On a brilliantly sunny day, more years ago than I care to admit, a middle-aged high school coach stared at seventeen-year-old me from across his desk and asked, rather matter-of-factly, what I wanted to be when I grew up. And while I cannot recall with any degree of certainty the response I managed to utter on that cloudless day in Macon, Georgia, I am relatively certain that it had absolutely nothing to do with the field of indirect tax.
Let’s face it. You simply don’t hear stories about teenagers boarding Greyhound buses to pursue their dreams of tax-related stardom in the big city. Yet all these years later, the indirect tax sector is getting its moment in the spotlight, as an ever-growing list of countries scrambles to find new ways to use indirect tax to fund government. To say that indirect tax is ‘here to stay’ would be an understatement. On the contrary, it could be argued that indirect tax has become the ‘tax of choice’ for legislatures around the world when looking to raise income.
However, the sustained popularity and growth of indirect tax is not without its challenges. In addition to becoming more prevalent in jurisdictions throughout the world, many indirect tax regimes are also becoming increasingly complex. In turn, in many instances, this added complexity is translating into serious headaches for companies in areas including supply chain management, compliance and technology. A significant number of companies are straining to manage their indirect tax functions efficiently because the weight of the complexity is ever growing.
A global surge in popularity
Over the last two decades, we’ve seen a significant increase in the number of countries and jurisdictions using indirect tax to fund government. While there are still some outliers, such as the US, that don’t have national-level VAT regimes, this is the exception rather than the norm. And while it would appear to be a bit of a ‘late bloomer’ in terms of taxation methods, it’s clear that indirect tax is going to be the way of the future – not only for the countries in which it has already been adopted, but also in the countries that have yet to embrace it.
On that note, one of the recent developments making headlines around the world is the trend for countries to impose taxes on financial transactions. France introduced a financial transaction tax of 0.2 percent on certain types of stock purchases this past August. Countries including Spain, Italy and Germany are actively pursuing similar taxes. And in the US, the proposed “Wall Street Trading and Speculators Act” would mean a 0.03 percent tax on trading transactions. Some critics are saying the bill, put forward by Senator Tom Harkin and Representative Peter DeFazio, could translate into a 6,000 percent spike in transaction costs for exchange members.
In recent years Hungary enacted a financial transactions tax and this year proposed to expand it to cover its Central Bank transactions. A host of other countries are ready to follow suit on the basic concept in one form or the other. And while it’s unlikely that we’re going to witness the passage of the Harkin/DeFazio bill any time soon, the mere fact that such a bill was even proposed in the US illustrates how mainstream and pervasive such forms of taxation have become in recent years.
Medical device excise tax highlights need for better structure
In conjunction with the Affordable Care Act (“Obamacare”), the US Government enacted a new 2.3 percent excise tax on the sale of ‘taxable medical devices’ to help fund health care. This new tax, which is expected to take effect on January 1, 2013, would be applicable to the manufacturer or importer of the medical device in question. The impending tax continues to generate significant controversy, with many critics claiming it will have a negative impact on jobs and medical innovation in the US for years to come. In fact, according to a KPMG i survey of medical device manufacturers in April of 2012, 40 percent of respondents said their companies were already contemplating actions such as price increases and cost reductions (e.g. head count, manufacturing processes, research and development or other means) in order to remain competitive going forward.
We don’t expect the trend toward these types of new taxes to dissipate anytime soon. In fact, many industry observers expect these types of new taxes to become more impractical in nature before they become more structured. Case in point: While the proposed medical device excise tax in the US was created to help fund the country’s struggling health care system, it is possible that Medicare itself could end up bearing the burden of the tax in some instances. It is an odd reality that has many industry observers scratching their heads with respect to the proposed medical device tax, while simultaneously calling for improved structure around similar taxes that are introduced in the future.
A matter of complexity and compliance
In general terms, the degree of complexity in the area of indirect tax is on the rise. And while corporate taxes continue to decrease in many jurisdictions, an increasing number of governments are turning to indirect tax as a tool to help generate additional tax revenue.
