Top Tax Considerations for SAP Customers

Discover the VAT Revolution: Four Trends in Tax Reporting That Can Impact Your Business

By Brianna Shipley, Senior Editor, SAPinsider

Do you remember playing the game telephone? Multiple people form a circle and everyone, in turn, repeats whatever message they just heard from the person on their left to the person sitting on their right. The message, which must be whispered and can only be delivered once, continues in this way around the circle until it is shared with every person.

Inevitably, the message reported by the last person in the circle is quite different from what its original storyteller intended. This, says Christiaan Van Der Valk, Vice President of Strategy at Sovos, is a good analogy to understand why value-added tax (VAT) was created. In the game of telephone, as the whispered message travels from person to person, its meaning is naturally lost in translation. Inserting a control at every stop, however, would save the last individual in the circle from the inevitable embarrassment of having to reproduce the corrupted message. This control would also distribute and manage the risk more evenly throughout the chain, and the final result would be of higher quality.

“VAT is a very clever tax in that it works between businesses to ensure, in part, that the quality of the transaction is retained at each step in the supply chain, and also that the tax is distributed throughout the supply chain, not simply placed on the final stop in the process,” says Van Der Valk.

In other words, as a product or a service that is subject to VAT moves along the supply chain, transactions are documented, allowing the government to verify whether VAT was introduced at each step correctly through audit. “VAT is great in theory, but it leaves massive holes in practice,” says Van Der Valk. “Even though documentation might be out there, verifying the reliability of that documentation at every step in the supply chain based on aggregate periodic reports, paper-based records, and auditing companies’ diverse accounting systems is an almost impossible job for millions of supply chains around the world.” The result? A VAT gap, which the EU reported to be 140 billion euros last year.

To fill in this gap and increase visibility and control, tax administrations are undergoing a digital transformation. According to Van Der Valk, four notable trends in VAT and technology have emerged that will have a significant impact on businesses. He says, “It is important that businesses recognize these trends as revolutionary in nature, as opposed to evolutionary. Viewing them as the latter is, in my opinion, very dangerous.”

Tax Authorities Now View Technology as an Opportunity, Not a Threat

To understand how this revolution in VAT will affect your business, you must first understand the history of digitization through the eyes of tax administrations. Van Der Valk sees this journey as happening in two phases, with the first being tax administrations’ conservative attitude toward companies experimenting with digital technologies prior to 2003. Tax authorities didn’t have enough experience with digital technologies to fully adopt a digitized method for auditing, so governments told businesses that it was acceptable to dematerialize office documents and other types of transactions with the exception of invoices, for example, or other documents that are critical to the audit of VAT.

“Tax-relevant documents therefore were carved out from the scope of digitalization projects and tax audits continued to be in part based on paper invoices and similar key transaction evidence. Some countries allowed invoices to be digital, but only if very high standards of digital authentication could be guaranteed. However, these countries were not using technology to radically change the legacy approach, but rather providing conditions for legally treating electronic data as equivalent to paper for purposes of traditional audits. This timid approach is often referred to as ‘post audit’ electronic invoicing,” says Van Der Valk.

Christiaan Van Der Valk, Sovos Christiaan Van Der Valk, Vice President of Strategy at Sovos

Then, in 2003, Chile was the first country where tax administrations began to look at technology as an opportunity for VAT, rather than a threat. “Tax administrations realized that as long as they could tell businesses how to use technology, they could achieve better control. After a period of optional use, they started to require that large businesses integrate their systems with government systems and send invoices in real time, giving tax authorities more visibility into and influence over invoicing processes,” explains Van Der Valk.

An important aspect of this e-invoicing model is referred to as invoice clearance, according to Van Der Valk. “Not only did the government tell businesses to transmit invoices with them in a digital way at the time of the transaction — the government also mandated that they would need to pre-approve those invoices,” he says. “This means that if you’re a supplier, you typically have to send your invoices to the government for approval through a machine-to-machine connection before you can issue the invoice to your buyer.”

