In the last decade, companies have increasingly automated their business processes. The most common method is by using an Enterprise Resource Planning (ERP) system. Such a set up can be hugely complex. This is definitely the case where it relates to European based indirect tax. As manual processes are subject to human error, automation could – under circumstances – result in performance improvements and savings.
A third party tax engine might be a better solution than improving the indirect tax functionality of its own ERP systems when the organization uses multiple ERP systems. Interfacing via a bolt-on could be a better alternative. Outsourcing is a topic for a next blog.
ERP systems such as SAP and Oracle either determine the VAT treatment (liability and VAT recovery) of businesses’ transactions automatically or this is a (semi) manual process.
Multinationals run often various versions of ERP systems or legacy systems without harmonization. The ERP set-up is often per business unit and thus multiple set ups per country are possible.
This could be the root cause that:
- running of system’s exception reports to look for missed opportunities, under claimed VAT and potential fraudulent transactions is still a challenging exercise
- a lot of manual (re)work is often needed to file the VAT reporting and reconcile the VAT numbers due to the use of multiple spreadsheets and various data sources (divisions, different systems)
The latter is interesting as spreadsheets are usually found at critical points in the audit trail and are designed by non-specialists with no system expertise .
An ERP system is not just an accounting system but also provides information about planning and production as well as being able to produce invoices and various reports.
Tax Controversy Strategy
The advantage of these systems is that management information is readily accessible and that should give some food for thought for tax auditors as well. Transactions from various business units can be monitored and managed on time. Is this something to take in consideration during updating or setting up your ‘Tax Controversy Strategy‘?
A ‘Material weakness’ Audit Item
The decision to adopt a particular ERP system is usually made for business reasons whereby the VAT administration is only a minor consideration or not considered at all.
Despite that according to Sarbanes Oxley the configuration of the VAT rules in an ERP system is a ‘material weakness’ audit item (a 1% mistake or less often impacts shareholders value), in practice, it is often still overlooked. The Global Survey of ‘KPMG Benchmark 2012′ confirms again that indirect tax policies are either not documented or monitored properly.
VAT as a transaction tax is an essential element within the ERP system. The impact of the ‘VAT Throughput‘ should be understood and managed properly within the organization (See also ‘Managing The Perception Of C-Level‘).
The advantage is that Indirect Tax functionality can be automated (full or to a certain extend) in a company’s own ERP system especially if SAP or Oracle is used. It is about mitigating of risks and reduce the amount of manual work and rework (the ‘hidden factory’).
Is the functionality of the ERP system used at full VAT capacity? What are the gaps and consequences?
The perception of Plug and Play
If you provide goods and/or services locally subject to the standard VAT rate it might be ‘Plug and Play’. That is the most simple VAT business model I could come up with.
In practice, configuration (the amount depends) is needed when companies deal cross border and/or complex business models are set up such as a centralized principal structure with for example a “Limited Risk Distributor” or a “Commissionaire”.
VAT Automation of Complex Business Models
There are all kinds of business reasons for centralizing supply chains and set up models like “Limited Risk Distributor” or “Commissionaire”. The challenge from an implementation perspective is indirect tax.
What makes it complex
Lets take LRDs/Commissionaires as an example.
LRDs/Commissionaires have neither legal ownership to the inventory during storage nor during transport as the Principal is at that stage still the legal owner. It is often the case that the Principal delivers the goods physically and directly to the final customer. This creates only one physical departure of goods (`goods issue’) in the ERP system. However, two invoices should be raised (one from Principal to LRDs/Commissionaires and one from the LRD/Commissionaire to the final customer.
In the ERP system, the correct ‘ship from’ information at the LRD/Commissionaire level might be missing so that the VAT treatment by the system is determined based on the ‘ship from’ and ‘ship to’ information present at the Principal level. In principle, for cross-border transactions this results in an incorrect VAT treatment.
Therefore, in practice, it is time consuming to correctly configure the ‘Tax determination logic’ set up. You need to know your practical workarounds, preferable in the design stage.
Even More Bottlenecks In Case of a Commissionaire Structure
A “Commissionaire model” has some more bottlenecks. A “commissionaire” is never the legal owner of the goods. From a VAT perspective, the commissionaire acts as though he were the owner and a fictitious supply takes place to and subsequently by the commissionaire.
Since according to civil law, the commissionaire does not have ownership, the commissionaire does not own any inventory not even temporarily.
That is different with the LRD as normally LRD gets ownership via flash title for a very short period. Tax technical risk analysis about e.g. “flash titles and transfer of economic ownership” is outside scope of this blog.
Based on the above the commissionaire has to issue invoices in his own name which can create problems if there are no bookings with respect to inventory.
There are all practically workarounds of course but that needs planning in time again preferably in the design phase.
For what can go wrong see “Indirect Tax Exposures Others Have Faced“.
General Overview VAT and Systems
If you like to know more about where VAT impacts the systems watch ‘Systems For Dummies‘.
Richard’s other Big4 publications
- How to Execute A Tax Strategic Plan And Be Successful
- About Market Leadership And Non Traditional Competitors
- How To Manage The Perception Of C-level And Realize Tax Objectives
- The Conflict Between ‘Actual To Budget’ Controls And ‘Budget-based Compensation Targets’
- Tax Controversy Strategy: ‘Proactively Managing The Changing Landscape’
- About ‘Business Integrity And ‘Being Inspired’
- The Indirect Tax Profession Is Evolving From An Individual To A Team Sport
- Would European Value Added Tax Work For The United States?
- US VAT Introduction Versus The Proposed Changes Of The ‘European Union’ VAT System
Richard Cornelisse is CEO of the KEY Group and worked previously as Big4 Partner in the Tax Performance Advisory and Indirect Tax Practice and blogs on Tax Function Effectiveness and Tax Control Framework developments.