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VAT determination: avoiding the domino effect

Aamer Bhatti

EY MENA Indirect Tax Leader

7 minute read 12 Sep 2023
Related topics
Tax
Technology
Tax compliance
Tax planning

Technology can be utilized by organizations to address the difficulties associated with the implementation of VAT.

In brief

  • Accurate value-added tax (VAT) determination is critical for organizations to comply with tax regulations.
  • The challenges in VAT determination include setting tax rules, consolidating data from multiple systems, incorrect tax codes, and frequent regulatory changes.
  • Technology solutions such as tax engines, ERP systems and automation tools can help organizations overcome these challenges and achieve accurate VAT determination.

Most businesses have experienced many technology-related issues during the implementation of VAT. The introductory article  in the MENA Tax Technology series reflects on the common technology-related issues businesses have experienced and more importantly, how to mitigate them. 

This article provides an overview of VAT determination, its significance for businesses, some of the challenges related to determining VAT, and using technology to arrive at the correct amount of VAT accurately.

VAT determination and its importance 

VAT determination allows organizations to identify the business scenarios where products and/or services are taxable and accordingly, the applicable tax rate and tax point. In layman’s terms, your business process needs to be able to define who bought the product or service, what product or service was purchased, when it was purchased, where it was purchased and how much they paid for the service. This information is subsequently used to determine how much VAT will be paid on the transaction in question and who is responsible for paying the VAT. 

However, there are multiple variables when you are trying to determine the amount of VAT to calculate and charge on the sales of your own sales of goods and services, also known as your output VAT.  It’s a common misconception that these variables are defined in the tax law or regulations; however, this is not the case. When governments introduce indirect taxes such as VAT, the regulations are for the masses and can be likened to a framework where the main structure is defined and organizations then need to tailor the regulations around their own business processes to be able to fill in the blanks. Failure to do so could lead to incorrect calculations which subsequently could result in an incorrect tax return, which in turn, could attract a fine. 

If we look at the technology journey of the VAT lifecycle, the first and most important step is to be able to configure your VAT determination process correctly. Accurate VAT determination should result in the correct VAT treatment for each transaction and subsequently, the rest of the VAT lifecycle is set on a firm foundation. This will ensure that organizations are collecting and subsequently paying the correct amount of VAT on each transaction, which in turn, helps organizations to arrive at the accurate amount to be paid to the tax authority. In addition, having your VAT determination done correctly will come with additional benefits such as reduced risk of cash leakage which in turn results in better cashflow management, accurate reporting, improved compliance and risk processes.   

VAT determination and the challenges

VAT determination can be a challenge for a multitude of reasons. Some of the most common challenges include:

  1. Inadequate data on application of tax rules: As VAT has recently been introduced into the region, there is not enough precedent for certain cases, which makes setting tax rules difficult at times. As an example, in the UAE, there was considerable confusion on the treatment of dividends and the management fee of said payments until the FTA published an official clarification in 2022 stating the dividends are not subject to VAT but the management of the payments are.
  2. Complex IT landscapes: Organizations with complex landscapes that include multiple systems with multiple data points often have issues consolidating data into a tax engine or any other system where their determination takes place.
  3. Complexities pertaining to tax codes: Although some organizations may have a tax engine or have their ERP configured to accommodate tax codes, it is often the case that tax codes either do not exist entirely, are too complex or are mapped incorrectly.
  4. Frequent changes: VAT regulations can change frequently, which can make it difficult to stay on top of the latest requirements. This may result in errors and noncompliance.

In addition to the above, there are other factors that can also make determination a challenge. When multiple issues exist, they have a compound effect — think about trying to unravel fairy lights that were put away during the last holiday season and are now in a tangled ball.

How EY can Help

Compound effect of wrong VAT determination

A tax point determines when tax is due and without determining the tax points correctly for every business scenario, organizations may have to deal with calculation errors. While controls such as the format and percentage to name a few would pass, the reporting may be incorrect, including important items such as tax returns, e-invoices and management reporting, just to name a few. Below is an example of the domino effect when VAT determination goes wrong.  If we take the same scenario and multiply it by hundreds of transactions, this could have a significant impact on cash flow.