These models subsequently evolved in many different directions across Latin America and beyond, together forming what today many call continuous transaction controls (CTC), and this trend — the first of the four to be discussed in this article — has made its way to countries around the world, including Turkey, Korea, Taiwan, Italy, Spain, and Hungary, and it is being introduced in many other European countries, such as Greece. These controls, says Van Der Valk, have led to operational concerns for businesses.

TREND #1: Continuous Transaction Controls

Increased Controls Turn Up the Pressure for Standardizing Technology Ecosystems

The high-level blueprint of CTCs remains the same across countries, but the way each country handles decisions relating to system authentication, how information is sent, process orchestration, and implementation varies place to place. As a result, small, local businesses are often less impacted by this first trend because, in most cases, a resident software vendor can be utilized to help them adjust to changing tax controls based on their country’s requirements.

However, for international companies trying to consolidate, centralize, and optimize their global processes using SAP software or some other ERP system and associated technologies, having a very large base of common processes can be difficult when also trying to accommodate changing and country-specific mandates.

To add another layer of difficulty, tax mandates are typically introduced very aggressively, allowing companies limited time to meet them. This results in organizations relying on local vendors to help them meet compliance in an ad hoc fashion, so that invoice processing is determined based on local tax rules. Companies end up fragmenting their core financial processes because they have different invoicing and core financial document f lows managed by local vendors in every country.

“This puts a lot of pressure on international companies to divert resources away from their digital transformation so they can address these ad hoc panic fixes to country CTC mandates,” says Van Der Valk. “Utilizing tax technology that helps businesses deal with the implications of this trend more strategically is the key for organizations to make independent decisions as to how they want to evolve their business and their IT, regardless of ongoing changes in tax rules.”

TREND #2: Destination Taxability

E-Commerce: The Taxability of Digital Services, Digital Goods, and Small Packages

One segment of business that has emerged from business and IT evolution is e-commerce and digital services. “This class of business did not exist 10 to 15 years ago, and many of these companies are multi-billion dollar businesses, such as Amazon and Airbnb, that were born in the digital age and are really software companies at heart,” says Van Der Valk.

E-commerce has been difficult for governments to control from a tax perspective because of its digital nature. Many digital services naturally cross borders without anyone ever really noticing — and small packages have historically been ignored by customs authorities, according to Van Der Valk. In response, governments have had to change the concept of taxability for digital services and small packages by tightening laws and practices to enforce tax reporting and payment at the point where the goods are received.

Van Der Valk refers to this trend as destination taxability and says that businesses accustomed to shipping packages and providing digital services to consumers around the world somewhat under the radar now need to understand different tax rates and mandates. These companies will also likely need to report and pay VAT in all the countries where consumers exist.

“If you are in e-commerce or the digital services business, your company is experiencing a massive increase in how the complexity of tax impacts your costs and day-to-day operations,” Van Der Valk says. “And it isn’t just these digitally born companies that are affected — there are plenty of traditional companies, such as consumer goods, that have also started doing their own direct-to-consumer e-commerce and sometimes very successfully, so those companies are impacted by this trend, too.”

TREND #3: Aggregator Liability

Alleviating the Operational Burden on Tax Authorities

To understand the third trend, think again from the perspective of tax administrations. At this point in their digital transformation journey, tax authorities have forced, through CTCs, billions of transactions’ start and end points to integrate with their cloud systems every week. This, in turn, has created a large operational burden for tax administrations, which now need to approve every transaction — or at least receive every transaction — in real time, requiring them to have massive infrastructure. To avoid slowing down the economy and to alleviate the operational burden of having to process those actions themselves, tax administrations identified natural aggregation points in the economy.

For example, instead of putting the burden of paying and reporting tax in all the different countries on vendors that are connected to an international marketplace, tax authorities put the onus on the marketplace itself, according to Van Der Valk. In practice, this means that when a small package crosses a border, rather than try to tax the vendor or consumer, the government taxes the e-commerce marketplace or the carrier that handles delivery of those packages.

He says, “There’s a massive trend of governments trying to look for different types of aggregators that are natural end points, and they put direct liability on those platforms.” Multinational businesses are also massive transaction magnets in their own right, and it’s only a matter of time before they and their solution providers, too, will be targeted to transmit data for small trading partners to the tax administration. “We are already seeing how existing third-party and inhouse transaction platforms for sales or procurement data exchange need to get certified or accredited for purposes of connecting to CTC platforms.”