For the large, multinational organizations forced to deal with the day-to-day realities associated with administering and collecting these indirect taxes, however, the implications can be significant. Even the process of managing a company’s supply chain with respect to these various types of taxes can be incredibly complicated to manage. Consider the example of a company that processes $10 billion in annual sales with an indirect tax throughput of $2 billion. In this case an error of just 1.0 percent would translate into $20 million. In addition, the financial penalties for making these types of errors can be extremely costly.
Indeed, there are substantial challenges associated with the efficient management of these vast sums of information and data, particularly at a time when many companies are grappling with lower head counts and increased regulation.
With respect to the challenges around compliance, more companies are opting to outsource, since for many of them, handling the compliance function in-house would mean an ever-growing head count in order to remain compliant against a backdrop of increasing complexity. In one company that I visited recently, for example, there were almost 40 indirect tax practitioners in their shop in just one country alone. Only a few years ago such a sizable indirect tax staff complement would have been unheard of.
As the sector continues to evolve, we’re seeing more companies centralizing the indirect tax function to an extent. So on one hand, while they might be outsourcing compliance, they’re also centralizing the management of the indirect tax function so they can maintain better insight and oversight of the function as it affects the entire organization. In the past, we would typically see this type of ‘oversight’ work being done locally on a country-by-country basis. Today, however, as the industry tax function becomes more complex, far-reaching and unwieldy, more organizations are choosing to centralize the oversight function to ensure that they have someone who is looking at the big picture on a company-wide scale.
Many organizations missing opportunities to enhance the bottom line
The objective of the indirect tax function within any organization is to successfully manage risk and create value. Something that sounds simple in theory, however, can prove extremely difficult to achieve in practice. And while we’ve addressed some of the issues associated with managed risk with respect to indirect tax, there are many organizations leaving potential value on the table because of their failings to manage and measure their VAT/GST positions in a more effective and strategic manner.
At its simplest, these opportunities might include activities such as improving VAT/GST cash flow management, recovering credits more efficiently, or reducing irrecoverable VAT/GST costs. And with an additional strategic focus, it’s possible for companies to realize opportunities to reduce the total business cost associated with compliance and to enhance sales by achieving a more competitive position in the marketplace. What’s clear in 2012 is that too many organizations are simply allowing these indirect tax opportunities to go unrealized.
Predictions for 2013
After several decades of waiting in the wings, indirect tax is finally coming of age. In short, it simply cannot be ignored any longer. Indirect tax is in too many jurisdictions and is spreading like wildfire as the tax of choice for an increasing number of governments around the world. The question now for large corporations is how to develop a practical, yet detailed, framework to successfully manage their indirect tax risks and to create value simultaneously.
On the global reform agenda, we would expect reform announcements to continue to develop in countries including China, India and the Middle East. And in some of those cases, like China, for example, there are already extremely short timeframes under which business will be expected to adapt their systems and achieve proper compliance. It’s clear that these will be key issues in China and other similar markets in 2013.
Another indirect tax issue that many companies will be forced to deal with relates to technology. For example, those Heads of Tax who are facing impending Enterprise Resource Planning (ERP) system upgrades in their companies will need to consider whether they should be bolting on appropriate tax solutions to help their companies to better comply with the continually-changing indirect tax requirements. And then, there are the matters related to the specific technology to use, vendor selection and how to implement rollouts (e.g. one region at a time or worldwide all at once), etc. These are questions that more and more companies will be faced with through 2013 and beyond.
It doesn’t take a crystal ball to know that indirect tax will continue to grow in adoption and scope over the course of the coming year as more and more world governments seek new ways to generate revenues. In addition to becoming more prevalent, indirect taxes will also continue to become more complex in the months ahead, meaning companies will have their work cut out for them in order to ensure their functions are prepared to face the global indirect challenges of today and tomorrow.
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