenge the company's current indirect tax priorities set.
Criminal charges and jail time
More often tax and public prosecutors‘ offices file criminal charges for tax-related scenarios with consequences for nor only the businesses reputation wise but also the executives and employees that could be jailed.
Prosecutors said they were investigating 25 bank staff on suspicion of severe tax evasion, money laundering and obstruction of justice, and searched the headquarters and private residences in Berlin, Duesseldorf and Frankfurt.
"Two of Deutsche Bank's Management Board members Juergen Fitschen and Stefan Krause are involved in the investigations as they signed the value-added tax statement for 2009," Deutsche Bank (DBKGn.DE) said in a statement.
See chapter: VAT fraud - effective management
An overview of some best practice approaches
Approach to consider
There is a process for managing indirect tax positions and documentation
Workflow / document management tool supports the process
The indirect tax function seeks proactively to engage with tax authorities and tax policy makers on a global basis to establish strong relationships in all jurisdictions in which the business operates
Developing a winning strategy to support an indirect tax position requires having clear insight about your tax policies and execution, how the tax authorities conducts their examination, anticipate next moves, etc.
Standard global processes exist for indirect tax enquires and litigation with supporting documentation stored in a central repository
Documentation is updated throughout the life cycle of an indirect tax position
A non-exhaustive overview of questions that could be useful as a guideline
What is the nature of the desired relationship between taxpayer and tax authorities?
Is there a tax policy who in the organization is allowed to contact the tax authorities and vice versa who can the tax authorities contact?
What are the audit methods of the tax authorities?
What is the impact of any new approach?
What information has to be shared mandatory on tax authorities request (understanding the rules of the game)?
Why is the audit conducted? (e.g. root cause)
What is the time schedule and scope?
Is there a reputational risk that needs to be considered?
How can the audit be more streamlined or even accelerated (e.g. how to set up a joint tax audit plan)?
Is there a tax policy to maintain an audit summary sheet (outstanding issues, status etc)?
Performance requirements for 'audit defense'
To define the performance requirements for audit defense the following non-exhaustive overview could be used as a guideline. The overview relates also to indirect tax planning and other regulatory matters to avoid a silo approach.
See chapter: Templates for VAT strategy plan
Enhanced relationship between taxpayers and tax authorities
A new trend: open dialogue between revenue bodies, taxpayers and tax intermediaries
The new trend is to have an open dialogue between revenue bodies, taxpayers and tax intermediaries. OECD promotes ‘enhanced relationship’ (OECD report: Study into the Role of Tax Intermediaries). Even if the authorities have not embraced such an approach (yet), a proactive mode and using elements of this way of working might not only safe time and money but also result in a good relationship.
A Guide on Compliance Risk Management for tax administrations has been developed as an update to the 2006 Risk Management Guide. It was made by tax officials for tax officials, both policy makers and operational staff. It is the outcome of work undertaken by the Fiscalis Risk Management Platform group since 2008.
SOAG - Senior Accounting Officer Guidance
Where possible, HMRC relies on large companies’ own governance, systems and processes to manage risks to tax compliance. As part of the Business Risk Review a CRM evaluates how the group’s approach to these factors mitigates the inherent risks to tax compliance within the group.The Senior Accounting Officer (SAO) provisions fully fit with this approach.
The provisions make the SAO of a qualifying company responsible for ensuring that the company establishes and maintains appropriate tax accounting arrangements that allow the tax liabilities of the company to be calculated accurately in all material respects.
The Australian Tax Office (ATO) Practice Statement: Tax benefits/avoidance & GAAR
Australia's proactive efforts to change the international tax arena. This practice statement is a draft for consultation purposes only. When the final practice statement issues, it will have the following preamble: this practice statement is an internal ATO document, and is an instruction to ATO staff.
Taxpayers can rely on this practice statement to provide them with protection from interest and penalties in the following way. If a statement turns out to be incorrect and taxpayers underpay their tax as a result, they will not have to pay a penalty. Nor will they have to pay interest on the underpayment provided they reasonably relied on this practice statement in good faith. However, even if they don't have to pay a penalty or interest, taxpayers will have to pay the correct amount of tax provided the time limits under the law allow it.
This practice statement is designed to assist Tax officers who are contemplating the application of Part IVA or other GAARs to an arrangement, including in a private ruling, Public Ruling (including a Product Ruling or a Class Ruling) or other document setting out the ATO view.
See Chapter: Australian Taxation Office (ATO)
Singapore - Enhanced Taxpayer Relationship (ETR)
The Enhanced Taxpayer Relationship (ETR) Programme was introduced in 2008 as a service initiative and aims to build an open and collaborative taxpayer relationship through regular engagement with large companies, mutually benefitting IRAS and these companies.
See chapter: Singapore - ETR
Irish Code of practice for revenue audit and other compliance interventions
This Code of Practice for Revenue Audit and other Compliance Interventions is effective from 14 August 2014 and replaces the Code of Practice for Revenue Audit 2010.
OECD's action plan on base erosion and profit shifting (BEPS)
"Tax Executives Institute, Inc. (TEI) commends the OECD for its thorough overview of the components of a potential mandatory disclosure regime and its comprehensive discussion of various options that countries may adopt to implement disclosure rules into their domestic law.
