Chapter 1
Understanding VAT trends
As VAT regimes spread, it’s crucial to understand rate volatility, issues around fraud and digital reporting requirements.
1. VAT is growing in popularity and importance
As a percentage of global taxation, VAT has grown steadily in importance from less than 5% in the 1960s to a peak of almost 20.2% in 20161, according to the Organisation for Economic Co-operation and Development (OECD) data. It has levelled off since – largely as a result of the global financial crisis at the beginning of this decade. At its core, the expansion has been due to nations wanting to reduce their corporate income tax rates, which serve as a means of attracting and retaining businesses.
“Most nations have, for most of their histories, relied on income tax to support their treasuries,” says Gino Dossche, EY Americas Indirect Tax Compliance and Reporting Leader. “By introducing VAT, increasing VAT rates, or implementing base-broadening measures, they are able to reduce, or at least avoid increasing, their corporate income tax rates without a net loss of tax revenue.”
As a percentage of global taxation, VAT has grown steadily in importance from less than 5% in the 1960s to a peak of almost 20.2% in 2016.
2. Nations are pushing the limits on how high VAT rates can go
In addition to the growing popularity of VAT, a growing number of jurisdictions that have implemented these types of tax are increasing their rates. Worldwide VAT rates began trending upward following the financial crisis, according to the OECD, peaking at 19.3% on average in 20152. They have remained stable since, although the OECD says that 10 nations now have rates above 22%, up from four in 2008.
“Whenever VAT is introduced, there’s always the risk that whatever the initial rate, it is something that will be raised later on,” says Geert Vandenplas, EY Global Indirect Tax Compliance and Reporting Leader.
Hungary, for example, hiked its rate to 27% in 2012, making it the highest rate in the EU and one of the highest globally. In practice, most jurisdictions view 20% as the practical, upper limit owing to the risk of fraud and the perceived regressive nature of VAT. “Particularly at higher levels, it begins inflicting too much cost on too many members of society,” says Vandenplas.
3. VAT rules and rates are entering a period of volatility
Tax rules the world over are in flux and VAT is no exception. In countries where it already exists, for example, tax authorities are doing all they can to raise revenues by broadening the base. “Specifically, they’re looking for goods and services that may have a lower-than-standard rate where VAT can be increased,” explains Dossche. Commonly zero-rated or exempted items include newspapers and periodicals, financial services, real estate, medicines, food and (non-alcoholic) drink and transportation.
Further, a growing number of jurisdictions are turning their attention to an emerging source of revenue: cross-border e-commerce sales. “A topical issue is the trend to update VAT law and policy to cope with the new technological world,” says Aaron Bromley, EY Asia-Pacific Indirect Tax Compliance and Reporting Leader.
VAT rates
19.3%Average worldwide VAT rate in 2015, a figure which has since remained steady.
“In Asia-Pacific, authorities are looking more closely at in-bound digital business-to-consumer (B2C) services by foreign service providers, as well as the import of low-value goods. The latter are typically ordered online via online platforms and may not have historically incurred VAT at importation due to relevant thresholds. B2C transactions have in many cases slipped through the gaps, with legislation only taxing B2B via a ‘reverse charge’.’” Rule and rate changes for both are underway or imminent in China, Malaysia and Singapore, among others, according to Bromley.
4. VAT fraud is alive and well
As nations turn to VAT for an ever-greater portion of their tax revenues, VAT fraud – when a business presents a refund request for VAT that was never paid or fails to deliver VAT, that it collected from its customers, to the host government – is coming more into the spotlight.
The issue is commonplace among developing nations. The UN’s Economic Commission for Latin America and the Caribbean (ECLAC) says3 that VAT evasion across Latin America has grown substantially, accounting for US$120 billion in missed revenues in 2015 alone.
In more developed economies, there has been some success in reducing VAT fraud. The European Commission, for example, estimates it reduced its VAT gap – the difference between expected VAT revenues and what is actually collected – from US$161 billion in 2016 to US$150 billion in 2017.
Consequently, governments are focusing more time and effort on reducing VAT fraud by overhauling their systems. In turn, this puts pressure on businesses to keep up with tax authorities’ changing systems and the latest technology.
5. Growing digital reporting and compliance requirements
Largely in response to the rise of VAT fraud, but also stemming from the rise of the digital economy and the general desire among tax authorities to reduce their operating costs and improve efficiency, VAT is “going digital.”
Traditional VAT compliance used to be a relatively relaxed affair. “Filing was always of a summary nature, never highly detailed,” says Dossche. “You could close your company books the first week of the next month and then still have 10 to 20 days to make corrections before filing your VAT forms.”
