Closing the VAT Gap—Automating Tax Compliance in a Digital World

The digital economy is currently the equivalent of 15.5% of global GDP and is growing at an astonishing rate—two and a half times faster than global GDP over the past 15 years. We can safely say that the rise of the internet economy has been rapid and impactful.

As a direct result of this, during the last decade countries across the world have rushed to introduce new rules and regulations to try and tax the revenue that’s being generated through this digital economy.

For indirect taxes, like value-added tax and goods and services tax, many of these new rules are essentially the application of the destination principle. This ultimately means that tax is levied only on the final consumption that occurs in the taxing jurisdiction.

Perhaps unsurprisingly, many countries that first introduced this kind of indirect tax regulation for digital services didn’t have the largest digital economy players as residents.

The debate about how to best tax the digital economy is still active and unresolved on many fronts. But for in-house tax professionals, tackling the challenges of today’s rules is their immediate concern.

When I was head of international tax at Uber, I experienced first-hand how onerous it is to keep up with the fast-changing business and legislative environments. Even with the best will in the world and the dedication of proactive tax teams there’s a hard truth: it’s not easy for companies to stay on top of and achieve full compliance with all the relevant rules and regulations, particularly when they’re operating with limited resources and in a fast-moving world.

What Are the Challenges Facing In-house Tax Teams?

Broadly speaking, in-house tax teams are faced with two major challenges. First, they need to understand which tax rules and regulations in which countries apply to their business and then how they should comply with them. As previously mentioned, having enough people with the right expertise to do this internally is hard.

Getting the knowledge externally by subcontracting to advisory firms is a good, but usually expensive, option. This isn’t an “annual update” situation. The speed at which the world continuously evolves means that existing rules change and new ones are introduced all the time. So companies need updated advice from their consultants just as frequently.

After getting a firm grip on the rules, it’s time for the in-house tax team to face their second challenge—finding the right automation system for their business. There’s no way that a high volume of international transactions can be processed manually. Automation is the only way to correctly calculate and collect all the relevant indirect taxes.

Building a homegrown automation solution appeals to an increasing number of in-house tax teams and product managers, mainly because it deals with the lack of flexibility that often comes with existing, off-the-shelf products. It seems like a simple development addition to core product functionality.

However, for most companies, homegrown automation quickly reveals its complexity. It requires the intensive efforts of dedicated teams and continuous maintenance. For example, if you have obligations in 50 countries and are trying to automate all of them through a native enterprise resource planning (ERP) system, you would need to use at least 50 different tax codes. If a country changed its rate, or created a new obligation to charge VAT that affected your company, you would become non-compliant unless, each time such an event occurred, you could find resources internally to make, edit, and test existing codes. A project of that depth would divert the product and engineering team’s attention from the company’s core aims to focus, instead, on calculating taxes. For many companies, it would become the equivalent of building their own power plant.

Alternatively, companies using traditional external tax automation software and tools have found upsides and downsides. One clear downside is that many of the existing tools have been around for some time and are built on old technology and designs. This makes them rather inflexible. It’s usually possible to customize these tools to better suit your business needs, you just need to be prepared to invest money and time.

Another consideration is that these tools usually require a lot of “custom” setup work. Consultants and tax advisers have to be brought in to help navigate the complexity of the tax automation software. Not only does this significantly increase overall costs, but it also means that integration timelines often run into months—with such projects sometimes taking more than a year to complete.

What is the Solution?

Whether it is worthwhile to build or buy a solution, or maybe a combination of the two, really depends on a company’s specific use case, risk profile, and existing resources. However, there are generally a few core things to be aware of early on in your assessment of which direction to take:

Start Right With a Focused Plan

A good starting point is to understand what your needs are across your tax processes and where the difficulties arise. Ask yourself questions like:

• Do you only want to determine indirect taxes accurately?
• Do you want to include withholding taxes and digital sales tax?
• Do you want to ensure compliant invoicing?
• Do you have e-invoicing requirements that oblige you to send data to governments electronically, via established government connections? What do you think about your tax compliance process?
• What causes the company pain and frustration when it comes to tax?

