Transactions in today’s business world
Indirect tax spread throughout the enterprise
Even as the world is shrinking, businesses and their growth strategies are becoming more complicated. A schematic drawing of the functions of a typical multinational today might look like a Rube Goldberg contraption—a complex of moving parts that must connect one to another for tax, regulatory, and reporting purposes.
And unlike the more contained structure for handling income-based taxes, responsibilities and key drivers for indirect taxes may be spread throughout the enterprise, residing not just in the tax department but in any of such diverse departments as finance, information technology, supply chain management and logistics, human resources, and beyond.
Added is the growing trend toward shared service centers (SSCs) that are responsible for operational processes including accounts payable and accounts receivable as well as other outsourced functions for tax, finance, and treasury. Tax determination and reporting for the entire operation may be governed by one or more enterprise resource planning systems, which in turn may be integrated to varying degrees, with or without the benefit of sophisticated technology tools.
All these factors make for a changing and increasingly sophisticated business environment that requires a different approach to business indirect tax advice.
From a Tax Control Framework perspective, for setting up risk-based controls, the more unusual the transactions, the greater the tax risks. An example of non-routine significant business transactions is the migration to new jurisdictions.
When migrating to a new jurisdiction, companies will likely encounter Value Added Tax (VAT). For some corporations, this may be their first experience with VAT, while for many others, it will be a familiar concept, albeit with some differences compared to their previous jurisdiction.
It is essential to assess the VAT implications of the migration itself and the subsequent activities in the new jurisdiction. This evaluation should occur alongside other critical work streams because VAT is a transaction tax that impacts costs and revenues. Numerous transactions will invariably take place during the migration process and ongoing operations.
Operational disruptions
Disruption of daily business
Misunderstanding or not recognizing the VAT implications of the migration and subsequent activities in the new jurisdiction could result in an unwelcome and unexpected cost. However, the change of a business model cannot only create VAT risks, but as well commercial risks such as logistics problems in getting goods into a country and delays and hold off of shipments resulting in disruption of daily business.
Some root causes: the company forgot to register for VAT or procurement forgot to agree with the supplier who was importing the goods.
A number of issues are addressed that should be considered for VAT purposes to ensure that the migration will take place in the most effective manner from a VAT perspective. It is very much a question of assessing the VAT position of the entities affected by the migration as it is currently and determining whether the future position will be better, neutral or negative. If it is the latter, determine whether and how the VAT cost may be reduced.
VAT status of the entity migrating
Avoid VAT costs
Assessing the VAT status of the entity or entities migrating to the new jurisdiction is the starting point as that will give us a good indication whether the migration itself and the subsequent activity in the new location will be VAT neutral, beneficial to the current position or result in a VAT cost.
The process to assess the VAT status of the migrating entity or entities is to review the current treatment of its activities from a VAT perspective. If it is a pure holding company, i.e, its activities are purely passive, its activities (certainly from a European VAT perspective) will be outside the scope of VAT. VAT that it incurs on its costs will be an additional cost, as such a holding company will not be able to deduct that VAT. That hits the bottom line.
It is essential that from a VAT perspective, the VAT consequences of the method of migration is determined on time.
Why?
Planning before and not after the facts
In practice - depending on the company's flexibility, of course - VAT entrepreneurship might be achieved via restructuring to avoid or limit such a VAT burden. This is, however, only possible if VAT planning is considered at the right time, as correcting status retroactively does not work.
One other area for particular attention is to plan how external fees are purchased, i.e. which legal entity should enter into the engagement with the different vendors. This is an area of contention with the VAT authorities over for example the VAT deduction on these costs.
Project plan and VAT effective manner
Migration can be carried out in various ways. From a VAT perspective, it is essential to determine the VAT implications of each migration method to assess whether the VAT incurred on the associated costs will be a genuine expense or merely a cash flow issue.
This assessment involves reviewing the project plan to ensure that the necessary steps are executed in a VAT-efficient manner, while also considering commercial and other factors. Specific migration methods may allow for using particular VAT reliefs; for example, many countries offer VAT relief for transferring a business as a going concern.
- How is the tax function involved in the legal structure and transactions?
- How is the tax function involved in operational changes in ERP implementation and cost reduction?
- Who is taking care of filing of the VAT registration?
- When should you apply for VAT registration, since average lead times in jurisdictions can be several months?
ERP setup or changes
The migration will result in that ERP systems have to be updated and tested to reflect new contracts and billing flows. Ownership of these tasks must be determined and communicated upfront, so that the ERP system can accurately issue invoices from day one.
Historical local knowledgePeople might also have left the company due to the migration and historical VAT knowledge - such as knowhow about the practical workarounds - might get lost. This often becomes in practice visible during a tax audit a couple of years later and questions raised by the authorities are then not easy, if at all, to answer.
Processes and controls, roles and responsibilities
- What are the VAT processes and controls going to be for the migrating entity?
- Who owns these controls?
- Will the tax knowledge of the migrating business be recruited, outsourced, or considered a responsibility of the central tax function?
- What technology will be purchased or reused?
From concept through completion and beyond
Managing change by design involves examining every process and transaction from start to finish while considering all requirements and controls. This is crucial for designing and optimizing a compliant VAT process. VAT should be considered at every stage of the migration process, from initial concept to completion and beyond. By adopting a design-oriented approach, we can ensure that all requirements and controls are incorporated, leading to an effective and compliant VAT process.
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.