 

Example scenario A
  • “Customer A” placed a deposit of AED105 for a service on 24 January 2022 from “Organization B”, an organization based in the UAE. 
  • The total amount for the service is AED1,050 (inclusive of VAT) and the service is due to be delivered in March 2022.
  • Initially, Organization B was declaring the full amount of VAT of AED50 upon receipt of the deposit in their January VAT return.
  • However, only AED5 was due to be paid in the January 2022 VAT return and the remaining AED45 would be due in the March 2022 tax return upon the completion of the service. 

Many organizations believe that the above can be resolved with “tax codes;” however, this at times can complicate the situation even further. As an example:

 

Example scenario B
  • An organization in the UAE that operates in a single Emirate and sells “standard-rated” supplies only.

Most people will treat this scenario as a simple one, as the assumption is that only a couple of tax codes are needed as there would be a single output box and a single input box. However, codes are also required for any taxes being claimed back under the bad debt-recovery scheme. This means that an organization- will need two codes for a single output box on the VAT return. Additionally, if the data originates from multiple systems, the organization may want to keep the tax codes different to help easily identify the originating system. Now, there are potentially four tax codes for a single output line. 

If the organization then decides to open in additional Emirates, this could result in 12 tax codes. Being able to track your reverse charges is another important factor, which results in another “X” number of codes. The list of codes can go on indefinitely. It is important for guidance throughout this journey to avoid ending up with a web of codes that requires even more time to extricate.

 

Selecting the correct technology

Technology solutions can help automate the VAT determination process. There are a range of solutions available and picking the right solution depends on many factors including your existing IT landscape, budgets, and your overall tax transformation strategy. The Tax, Technology & Transformation (TTT) teams of EY can assist you in selecting the correct technology that matches the needs of your organization.

 

One of the available solutions for organizations is an offering from our alliance partner Thomson Reuters — ONESOURCE Indirect Tax Determination (OITD). OITD comes with ready content for over 205 countries across the globe, which is managed and maintained by the Thomson Reuters team. Therefore, any updates in regulations or legislation that impact your determination are automatically updated. OITD has certified integrations for SAP, Oracle and Microsoft, which makes the solution very easy to connect to your existing IT landscape. The solution is available both as a cloud offering and on premise; and has been established in multiple sectors such as FMCG, oil and gas, banking, finance and manufacturing to name a few. In addition, if you have a highly complex landscape with multiple systems, it can become your single source of truth, as OITD can connect easily to multiple systems.

 

Furthermore, EY is a Diamond tier ONESOURCE Certified Implementer Program organization. Combining ONCESOURCE OITD with existing technologies, deep tax experience and a connected global network of the EY organization will help us guide clients as they embark on digital and business transformation to simplify tax processes, reduce operating costs and maintain transparent global tax compliance.

 

Why work with EY?

Taxes and tax-related processes are becoming technologically advanced and often drive business transformation.  The EY TTT team helps clients realize transformational benefits through system integration and business integration for tax by transforming tax functions into intelligent tax functions.  TTT operates as one connected team across the globe with physical hubs in the key markets, including MENA. With EY teams across EMEIA, we will be able to assist you in your tax transformation journey. This in turn means that you get access to professional minds in every jurisdiction that EY operates in.

 

With all the recent indirect tax developments and rapid overall digitalization of tax processes in MENA, EY TTT and Indirect Tax specialists have begun working hand-in-hand. Together they have implemented effective indirect tax solutions for multiple organizations across the world. Furthermore, the TTT team works very closely with all our alliance partners to ensure that we are always at the forefront of technology, to be able to recommend the best-fit-solution for your organization.

 

What’s next?

Next articles in the MENA Tax Technology’ series focus on data quality management, managing VAT reporting and VAT controversy.

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    Summary

    Organizations can leverage technology to mitigate the challenges that come with VAT implementation. Accurate VAT determination is critical in identifying business scenarios where products and services are taxable and accordingly, the applicable tax rate and tax point. The article outlines some of the challenges of VAT determination, such as tax rules, complex IT landscapes, tax codes, and frequent changes. If VAT determination is not done correctly, it can have a domino effect on cash flow, tax returns, e-invoices, and management reporting. 

    About this article

    Aamer Bhatti
    EY MENA Indirect Tax Leader
    Indirect Tax leader at EY MENA. Global experience of managing indirect taxes and VAT implementation. Delivering the exceptional EY experience. Father of two. Loves travelling and the outdoors.
    Related topics
    Tax
    Technology
    Tax compliance
    Tax planning

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