But no longer: “What we’re seeing now – and this will accelerate – is a shift to real-time, fully digital VAT reporting,” says Vandenplas. “You will no longer have time to make corrections before you file these digital reports. Each country will have its own rules for addressing errors or updates – fines and assessments for missteps will likely be more frequent.”
What we’re seeing now – and this will accelerate – is a shift to real-time, fully digital VAT reporting.
Digital VAT reporting took off initially in Latin America primarily in response to fraud. Brazil was the first, introducing sweeping new measures in 2008 requiring corporations to begin filing their VAT transactions digitally. Any intracompany, B2B or B2C sale must now be accompanied by a digital invoice that vastly improves the Brazilian tax authority’s ability to monitor transactions.
Similar measures were implemented in Mexico, which introduced a “factura electrónica” protocol for all invoices in 2011. More recently, beginning in 2016, but due to reach full rollout in January 2020, Poland introduced an electronic VAT regime with a key form now required monthly – and six more that must be “at the ready” if called for by authorities.
Today, the UK is entering the realm of digital VAT filing. Making Tax Digital is Her Majesty’s Revenue and Custom’s (HMRC) broad-based program for digitalization of the whole of the tax administration. As of April 20194, firms with sales of $105,000 or more are required to maintain and file their UK VAT forms in a digital format.
In Asia-Pacific, only a handful of countries, such as South Korea and Indonesia, require transaction-level digital reporting, but change is coming. “For now, most are merely offering electronic filing of overall VAT returns – few are making it mandatory,” says Bromley. “However, digital reporting is a trend we see accelerating in the near future.”
Chapter 2
The VAT opportunity
Even as companies must navigate VAT-related upheavals, the disruption presents an opportunity to rethink tax planning and compliance.
The net result of these trends is a growing list of challenges for companies to negotiate. Many are hamstrung by legacy organizational structures. The lack of any harmonized standards around the world has led many multinationals to take a decentralized approach to tax in general and VAT in particular.
VAT is often delegated to the local finance team to manage. “Having different, often non-tax or VAT-versed, internal people preparing returns, the lack of a standard process and typically little visibility from a regional or global perspective, leads to heightened costs and risks,” says Bromley.
A rising risk for businesses, as technology requirements increase, is the proliferation of point solutions. Local tax or business teams, in a hurry to achieve compliance with a new digital VAT regime, may be apt to overlook strategic solutions and may be more tempted to contract with local vendors. “This is not only inefficient but, because of the difficulties in due diligence, also exposes the company and its tax department to vendor risks,” says Bromley.
The shift to consumption taxes presents companies with a compelling opportunity to fundamentally rethink their global approach to tax planning and compliance.
Businesses also face the ongoing and ever-growing challenge of finding the right talent to keep their global VAT processes running efficiently. “With so many changes happening so often, you need tax talent that understands the local environment and is keeping up with it,” Vandenplas says. At the same time, they must also be able to work with a global view, in particular helping to reduce tax risk and compliance costs by collaborating to harmonize processes across a global network. “Professionals with this range of experience are becoming more costly and harder to recruit and retain,” says Vandenplas.
Seizing the opportunity
Tax administrations’ shift to consumption taxes presents companies with a compelling opportunity to fundamentally rethink their global approach to tax planning and compliance. The ultimate objective should be to create greater standardization across global operations, reducing the number of adjustments that are required at a local level. In this way, expertise is concentrated and leveraged, while workflows and compliance are optimized.
A key consideration is a company’s ability to keep up with real-time reporting requirements. “The technology investment needed to do that can be too great for a single entity or even a group of companies,” says Vandenplas. “For example, if you are using technology built to serve lots of companies, it is more likely to have the latest and greatest technology tools and insights, which in turn can reduce costs and risks of missing compliance deadlines and key information.”
Increasingly, the use of outsourcing and co-sourcing options in the execution of global VAT compliance is gaining credence. “You need the right expertise in the right places. Plus, you need to be current on developments and changes in each country all the time,” says Vandenplas. “These are conditions that are ideal for an outsourcing or co-sourcing model, where you can achieve cost savings and work with a provider that has similar experience in other markets and can introduce leading practices.”
Summary
More than 160 jurisdictions now collect VAT revenue, accounting for approximately 20% of global taxation. Goods and services subject to VAT, including cross-border e-commerce, are also on the rise – as is real-time VAT reporting. The undeniable compliance burden of VAT can be transformed into an opportunity, however, if companies create greater standardization across their global operations. Many are using outsourcing and co-sourcing options to tackle the problem.
