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Claudio Fischer is a Senior Manager at Ernst & Young AG in Switzerland and Robert Smithis an Indirect Tax Partner at Ernst & Young in China
The sheer number and variety of changes in indirect taxes in recent years and the challenge of implementing them into accounting and reporting systems can be overwhelming -- making it hard to keep sight of the bigger, strategic picture. But what do all these changes add up to? Do common themes emerge? What changes can we expect in the future?
The economic crisis has caused many governments to find sustainable ways to rebalance their budgets and stimulate growth. This would imply governments will continue the shift from direct to indirect taxes, which are less harmful for growth, look to improve the efficiency of indirect taxes and take action to combat tax fraud and avoidance. We believe that the importance of indirect taxes will continue to grow. We have identified five key trends in indirect taxation that we believe will be significant for international businesses in 2013 and beyond.
Limited to less than 10 countries in the late 1960s, value-added tax (VAT) -- or, in several countries, goods and services tax (GST) -- is today an essential source of revenue in more than 150. The spreading of these taxes has also driven constantly rising rates in many countries. In the European Union (EU), between 2008 and 2012, the average standard VAT rate increased from around 19.5 percent to more than 21 percent. The upward rate trend in Europe continues as Cyprus, the Czech Republic, France, Finland, Italy, Poland and Slovenia have already increased rates recently or have announced increases later in 2013 and 2014.
In Asia Pacific, the upward VAT and GST rate trend is less explicit, but still noticeable. Japan, for example, which is struggling with massive budget deficits, decided in August 2012 to increase the current VAT rate from 5 percent to 8 percent effective April 1, 2014 and to 10 percent effective October 1, 2015. Thailand was also considering the possibility of raising its VAT rate from the current temporary 7 percent to the normal 10 percent rate but it is still not known if this will happen.
By contrast, VAT and GST rates in the Americas remain relatively stable. In South America, where VAT systems are widespread and have been in use for some time, rates have not changed much in recent years. One exception is in the Dominican Republic, where the rate is set to increase from 16 percent to 18 percent this year and next year.
The significance of this trend for final consumers is clear: retail prices rise. But its impact on businesses is equally important: higher VAT and GST rates increase compliance risks and may result in a higher tax burden where cascading VAT may not be fully recoverable. Companies must ensure that all the increases are properly dealt with in their accounting and reporting systems, which often results in a range of IT and administrative costs. Errors frequently arise when rates change, resulting, for example, from incorrect product or tax codings or confusion about the correct rate for supplies that span the change. More generally, rate increases mean the amount of VAT or GST “under management” also increases, as do penalties for errors that are based on the amount of tax payable.
Europe also seems to be the leading region for increasing excise taxes as the three important groups of “classic” excise taxes (alcohol, tobacco and mineral oils) have seen significant increases. This year, excise taxes on tobacco and alcohol have increased, or will soon increase, in most EU countries, including Guernsey, Moldova, Norway and Switzerland. But the trend can also be seen in other parts of the world; in Africa, higher excise taxes are being imposed on these items, e.g. in Benin, Gambia and Zimbabwe. In the Americas, Aruba, Canada, Costa Rica and Mexico have also raised taxes on alcohol or tobacco, as have Fiji, New Zealand and the Philippines in Asia Pacific.
While the main purpose for excise tax rate increases is to raise revenue, these taxes are also increasingly being used to discourage consumption of certain products considered to be harmful, thus influencing consumer behavior in a number of areas. A relatively new trend is the introduction of excise taxes on health-related products (other than alcoholic beverages and tobacco products), such as snack taxes on “unhealthy” food. For example, Benin, Costa Rica, Norway and the Philippines have all increased excise duties on soft drinks, Finland has introduced an excise tax on sweets and ice cream, and in France a specific contribution has been introduced on suppliers of beverages (sodas) with added sugar or sweeteners.
Over the last decade, environmental issues have also played an increasing role in determining the nature and application of taxes, e.g. on road fuel, motor vehicles and CO2 emissions. This type of measure includes tackling issues such as waste disposal, water pollution and air emissions. With support from the Organisation for Economic Co-operation and Development (OECD), whose analysis seems to confirm the advantages of environmental taxes,1 many countries are introducing or increasing such taxes. Current examples are Germany, Ireland and South Africa.
Finally, there is a noticeable trend toward increasing the tax burden on financial transactions. Although there seems to be a common and widespread belief among countries that the financial sector should contribute its fair share in remedying the damage arising from the financial crisis, there is no common approach as to how this should be achieved. Some countries have increased supervision of the industry and tightened regulations. However in Europe, in particular, the preferred approach has been to levy taxes on financial transactions. France introduced a financial transactions tax in August 2012, and on January 1, 2013, Hungary introduced a tax of 0.1 percent on the amount involved in any payment service. Italy followed in March 2013, with a tax on the transfer of shares and derivatives and high-frequency trading. In addition, 11 EU Member States have agreed to introduce a common transaction tax on the exchange of shares and bonds and on derivative contracts, which could be introduced as early as 2014.
