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Why boards, auditcommittees andsenior executivesshould understandthe risks
Tax authoritiesare going digital
oday, new, digitally-enabled business models can be activated overnight.
A start-up can sell into more than 100 markets within 24 hours. Likewise, established businesses in allsectors are finding new ways for digital to drive innovative new revenue streams and support globalbrand.
Tax administrations around the world are going digital at an even more rapid pace, in some locations. Andmore and more often, they are creating new capabilities to interact with taxpayers at source, instead ofrelying on historical information from the tax return.
In some rare cases, they are demanding taxpayer data before a transaction has even occurred, or areaware of a transaction occurring within seconds of the cash register transaction. This turns the wholemodel of tax compliance on its head. And when digital advances are combined with the global revolutionin tax transparency, companies old and new are finding that revenue authorities are forging ahead at apace that has the potential to outstrip their ability to keep up.
The results can be unpleasant; they include internal disruption, operational risks, “surprise” taxassessments or audits, financial penalties and reputational risk.
But many boards, audit committees and senior executives remain unaware of the new risks andhow quickly they have evolved.
Tax authorities are going digitalWhy boards, audit committees and senior executives shouldunderstand the risks
T
1 An interview with Hans Christian Holte, EY, May 2018. ey.com/Publication/vwLUAssets/ey-a-discussion-with-the-hans-christian-holte/$FILE/ey-a-discussion-with-the-hans-christian-holte-issue-22-june-2018.pdf.
Governments are reaping significant returnson their investment in digital. Starting in 2015,for example, Russian taxpayers were requiredto submit value-added tax (VAT) transactionaldata along with their electronic VAT returns.That year, domestic VAT revenues increasedby more than 12%, the equivalent of aroundUS$4 billion (RUB267 billion). Mexico reports a38% increase in tax revenues without anincrease in headline corporate tax rate, whileBrazil reported a 42% increase over plan for2017 audit and penalties collected afterimplementing a series of new digital reportingrequirements.
What is digital tax administration?Digital tax administration has come far in recentyears. Indeed, the electronic filing of tax returns isnow more than three decades old in manyjurisdictions. In some nations, tax returns are nowautomatically pre-populated for taxpayers toapprove, taking in information from banks, brokersand other third parties, almost fully automating aprocess that for many previously represented aburdensome review of physical documents.
Although not the initial focus of attention, corporatebusiness taxes are now experiencing their time in thespotlight. “We clearly started this journey withpersonal taxpayers. I think the next wave will be thebusiness side,” says Hans Christian Holte,Commissioner of Norway’s tax authority and Chair ofthe Organisation for Economic Co-operation andDevelopment’s (OECD) Forum on Tax Administration,a collection of more than 50 tax commissioners whoregularly share ideas and insights with each other.
So what does digital tax administration look like, andwhat exactly are revenue authorities trying toachieve?
Tax authorities have many reasons for their journeysinto digitalization. The first was out of necessity —only by applying digital techniques could taxauthorities start to address the shadow economy.Second was efficiency as at a broader level, allgovernment departments have found that they need
to do more with less. Shrinking internal budgets,while still under pressure to deliver revenue was akey driver.
Chiefly, collecting more tax revenue (and earlier)heads the list and data matching and advanceddata analytics can be used to identify not only taxfraud and evasion, but also to tackle what theyconsider to be aggressive tax planning.
Key characteristicsWhile there is no one-size-fits-all approach, thereare two common characteristics playing out withinevery tax authority:
First, governments are requiring more and moresource accounting and transactional data to besubmitted in digital form, creating a “web” oftaxpayer data to which data matching and dataanalytics routines can be applied. The types of datarequirements — which tend to be layered upon oneanother in quick succession, once a tax authoritydecides to go digital — vary widely, but include:
• Electronic invoices (e-invoicing) are a commonrequirement, and an early sign that a revenueauthority is digitalizing more widely. E-invoicesare typically generated on a per transactionbasis, and, in many emerging markets, oftenrequire tax authority approval before thetransaction can commence. Formats andtransmission modes vary from country tocountry, and this can pose a real and ongoingchallenge to international taxpayers.
• Electronic accounting information includes abroad range of accounting and financialinformation, including general ledgers, trialbalances and journal entries as examples. Theseare typically submitted to a tax authority inprescribed formats, on a periodic basis, withmany countries requiring monthly or quarterlysubmission. Again, formats differ around theworld, with no common standard anywherein sight.