TREND #4: Standard Audit File for Tax

Tax Administrations Want Access to Your Accounting Data

The first three trends represent the success that tax authorities have achieved in establishing control of receiving and approving transactions in real time. With the emergence of trend four, they want to use technology to better understand how businesses deal with those transactions from an accounting perspective, according to Van Der Valk. “Tax administrations are not satisfied anymore with assuming that businesses have good controls around their accounting practice,” he says. “They want a copy of your accounts — all your accounts, not just your accounts payable and accounts receivable transactions — so they can verify themselves that you are paying all the taxes you’re supposed to, across the board.”

In the EU, a growing number of governments require accounting data to be sent to them on demand. This is called the standard audit file for tax (SAF-T), and it serves as a foundation for these requirements. “SAF-T is basically a format that tax administrations require businesses to follow when they provide their accounting data for auditing purposes,” Van Der Valk says. “This information gives tax administrations an incredible amount of power not only over transactions as a business performs them with buyers and suppliers, but it also gives them more meaningful and ongoing insight into the full picture of how that organization accounts for those transactions and how it accounts for other financial movements within the business. This is huge.”

In Greece, for example, businesses are not only managing their accounts in their own ERP system or accounting system, but beginning October 1, 2020, they also have a shadow set of accounts = they are mandated to keep in accordance with certain specifications, based on their invoices and other required information. The organization’s ERP system needs to transfer data for these shadow accounts continuously, or with a certain frequency, to the government.

“These companies have the responsibility then for ensuring their accounts and the shadow version of those accounts — which are accessible by the government system — are in sync. And if they are not, the organization needs to be able to explain why,” says Van Der Valk.

How to Drive Your Own Digital Transformation Agenda

An important takeaway from learning about these four trends in VAT is the fact that, just as many businesses are on a digital transformation journey, so too are tax administrations — and it is up to the businesses to ensure these two journeys are aligned so they are not caught off guard and ill-equipped, according to Van Der Valk. “Tax administrations are using technology to their advantage the same way that organizations do: to fix things that have always needed improvement, such as visibility and control, and now they are using the tools available to help them do so,” he says. “This innovation within tax administrations is already having an impact on business processes, and taking a case-by-case approach to adapting will be catastrophic for businesses.”

Many large SAP users perform country implementation after country implementation to adjust to new tax mandates, Van Der Valk says, resulting in “huge technical and business process debt and the fragmenting of their systems little by little.” For SAP customers migrating to SAP S/4HANA, taking a siloed approach to tax compliance from a planning perspective leaves businesses exposed and unprepared. As impacts from tax authorities’ digital transformation continue to revolutionize organizations’ processes, resources allocated for IT will compete with the ongoing introduction of various mandates in different countries.

Additionally, many companies don’t simply have one SAP instance. Instead, a lot of large organizations have grown through acquisition and use legacy software to manage different parts of the business. “Sovos recommends cleaning up these disparate processes and standardizing systems, and such action becomes even more important when planning a migration to SAP S/4HANA,” says Van Der Valk. “It is a critical time for companies to consider their digital tax strategy and how to use cutting-edge, forward-looking tax technology to remain relevant in today’s changing and unpredictable environment.”

To highlight the importance of Van Der Valk’s message, consider the story of one multinational company. A main piece of its business systems landscape — travel and expense management — was being impacted by CTC regulations. The company, being a large organization with many people traveling and submitting expense reports from around the world, was accruing a significant amount of receipts subject to e-invoicing and CTC rules. But because the company’s human resources function that managed travel and expenses was unaware of the tax regulations, noncompliance was exposed during audit without the business even knowing it had been neglecting the law.

“Don’t underestimate just how many more business processes and people in your organization will be impacted by these very pervasive trends,” advises Van Der Valk. “Cast a very wide net and take stock of what you’re doing today that can be affected by these trends. Organizations should be able to go about their business and make decisions free of any tax considerations. In an ideal world, all the tax reporting, paying, and interaction would happen behind the scenes, and that’s what Sovos helps companies achieve.”