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VAT control framework

There are a couple of elements that need to be considered to determine the materiality of VAT risks. Using absolute amounts is the way a business controls framework sets up a risk-based approach.  However, this is not sufficient as a VAT control framework is not only about paying the right amount of tax but also nowadays about avoiding risks that impact the reputation of the company.

A Tax Control Framework (TCF) is an internal control instrument specifically aimed at the tax function within a company and an integral component of a company’s business control framework, which is different for every organization. It is a system (process) to identify, mitigate, control and report tax risks.

The objective of a TCF is to be in compliance with tax laws and reporting requirements and manage the risks that exceed the companies' risk appetite. A TCF should prevent tax errors, identify opportunities in a timely manner, and perform correct filings at the right moment.

A company's VAT control framework system is adequate if it provides insight into where material VAT risks may arise in the company (awareness), while the degree of risk tolerance is established internally and where appropriate control measures are taken regarding these risks.

A review should take place of the categories of VAT risk the company is facing as well as the likelihood of occurrence, its potential impact and mitigation measures. Review the company's risk appetite and risk tolerance and the way in which risks are measured.

Sufficient internal communication

A TCF requires a clear understanding of the companies' material risk areas, the company's tax policy derived from business objectives, the VAT processes and risk-based control measures (hard and soft controls) and the roles and responsibilities of the indirect tax department and its shadow tax function.

  • Internal control is a process. It’s a means to an end, not an end in itself. Internal control is affected by people. It’s not merely policy manuals and forms, but people at every level of an organization.
  • Internal control can be expected to provide only reasonable assurance, not absolute assurance, to an entity’s management and board.
  • Internal control is geared to the achievement of objectives in one or more separate but overlapping categories.

From: The Institute of Internal Auditors, Does Your Control System Pass the COSO Test, March 1998, Issue 2

A tax control framework consists of

  • Strong tax governance with an agreed tax strategy that is in line with wider business objectives an in-depth understanding of where the key risks lie within the business, including indirect and wage tax
  • Effective and efficient controls in place to mitigate identified risks
  • A clearly defined communications strategy for managing tax internally and externally
  • Ongoing monitoring activities and improvement efforts
  • Ensure strong governance, including the implementation of strict guidelines.

Threats and opportunities

Managing risk is about making decisions, at all levels of an organization, to limit the effect and likelihood of threats happening and to increase the effect and likelihood of opportunities.

In many countries, indirect tax returns are not audited by the tax authorities. Tax certainty about tax positions taken will exist once the statutory time limits are exceeded. That might change when e-audits approaches are standard implemented as audit method or other VAT fraud measures come into force. What is often missed in a business case, planning and execution is a full understanding of the processes and controls needed to effectively and efficiently manage indirect tax.

Below, gaps might give rise to some important considerations from a benchmark perspective

Inability to comply with local VAT rules — Although the root cause will vary from one company and country to another, the risk is likely to arise because of the fundamental lack of resources with local knowledge, clear VAT policies and procedures, technology enablement and controls and metrics to facilitate and monitor compliance. In most cases, there is some combination of these causes.

System incompatibility — It isn’t uncommon to find that the ERP system or other available technologies do not support, for example, SSC staff as fully or effectively as required in making sound decisions related to VAT.

Processes not clearly defined  — Staff sometimes find themselves operating without clear descriptions or instructions as to how certain processes should function internally. That typically includes specific division of duties and defined responsibilities for every task and the person assigned to perform it, as well as the protocols for communicating with the tax office to receive updated information, escalate issues and solicit valuable feedback. The more pieces missing, the greater the risk.

Non-existent or inadequate processes and documentation — Since indirect tax guidance is not typically part of the brief, staff may not have access to VAT training, manuals or web-based technology to support their decisions and activities relative to VAT.

Insufficient communications — Staff may also be hampered by inadequate or unorganized communications between the indirect tax function and other operational business units (e.g., IT, logistics, group tax department) within the organization, making it very difficult to identify and address any crossover issues relating to VAT.

Non-existent or inadequate compliance controls — An indirect tax control framework and key performance metrics that focus on relevant indirect tax risk must be in place to provide the stability and transparency required to both enable and sustain compliance.  None of these “risk drivers” are insurmountable or prohibitively complex to overcome. That said, there are some equally significant VAT-specific rewards in a well-run and well-founded indirect tax function.

Performance improvement — Companies have seen a reduction in both manual effort and error rates in VAT processes from automating VAT decisions in an ERP environment and (or) using technologies available on the market, such as tax engines and certain web-based applications.

Better time management — More time is available to tax staff to set up and implement VAT strategy and planning. Since problems can be anticipated at an earlier stage and action taken to pre-empt or solve them.

Process improvement — With, for example, a SSC doing a good portion of the “heavy lifting,” the organization has more time and resources to review, adjust, structure and optimize existing VAT processes. It may also lead to the development of a VAT team to operate as part of the overall international tax team.

Consistency and flexibility — An efficient and effective tax function can provide the company with a consistent operating model as well as flexible organizational design to support growth, profitability and compliance.  Once the company has evaluated the risks and rewards and conducted any other due diligence, the processes begin for identifying the VAT-critical functions, diagnosing the current state and designing the structure that will enable any effective migration.


How KGT can support

KGT helps clients establish effective VAT control frameworks to boost compliance and efficiency. Our standardized framework allows you to assess your current position and identify gaps. Following this evaluation, we recommend standardized controls to address any issues.

Developed by a former EY Indirect Tax partner and a former Director at Deloitte, this framework integrates insights from senior VAT leaders across industries. You'll also benefit from the expertise of former VAT function leaders from multinational companies, and we can help you understand your specific challenges.

KGT delivers comprehensive tax consultancy and advisory services and expert internal audit support designed explicitly for multinational corporations. Our commitment to aligning with best practices ensures that your organization meets compliance requirements and enhances overall performance and efficiency. Trust KGT to optimize your tax strategy and strengthen your financial integrity.