• Standard Audit File for Tax (SAF-T): SAF-T filesare pre-defined audit files that must besubmitted to a national tax authority, either ondemand or on a regular schedule. SAF-Ttypically addresses all tax types, as well as alsoincorporating many of the electronic accounting
2OECD publishes two handbooks on Country-by-Country reporting, EY Global Tax Alert, 3 October 2017.ey.com/gl/en/services/tax/international-tax/alert--oecd-publishes-two-handbooks-on-country-by-country-reporting.3An interview with Jeremy Hirschhorn, EY, November 2017. ey.com/gl/en/services/tax/ey-an-interview-with-jeremy-hirschhorn.
• data types. While SAF-T adoption started(around 2009) in Europe, it has been adoptedmore widely recently. While there is a suggestedstandard, many countries substantially deviatefrom it.
The second characteristics – employed once taxauthorities have sourced all of the above datatypes is that they are becoming far more advancedin their use of data matching and data analytics. Allof the data sources noted thus far — along withmany others, including a company’s country-by-country reports — are combined to form a completecorporate tax profile. Data analytics and datamatching are then utilized, often right across acompany’s supply chain, highlighting errors(intentional or not), data inconsistencies, systemicfraud and compliance risks.
The OECD, in fact, published a handbook of 19tests that it thinks all tax authorities should berunning across the data submissions for largemultinational companies’ (MNCs). But many taxauthorities go far further. As Jeremy Hirschhorn,Deputy Commissioner for Groups in the AustralianTaxation Office, said in a recent interview with EY,“We have approximately 100 risk factors that weapply to international dealings, and the aim is tomake these transparent over time. That waytaxpayers can consciously decide whether theywant to take a low or a high risk position. We callthis 'setting out the flags' at the beach.”
Key global trendsGraphic 1 illustrates the current state of digital taxadministration, with each of the country’s digitalmaturity levels (1–5). Below are some key points,regionally, on that graphic:
Graphic 1: Global tax authority digitalization maturity
• Initiatives vary by country,with few common trends
• India requires reporting ofdetailed invoice data
• China introduced datareporting through its 1,000accounts plan for select largetaxpayers
• Key focus countries: Russia,China, India
• Growing number of countrieshave/are adopting theOECD’s SAF-T guidance
• SAF-T Includes the regularprovision of detailed invoiceand accounting data
• Other countries haveadopted their own variationsof digital data reportingrequirements
• Key focus countries: Spain,Poland, Italy, UnitedKingdom
A pioneer region in digital taxadministration and arguably themost mature• Jurisdictions’ primary
objective is to raise taxrevenue by detecting fraudand tax evasion
• Focus on e-invoicing andtransactional accountingdata; emphasis on inter-country sharing
• Key focus countries: Mexico,Brazil, Chile, Peru
Americas EuropeAsia-Pacific
Countries want to move to real-timeanalysisAs well as increasing their overall levels of dataacquisition and data analytics, tax authorities aremoving to real-or near real-time tax compliance,demanding data immediately after (and in somecases, even before) a transaction has occurred.
This completely disrupts the traditional taxcompliance life cycle and, in turn, the tax andfinance departments, which must now deal with acompliance timeline that has changed from severalyears to just 90 days, and often shorter.
Moreover, digital tax administration presents amajor organizational challenge to the taxpayer;while the finance department may submit someelectronic accounting information, the taxdepartment is then responsible for submitting thebalance and also then addressing incoming taxauthority inquiries — and, in time, tax audits.
Four key areas of riskSuch significant change also brings significant risk.With more countries moving data acquisition“upstream” (i.e., closer to the point where atransaction originally occurred), unless changesare made companies will be submitting data thathas not tax sensitized, checked for errors andgenerally prepared for final submission (i.e., as itwould be for a tax return).
As a result, there are growing frictions betweentaxpayers and taxing authorities in countries thatare going digital. Audit notices tend to increase,and companies find that they have to respond toincoming inquiries in a far more efficient and timelymanner, creating a litter of penalties if they fail tokeep up. In some unfortunate cases, requests fortax refunds may be rejected should the taxpayer bedeemed to be noncompliant in other areas.
But these are not the only dangers. Broadlyspeaking, digital tax administration risks tend tospan four key areas:
Operational risks — a common examplebeing where e-invoicing requirements arein place, clearance may be needed from thegovernment before moving forward with aspecific transaction. In effect, what shouldbe a relatively simple task to complete hasthe potential to bring business to acomplete halt.
Internal disruption — meeting digital taxadministration requirements requires closecoordination between tax, finance and ITdepartments, particularly when datasubmission requirements are rapidlychanging. But where such coordination isnot planned in advance and companies findthemselves in a reactive state, IT projectsbecome mission critical and financeprocesses must be re-engineered withoutwarning. This causes internal disruptionand the inability to
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How the leading companies are respondingPreparing for digital tax administration today isrelevant and necessary. When forming a response,a key first question companies are askingthemselves is “Who owns this in our organization,and who has visibility into how we are complyingwith these new and ever-changing requirements?”