Take a step back, and then review your current processes and identify where you need workarounds. Make an effort to really understand where steps are taking too long, where manual intervention is required, and where multiple tools are used. This is where you should focus your efforts. Whether you choose to build or buy, the solution you choose should alleviate pain while making tax compliance efficient and scalable.

Such a thorough examination doesn’t just tell you what type of automation is needed but also gives you an idea of where you’ll use external tools and what will remain with in-house teams.

Focus on Data Consistency

Designing your tax automation processes to have one single source of tax data that’s easily accessible and consistent will greatly improve control and reduce resource needs.

In many of the interactions I’ve had over the years with in-house tax teams, a common problem that keeps surfacing is the lack of consistency in data. Inconsistencies create a huge amount of work reconciling data, centrally tracking the “source of truth,” and having all the data in one place.

Let’s consider, for example, the journey of data through the indirect tax compliance process. It begins when your tax teams extract data from one or multiple systems or sources. They then share it with external parties, usually via email, which is not the best practice but is often the practical tool of choice. The third-party service providers adjust or manipulate the data for tax reporting purposes and then share the actual return, including working papers, with the tax team. The root source of all the data, however, does not reconcile with these out-of-system changes. This leads to additional work, either at the time or later, during audits. The audit trail is unclear because it’s hard to track who did what and when.

Get Familiar With the Technology

Most tax professionals are incredibly well versed in technical tax matters but are less knowledgeable about tax automation technology. It pays, however, for tax experts to understand, at least at a high level, the options and limitations different technologies bring as they are conceptually responsible for translating current and future tax requirements into automation requirements. Understanding the technological choices that are available helps them achieve their goals and reduces unwelcome surprises.

Think Longer Term

One mistake I’ve made in the past, and which I often see my peers make, is to focus on known, short-term automation needs without taking into account expansion and business model complexities that may emerge over time.

For example, your central principal model may evolve into a local distributor model, or your direct-to-customer business could become more of a marketplace enterprise. Perhaps you’ve forecast growth into 10 new markets but in reality your business quickly ends up expanding into 50. All these factors can greatly impact the robustness, scalability and future-proofing of your tax automation decisions. Tax should be an enabler for the business, never a blocker.

Act in a Timely Manner and Use Your Resources Wisely

This advice should be a no-brainer. Your best talent wants to have impactful and challenging work. If they don’t get it then, as we’ve often seen, the talent will leave your company to find more significant work elsewhere.

Losing expertise means that your business becomes heavily reliant on a few remaining key employees and their institutionalized knowledge, increasing the risk of a single point of failure.

In order to mitigate this, you need to find out how much repetitive and mundane work your team actually does, then minimize (or eliminate) it as much as possible through automation.

The key takeaway is to not shy away from or postpone automation initiatives but instead to embed automation into your early thinking and add it to the toolbox of solutions you use to tackle any tax and business issues, even the unexpected ones.

Automating for Impact and Success

The rise of the digital economy has certainly made the life of many in-house tax professionals much more challenging. Tax exposure and obligations, with specific digital services rules in more than 90 countries, are now the reality. There may be one tax person, or perhaps a small tax team, that has all this responsibility (with only a limited budget).

Automation not only will help you cope with many critical tax processes, it also will enable you, as a key tax expert, to focus on the value-added tasks that will maximize your impact.

It’s truly important for tax teams to be deeply involved with tax automation and to approach such projects with the right focus, goals and understanding, ensuring that success is built in from the start.

I strongly believe that we’ve yet to see the true potential and full adoption of technology by in-house tax teams. Technology is revolutionizing tax in ways that go beyond mere compliance. Automation allows businesses to respond quickly and agilely to the ever-changing global business environment. Tax teams play a vital role in unlocking this value.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Rob van der Woude is chief tax officer at Fonoa, having previously been Head of EMEA Tax at Uber, and prior to that having worked at EY in the Corporate Tax division.

The author may be contacted at: rob@fonoa.com