Customs duties were once a primary source of revenue for most countries. Global, multilateral and bilateral efforts to globalise trade, through organisations such as the World Trade Organization (WTO) and others, have led to decreasing duty rates and a downward trend in customs duties around the world.
The WTO currently has 158 members (the most recent, Laos, joined at the start of February 2013) and it reports 546 active and pending reciprocal regional trade agreements among its members. A number of new free trade agreements (FTAs) are expected to enter into force in 2013, thus further reducing the amount of customs duties imposed on global trade. Examples include the agreement involving the EU and Peru and Colombia, Montenegro and the European Free Trade Association, Hong Kong and the European Free Trade Association, and Indonesia and Pakistan. Nearing completion are, among others, the trade agreements between Costa Rica and Peru and between Canada and India, and negotiations are in various stages of completion for a range of others.
However, the situation is not always that straightforward. Although customs duty rates are generally reducing for international trade, these taxes still play a very significant role in meeting countries' budgetary needs. In many cases, duty rates on many goods and materials remain high. Additionally, the compliance obligation to access the lower customs duty rates, such as meeting strict country of origin requirements, means companies must maintain controls to enjoy the preferential rates or risk large assessments for violations.
Unlike VAT and GST, duties charged at one stage in the supply chain are not offset against taxes due at later stages, so duties form part of the cost base of affected goods. In addition, customs clearance procedures can add to the time and related costs of moving goods cross-border. And even where FTAs exist, many businesses are not actually obtaining the potential benefits offered because they cannot, or do not, meet the qualifying conditions.
More generally, global trade may be hampered by the current economic climate, which is encouraging protectionist tendencies, as evidenced by the current difficulties encountered in the Doha Round. Non-tariff barriers have grown substantially in recent years, many in the form of health, safety or environmental requirements. The WTO reported 184 new trade-restrictive measures enacted between October 2010 and April 2011 and 182 between October 2011 and May 2012.
In addition, where countries are not bound by FTAs, import duties are still a common and often-used means to steer trade and production. For example, to boost the development of sugar cane production toward meeting the raw sugar needs of domestic sugar refining companies, effective January 1, 2013, Nigeria now applies a 0 percent import duty on machinery for local sugar manufacturing industries, but it has increased the total tariff on imported refined sugar to 80 percent from 35 percent, and raw sugar tariffs increased from 5 percent to 60 percent.
Many countries are currently in the process of refining their indirect tax systems. In developed markets, long-standing VAT systems need to adapt to the demands of a 21st century digital economy. In emerging markets, which are experiencing economic developments at a fast pace, indirect tax systems need to adapt to keep pace. In India, for example, a new nationwide GST is ready to be implemented and only awaits agreement between the central and state governments. Similarly, China is in the process of combining its current business tax (BT) on services with a broader-based VAT through a series of VAT pilots. In the end, the VAT pilots and reforms are intended to join China's BT and VAT into a single GST, with the authorities targeting an aggressive timeline of 2015.
In the EU, the European Commission has launched a comprehensive reform of the existing VAT system. The Commission has identified no fewer than 26 priority areas for further action. Significant changes can be expected in the near future, such as the adoption of a one-stop-shop registration for all taxpayers' duties or a standardised EU VAT return.
The US is still far from implementing a federal VAT. But, even in the US, a trend can be seen toward states extending the scope of their current sales taxes. While sales taxes, by definition, only apply to purchases of physical goods, it is the market in electronically supplied services (such as digital music distribution, internet downloads or telecom services), which is growing fastest. An increasing number of states are, therefore, trying to expand their current sales tax to cover electronic goods and services or are trying to create a “nexus” for out-of-state vendors to constrain sellers to collect sales taxes on remote sales.
Finally, governments have discovered that, on the administrative side, the efficiency of indirect tax systems can be drastically improved -- which increases tax revenues. There are many approaches taken by governments, but an important one is to create common interfaces and reduce gaps in the system. This is one reason why many governments are enforcing the use of electronic data transmission and filing. The reason for this trend is clear: e-filing considerably eases processing the information for tax administrations and makes administration faster and more efficient. In addition, having electronic data enables tax administrations to use IT-based audit tools more easily, which can help to combat fraud and evasion.
Most taxpayers can also benefit from increased efficiencies arising from e-filing, but dealing with multiple tax administrations' different requirements and tax administrations' increased audit capacities means that greater focus must be given to the accuracy and efficiency of indirect tax compliance processes to avoid an increased risk of incurring penalties.
The growing importance of indirect taxes to governments places more pressure on tax administrations to enforce compliance. This focus is leading to greater scrutiny of taxpayers' affairs through more frequent and more effective tax audits and greater consequences for errors.