Next, companies are asking themselves whetherthey should adopt a global (or regional) approachor develop point solutions in each and everycountry. Generally speaking, while formats anddelivery schedules may be very different, allcountries do in fact have some level of consistencyin what they are asking taxpayers to deliver. Aglobal or regional response is therefore a moreefficient and cost effective proposition.
Companies must then assess their readiness, definean enterprise-wide strategy and assess dataintegrity and quality before finding ways to bothpre-test the data they are submitting and thenstreamline data submissions and the ways in whichthe company will respond to any incominginquiries.
Final thoughtsDigital tax administration is a rapidly evolvingtopic, and a country’s progress is not necessarilylinear. Many countries are only beginning theirjourney, while others are far ahead, alreadyexperimenting with the possibility of reachingdirectly into corporate Enterprise ResourcePlanning (ERP) systems or connecting directly topoint-of-sale cash registers to track sales. Somecountries (emerging markets especially) mayleapfrog from zero to advanced in a very shortperiod of time. Others may be struggling withlegacy systems, and the forward progress may beslower. But for most MNCs, the truth is that theywill need to deal with revenue authorities rightacross the digital maturity spectrum. That meansworking hard to get onto the front foot, drivingefficient operating models and building changemanagement and flexibility into finance processes.
execute previously planned projects.Likewise, many companies may experienceduplication of efforts, with both the taxand finance departments working onidentical efforts and solutions.
Financial risks — many countries imposeautomatic penalties in the hundreds ofdollars for every single transactionalmistake, however small. This includes dataquality issues such as missing requiredfields on invoices, incorrect formats andother seemingly minor infractions. Withsome companies making hundreds ofthousands of transactions, the penaltiescan quickly amount to millions of dollars.
Audit aggressiveness — alongside shiftingdata submission requirements, many taxauthorities are also demonstrating higherlevels of audit aggressiveness in this area.They are implementing higher levels ofdata analytics and data matching,generating a greater number of incominginquiries — many of which areelectronically generated, without humanintervention. And where an incominginquiry triggers an audit, such audits tendto be quite aggressive in nature.
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Questions the board should be asking1. Do we have the proper governance and
global operating model, demonstrating riskaversion, visibility and cost effectiveness?
2. Is our approach to digital and technologykeeping pace with that of the taxauthorities?
3. How are we monitoring global changes tosubmission requirements and preparing fornew mandates?
4. Are we confident that our data quality andgovernance is sufficient?
5. Do we have visibility and understanding ofwhat the tax authorities are doing with ourdata?
6. How do we integrate digital audit defenseactivities into our tax team’s dailyprocesses?
Albert LeeAsia Pacific Digital Tax [email protected]
Aidan StokesEMEIA Digital Tax [email protected]
Frank CambieTax Technology and [email protected]
Yuko KearnsJapan Digital Tax [email protected]
Learn more: scaling the digital tax divideWhy boards, audit committees and executive leaders should know about new digital tax policies
The rapid pace of technological advancement and the ability to trade goods and servicesseamlessly and instantly across borders continues to exercise the minds of international taxpolicymakers.
At the heart of the debate is the question of whether net profits derived from the sale ofdigital goods and services can be taxed using traditional methods of taxation or whether anentirely new approach is required.
This is resulting in a number of both multilateral standard setters and individual countriesdeveloping new policy options. In turn, this impacts both current and future digital projectsof businesses of all sizes in all sectors.
As a result, the impact of new digital tax policies may need to be incorporated into investorcommunications. Investors need to know about tax issues related to digital activities thatmay reduce profits if these taxes go into effect. They also should be informed about thepossibility and potential impact of restructuring parts of a digital strategy or even the needto exit lines of business or markets completely depending on how tax proposals advance.
Scaling the digital tax divide is a short, new EY article designed with the C-suite, board and auditcommittee audience in mind. It is designed to help educate these audiences on why this digital debate isoccurring, setting out the high level contours of the debate and the related proposals, and offeringexecutive leadership a number of questions to ask themselves. Scaling the digital tax divide may bedownloaded at ey.com/tpcbriefing.
Contacts
Rob ThomasDirector — Tax [email protected]
Chris SangerGlobal Tax Policy [email protected]
Channing FlynnGlobal & Americas Digital Tax [email protected]
Carolyn BaileyAmericas Digital Tax AdministrationServices [email protected]
Cheryl BellesBusiness Tax [email protected]
Tony LaBoveBusiness Tax [email protected]
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