Incoming and outgoing invoices provide important information about the scale of indirect tax risks within the company. By selecting a number of transactions either judgmentally or by applying statistical sample access to that information is obtained.
Statistical sampling has the added benefit of allowing the determination of the exact amount of any supplementary tax assessment. For this reason, the Dutch tax authority also prefers sampling as a monitoring method.
In the working method, the same parameters as the Dutch tax authorities can be used. If an organization chooses a different method, then the tax authorities will conduct their own sampling.
A "pre-audit" statistical sampling offers insight into the tax risks that an enterprise encounters regarding indirect taxes. In addition, giving only instructions and training is, in practice, insufficient for keeping "control." A periodic audit can help establish whether internal instructions are actually observed, whether they are adequate and whether they require adaptation to new transactions, for example.
Statistical sampling has the added benefit of allowing the determination of the exact amount of any tax assessment by the tax authorities
A "pre-audit" statistical sampling conducted internally provides valuable insights into the tax risks that an enterprise faces regarding indirect taxes. Additionally, this approach serves as an efficient and effective method for the tax department to assess the effectiveness of its Tax Control Framework. The results can be used to elevate the importance of managing indirect taxes, as addressing quantified material risks aligns with the Key Performance Indicators (KPIs) of a CFO.
Work method
- Delivery - process owner delivers files or supplies the necessary information using standard ERP system functionality - Subject-Matter Expert (SME) provides instructions for this.
- Sampling - SME conducts the sampling. The client is instructed to gather the selected (physical) invoices, declarations, receipts or other documents.
- Assessment - SME then evaluates the delivered material and determines the correctness of the VAT entries based on the tax authority's parameters. In case of incorrect VAT entries and errors, we calculate the potential additional VAT assessment.
- Measures - SME formulates argumentation and help draw up and improve the (risk management) strategy for future VAT audits.
Effectiveness of Tax Control Framework – single audit via statistical sampling
Tax authorities can utilize the single audit method to quickly assess tax risks across all categories (including potential assessments). This approach offers a fast overview of the Tax Control Framework's performance, allowing companies to determine whether their results fall within acceptable risk tolerance limits. Below is an overview of this method.
The term "Single Audit" comes from government accounting. Initially, it referred to an audit conducted simultaneously for multiple supervisors or regulators, for whom the audited entity must report.
By employing a single audit, much unnecessary duplication of effort can be avoided. Monitoring different reports stemming from the same financial accounting system can create a significant audit burden. A single audit helps to reduce this burden.
In the context of Horizontal Monitoring, the Dutch Tax Authority also uses the term "Single Audit." This term refers to the simultaneous monitoring of all relevant tax types, such as:
- Corporate Income Tax
- Value Added Tax
- Wage tax
- Excise and Customs duties
- Etcetera
The Tax Authority has previously referred to "integrated control." Although the Tax Authority is a single entity, the single audit can still, like other single audits, help reduce the audit burden.
To ensure thoroughness, each single audit must be conducted by specialists. This is crucial because the various financial statements require scrutiny, which necessitates the involvement of different tax experts.
A multidisciplinary team should oversee most of these single audits. In addition to audit expertise, knowledge of various tax types is essential.
What makes the fiscal single audit unique is that the Tax Authority evaluates the accuracy of tax return collections from taxpayers primarily in terms of monetary value. This means that the financial statements being assessed are often represented in the monetary units corresponding to the taxable amounts of different taxes.
A few tax examples
- Corporate Income Tax – the General Ledger, and thus the CIT return, only includes revenues, expenditures and balance sheet accounts but lacks the applicable CIT tax rate.
- Value Added Tax – the expenditure (investments/costs) will be posted in the General Ledger net of applicable to input tax and the VAT is posted on a separate VAT balance sheet account
- Wage tax - the payroll posting in the General Ledger is based on gross amounts, while tax audit samples are generally based on the net amount of wages.
A "single audit" does not mean the defined transactions should be viewed as a single, indivisible group. However, this assumption of indivisibility can be applied during sample selection when risk analysis is not considered.
In practice, this means the following steps should be followed:
It is essential to recognize that specific subpopulations may arise from more complex interpretations, making them susceptible to a higher probability of error. In contrast, other subpopulations possess a lower risk profile, often due to consistent and adequate internal monitoring.
This distinction should be considered when determining the amount of work required, and if feasible, the sample size could be reduced.
Using the full sample (thus skipping steps 5 and 6) is always permissible when conducting an internal sample check to assess the effectiveness of one’s own Tax Control Framework.
If the Tax Authority has conducted a tax audit using the single audit method and has issued substantial tax assessments, it is crucial not only to evaluate the validity of the Tax Authority's position but also to scrutinize the process itself. It is essential to determine whether this process can withstand scientific scrutiny.
The following paragraphs will outline the methodology for reducing the sample. The figure below illustrates the population from which a proportional sample of funds is drawn from each subpopulation. The assumption is that the tolerable rate in monetary terms for each subpopulation is the same as that for the entire population.
For instance, a subpopulation of the total expenditure collection could include net wages or expenses for which input tax is deducted on VAT returns. Additionally, one might select transaction classes that share similar risks.
Figure 1
First Arrow – sample size:
sample size proportionally distributed over subpopulations
sample size per subpopulation after incorporating “prior information”
Second Arrow – incomplete transactions
The dotted lined rectangle depicts the possibility that – due to whatever reason – not all transactions are included in the to be evaluated overall population. The figure above displays the situation in which the risk is equal across all subpopulations.
The figure below depicts different sample sizes per subpopulation. This results from a different amount of ‘prior information’ for each subpopulation.
Figure 2
Sample size per subpopulation after incorporating “prior information”
Contributors
Ferry Geertman, (RE, CISA) has a background in Applied Mathematics. Ferry has vast experience in data analytics, including the design and evaluation of statistical samples as part of internal and external audit. Ferry is CFO of KGT and lectures at the Nyenrode University.
Hein Kloosterman (RE RA) used to be the chairman of the IT audit professional practice office and chairman of the statistical knowledge group of the Dutch Tax Authorities. Hein has extensive experience with the so-called integrated audits (single audits). Hein is involved in the education in accountancy, both at the Nyenrode and the Erasmus University
Hein and Ferry are both members of the Steering Committee of Statistical Auditing. This steering group is connected to the Limperg Institute and aims to promote the proper (effective and efficient) use of statistical methods and techniques in auditing and related audits of financial statements and reports.
Literature (in Dutch)
- Belastingdienst (2013) Controle Aanpak Belastingdienst; document cab_dv4221z1fd.pdf via de site van de Belastingdienst.
- Kerpershoek, L. (2010), Single information, single audit: de impact op stakeholders, PwC Spotlight, Jaargang 17- 2010 uitgave 4, pp 38 – 41
- Kloosterman, H.H.W. (ed)(2003) Optimalisatie van Controlebeslissingen; project Platform Versterking Vaktechniek Belastingdienst