TEI appreciates tax authorities’ need to obtain a better view into the aggressive tax planning engaged in by some businesses and we do not oppose a mandatory disclosure regime in principle. Indeed, an objective, clear, uniform, and easy-to-apply mandatory disclosure rule could help level the playing field between multi-national enterprise (MNE) competitors that might have differing appetites for tax risk.
While the flexible approach in the Discussion Draft gives countries the ability to tailor a disclosure regime to their particular domestic tax policy concerns, varied approaches to mandatory disclosure across jurisdictions present several concerns for MNEs."
Tax Compliance Consultation – UK
On 22 july 2015 the Revenue & Customs in the UK have published two linked consultation documents that relate to compliance and anti-avoidance. Both are directed at behaviours and behavioural change for large corporates in particular.
The document entitled Improving Large Business Compliance contains 3 main proposals:
- A legislative requirement for large businesses to publish their tax strategy
- A voluntary ‘Code of Practice on Taxation for Large Business’
- A ‘Special Measures’ regime to apply to businesses continually undertaking aggressive tax planning or persistently refusing to engage with HMRC in an open and collaborative manner.
HMRC published a report following research into what it is that drives large businesses’ approach to their tax strategy. In particular they wanted to investigate what the triggers are to a change in tax strategy and who within the business takes that decision.
OECD Tax Administration 2015
Tax Administration 2015, produced under the auspices of the Forum on Tax Administration, is a unique and comprehensive survey of tax administration systems, practices and performance across 56 advanced and emerging economies (including all OECD, EU, and G20 members).
Its starting point is the premise that revenue bodies can be better informed and work more effectively together given a broad understanding of the administrative context in which each operates. However, its information content is also likely to be of interest to many external parties (e.g. academics, external audit agencies, regional tax bodies, and international bodies providing technical assistance).
The series identifies some of the fundamental elements of national tax system administration and uses data, analyses and country examples to identify key trends, comparative levels of performance, recent and planned developments, and good practices.
BEPS has an Indirect Tax impact too
Let's highlight for example action 7 and 13:
Prevent the artificial avoidance of PE status'
Country-by country reporting (CbC)
Action 7 – prevent the artificial avoidance of PE status
The final BEPS report includes changes to the definition of PE for income taxes of Article 5 of the OECD Model Tax Convention. Action 7 broadens the threshold to determine when such PE status exists. Currently such a PE status does not exist for commissionaire arrangements and the specific activity exemptions in treaties, such as warehousing, purchasing and preparatory and auxiliary activities.
The indirect tax definition of a fixed establishment (FE) is different from a PE and has its foundation in EU VAT law and should therefore not be affected by the BEPS initiative or OECD definition. Some countries however do (still) not accept the absence of a FE once a PE has been established. Note that the amount of PEs will increase when "Action 7" is in force.
As businesses are facing global challenges it makes sense that the existing business model is reevaluated and amended when necessary to meet the new PE environment. That most likely means moving away from a commissionaire structure.
Action 13 – country-by country reporting (CbC)
Action 13 provides a template for multinationals to report on an annual basis and for each tax jurisdiction in which they operate revenue figures and other key figures. The data of these reports give direct tax authorities the possibility to audit the amount of direct tax paid.
However for indirect tax authorities it is useful data as well. From a custom perspective it could be supportive during auditing the valuation of the transactions when customs duties are due and for VAT cross border intercompany transactions have always qualified as a high risk area.
The SAF-T standard, originally created by the OECD, is intended to give tax authorities easy access to the relevant data in an easily readable format for bot corporate income tax as VAT. This leads to much more efficient and effective tax inspections. Data analytics will become the most efficient and effective way of future tax auditing.
Fast adoption of technology
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Embrace new technologies and catch up
Compliant tax software solutions for the global management of tax processes
In essence, HRMC’s increases its expectations towards large businesses with regard to a more and more transparent tax management strategy. However, the publication of a tax strategy will clearly not be sufficient. It is just the starting point for the provision of a clear picture about the risk management and controls in place of tax relevant processes. The daily management turns on the radar.
State-of-the-art tax compliance management software is required.
In difference hereto, the view into the current daily practice provides a different and non-compliant picture:
Widespread use of Excel spreadsheets, decentralized storage of tax relevant documents, lack of documented controls, lack of automation, global lack of tax compliance software tracking individual changes and filings, lack of standardized reports immediately available upon request, lack of in-built double-checks for the calculation of current and deferred taxes on reporting entity level, lots of tax relevant data stored at external outsourcers (e.g. external tax advisors and accounting firms), several tax software tools in place at various locations which are neither interfaced among each other and with the ERP systems in place, etc.
It is obvious that tax departments which are not adapting its process management to the requirements addressed by HMRC and other tax authorities may struggle with regard to compliance, efficiency and transparency.
Therefore, compliant tax software solutions for integrated tax management like the U² software from Universal Units become more and more important
Written by Richard Cornelisse
Richard advises multinational businesses in improving the efficiency and effectiveness of their Indirect Tax Function and Tax Control Framework.
He started his career as a manager at Arthur Andersen and then became a partner in EY where I led the indirect tax performance team for Netherlands and Belgium. Currently he is a senior managing director of Phenix Consulting.
Richard has over 20 years’ experience advising clients on international VAT issues. He is specialized in the tax aspects of financial transformations, shared service centre migration, and post merger integration work. Richard is also somewhat of a mentor, giving back to the profession. If you are interested in conversation and discussion, please feel free to contact him.