In December 2012, we conducted a survey of Ernst & Young Indirect Tax professionals in 39 countries.2 The responses given in the survey indicate that the number of tax audits has increased in recent years and is likely to increase further in the future. Only six countries reported that audits had decreased; even then, in some cases, while the number of audits carried out was said to be lower, the amount of additional tax levied due to tax audits is still increasing. This can be explained by tax administrations carrying out more targeted audits; 24 out of the 39 countries already use specialised IT tools, such as audit software, to detect irregularities or suspicious patterns in taxpayers' tax returns.
The level of exchange of information between countries varies widely. It is widespread in Europe, where the common EU VAT system requires an extensive information exchange. On a global scale, the multilateral Convention on Mutual Administrative Assistance in Tax Matters, which is open to all interested countries, facilitates exchange of information on all compulsory payments to the general government except for customs duties.3 In the last two years, more than 50 countries have either become signatories to the convention or have stated their intention to do so. But, even if countries do not (yet) share information, they increasingly exchange information internally, between different authorities and departments (e.g. with customs or social security authorities). Only 4 out of the 39 countries we surveyed do not share any information at all.
There is nothing to be said against stricter compliance enforcement if it actually helps to fight fraud and abuse. The other side of the coin, however, is that tax administrations have generally become more wary toward all taxpayers; they are less open to entering into discussion, and it is more difficult to reach mutual agreement on specific issues.
Tax administrations increasingly apply a strictly formal approach without considering specific economic and business issues. This has massive consequences, in particular for VAT and GST, where being compliant increasingly requires deep expertise, even more so as our survey shows that formal mistakes (e.g. missing information on invoices) are still by far the most frequent reason for VAT and GST adjustments, be it an additional tax charge or the denial of input tax recovery. In addition, we observe a tendency for tax administrations to pay out input tax surpluses with increasing delay -- if at all -- or to reject an input tax claim based on bad faith, stating that claimants should know that their suppliers did not handle the tax correctly.
At the same time, many countries are applying stricter penalty regimes in the case of non-compliance and mistakes. In our survey, 27 of the 39 countries reported that penalties are increasing, and only 3 saw a decrease. Fines are generally imposed faster and sooner and the fines are higher than in the past. Increasingly, fines are enforced for timing issues, such as late payment, where in the past tax administrations were more lenient on these issues (for example, Austria, Germany, Pakistan and New Zealand).
The trends identified in this article are not entirely new but they have become more pronounced in recent times. And it is precisely their continuing existence that indicates that they are important and long-term developments. All of these trends have a direct impact on businesses, which need to keep abreast of these changes.
Indirect taxes are not easy to manage. For example, excise duties, such as carbon taxes, change quickly and represent a high compliance risk because they typically operate differently in each country. Taxpayers who collect VAT or GST from final consumers on behalf of the state run increased risks of carrying the tax burden, and eventual penalties, themselves if they do not manage the tax correctly.
With tax administrations assessing taxes more thoroughly and using powerful and efficient tools, the chance that mistakes will be found has risen considerably and will remain high. Also, as indirect tax rates increase, the consequences of mistakes become more severe. This is particularly true for businesses that do not recover VAT or GST in full (e.g. because of VAT-exempt activity), such as banks and insurance companies. But higher rates also have an increased cost or cash flow impact on companies that incur VAT or GST in foreign jurisdictions, which is not refunded quickly, or which they do not or cannot recover (e.g. because of an absence of refund schemes for non-residents or because of complicated refund procedures).
As indirect tax administrations are turning increased attention to enforcement -- including joint audits with other taxes and even other countries -- these activities may disrupt business activity. Large assessments for underpaid tax or penalties for late filings do not only have an impact on profitability, they may draw unwanted adverse publicity, even for compliant businesses.
More than ever, it pays to manage indirect taxes proactively. Establishing a clear indirect tax strategy aligned to the overall business strategy will help in staying up to date with the rapidly changing tax environment and avoid the additional costs and risks of poor compliance or missed opportunities.
Claudio Fischer is a Senior Manager in Indirect Tax and Tax Policy Development at Ernst & Young AG in Switzerland.
Robert Smith is a Partner at Ernst & Young in China and Indirect Tax Leader for Asia Pacific.
The views reflected in this article are the views of the authors and do not necessarily reflect the views of the global Ernst & Young organisation or its member firms.
1 Environmental Taxation: A guide for Policy Makers, available at http://www.oecd.org/greengrowth/environmentalpolicytoolsandevaluation/48164926.pdf
2 The survey included the following countries: Australia, Austria, Belarus, Brazil, Canada, Chile, China, Cyprus, Czech Republic, Denmark, Egypt, Finland, Germany, Greece, India, Indonesia, Italy, Kazakhstan, Latvia, Malta, Moldova, Morocco, New Zealand, Norway, Pakistan, Peru, Portugal, Romania, Russia, Singapore, Slovakia, Slovenia, South Korea, Spain, Sweden, Switzerland, Tunisia, Turkey, Ukraine.
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