Business challenge
Technology is a facilitator for optimizing processes. In order to determine areas of improvements in current processes, the starting point is a good understanding of weaknesses (i.e. limitations) of SAP, insight into the current processes of a company, current SAP set-up and the company's operational business model.
If full ‘VAT automation of Accounts Receivable (AR) and Accounts Payable (AP)’ and ‘being in control’ are important objectives of your organization, it is important to understand what exactly makes Standard SAP not functioning optimal from an indirect tax perspective.
Only then it is possible to validate whether a company’s objectives can be achieved via upgrading Standard SAP functionality and/or implementing an external tax engine.
When is Standard SAP sufficient?
Standard SAP itself is only processing a transaction within one specific company code and the consequence is that standard SAP VAT determination logic and functionality for VAT determination should therefore only work for:
- AB scenarios
- Cross border intercompany
- AB scenarios: electronic invoices via EDI/iDoc
- Local ABC scenarios (e.g all legs in France)
- ABC scenario with a static business model (for instance leg B-C triggers always the same VAT treatment)
Any standard SAP gaps could be resolved with limited adjustments the overall VAT determination improved via standard design of VAT condition tables, access sequences, tax codes, tax sensitive master data, configuration of customer VAT registration number.
When is additional VAT functionality required?
The SAP VAT determination logic was developed a long time ago (1980s) and except for the “plants abroad” logic, SAP’s VAT determination logic has not changed much. This stands in contrast with the VAT rules and business models as these have changed significantly.
The VAT landscape and rules have gone from fairly simple to rather complex. Cross-border transactions changed from solely export to a new category within the EU: Intra community transactions (goods and services) with distinct rules and new formalities to manage.
New business models have resulted in an increase of intercompany transactions, the use of chain transactions, drop shipments and pick up transactions.These are causing IT bottlenecks to implement as Standard SAP VAT determination logic and functionality do not work for these complex dynamic business models.
The root cause is that both Standard SAP and bolt-on tax engines exclusively focus on transactions within a single company; it only assesses the underlying individual transactions and fails to link the current transactions to the VAT results of previous transactions.
When more than 2 parties are involved, the VAT treatment depends on the VAT treatment of the prior transactions:
- ABC (D) transactions involving supplies of goods and which are transported to another Member State or Member States. In that case it is important to identify in which part of the chain the intra-EC supply and local supply or supplies take place (see below 'Cross border drop shipments')
- ABC transactions involving 3 parties in the supply-chain, which are identified for VAT purposes in three different EU countries, and for which the goods are transported directly from EU country A to EU country C. Under certain additional country specific requirements (not harmonized amongst the EU member states) such a transaction may qualify as triangulation, so that the re-spective “simplified triangulation rule” would be applicable
- ABC (D) transactions involving a supply of goods which are exported to a place outside the EU. In this case, it is important to identify in which part of the chain the export takes place in order to determine the impact on the VAT qualification of the other parties in the chain transaction (see Import / Export transactions ABC transactions)
- ABC (D) transactions involving a supply of goods which are imported to a place inside the EU. Again, it is important to identify in which part of the chain the export takes place in order to determine the impact on the VAT qualification of the other parties in the chain transaction (see Import / Export transactions ABC transactions)
When we take the first bullet as an example of the complexity, one could think of the possibility that the invoice flow and physical flow of goods have a mismatch. That could be the case if party B request party A to deliver the goods directly to party C in another Member State (i.e. drop shipments).
Standard SAP will determine the VAT qualification based on the ‘ship-from’, ‘ship-to’, ‘material’ and ‘customer tax classification’ information in SAP. It will for instance not take into consideration the multiple VAT registrations from party B. That would mean that not only the transaction A-B but also B-C cannot be derived correctly.
From a legal perspective only one transaction can qualify as a zero rated intra-EC supply. In such ABC cases, one of the 2 transactions should be charged with local VAT. An exception exists - second bullet above - when the supply chain fulfills all requirements of the simplified triangular. Under these strict conditions both transactions could be zero VAT rated.
Financial impact
The supplier is responsible for ensuring that all the conditions for applying the zero VAT rate are met. If not, the tax authorities will seek to recover tax due from this supplier via a levy of a tax assessment. If the applicable VAT rate is 25%, the tax assessment will be 25/125 of the consideration charged. This assessment has to be increased with interest and penalties to determine the total tax burden.
Without adjustment of Standard SAP setting, an incorrect VAT treatment would be determined causing non compliance risks.
Patch-up solutions
One approach is to work with assumptions and to implement these in the system resulting in predefined VAT treatment (hard coding). An example is the assumption that the company is always buying with local VAT in the vendor country and therefore always sells using the VAT number of this vendor country.
This means that a VAT treatment is no longer determined based on actual transactional data in SAP. Assumptions may be implemented incorrectly or may change after go-live. This might result in an incorrect VAT treatment with potential compliance and/or financial risks. If managing VAT risk is the company's policy, periodic VAT audits as detective control need to be set up since the risks at hand will likely exceed the company’s risk tolerance.
This results in extra man-hours, additional costs due to rework (credit/debit notes) and retrospective corrections and/or disclosures.
In order to fix a problem, we have to first understand the root cause thoroughly. We have to accept the possibility that the problem involves far more than what is immediately apparent and will require more work than is estimated at the beginning.
An important question to raise is: what tools are available in the market that achieve full VAT automation without making use of assumptions and that determine the VAT treatment based on all real time VAT sensitive data in the SAP?
Solving the real problem
Specific SAP VAT areas of attention
Cross border drop shipment
Specific considerations about triangulation
- DK company code sells to DK customer
- Stock is not available and is purchased from NL Company code with NL stock location
- Direct shipment from Plant NL01 to customer
Result: wrong VAT treatment with potentially twice an 0% rated intra EU supplies
Root cause: Standard SAP is not able to link the VAT treatment of AP and AR as data is gathered at company code level and cannot be linked to AP and AR
Simplified triangulation
Specific considerations about drop shipments
- Country specify rules apply when triangulation is allowed (country by country deviation). Different local rules apply when Party B is VAT registered in ship-to country where the customer receives the goods
- If the supplier (plant or third party) is not set up in SAP the ship-from location will not be known during billing and sales
- Standard SAP requires manual intervention
Import / export transactions ABC transactions
Specific considerations about export/import
- Define the correct legal partner for VAT
- Determine the correct ship-to country
- Differentiate between export/import and out of scope
Customer pick up
Specific considerations about customer pick up
- Country specific rules apply when a customer picks up the goods and the goods leave the country
- 0% VAT rate for intra EU is only allowed if supplier can prove that goods have left the country
- If proof is not available the tax authorities could assess the supplier for VAT
Services
Specific considerations about services
- Default place of supply rule should be the country of establishment of your customer
- Standard SAP: place of supply is by default ship-to
- Default rule has exceptions (e.g repair services connected to immovable property)
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 an EY partner where he led the indirect tax performance team for Netherlands and Belgium. Currently, he is a managing director of SAP Tax Consultancy Firm.
Richard has over 20 years of experience advising clients on international VAT issues. He is specialized in the tax aspects of financial transformations, shared service center migration, and post-merger integration work.
