“Real-time reporting” is currently a hot topic in the value-added tax (VAT) compliance world. Some countries already require taxpayers to report their VAT transactional data nearly in real time. For example, many European countries, such as Spain, Italy, Hungary and Poland, have already introduced digital regimes which affect VAT reporting. Italy has implemented real-time reporting, with draft invoices transmitted via the Sistema di Interscambio (SDI system). This platform is run by the Italian tax authorities, and each invoice draft is validated and approved in the SDI. Outside of Europe, Brazil, China and Argentina have also made changes.
In the U.K., Making Tax Digital for Business is the government’s policy to move all business-related tax reporting online. VAT was the first introduction from HM Revenue and Customs (HMRC) into the program and the Making Tax Digital for VAT (MTDfV) regime is effective for VAT periods starting on or after April 1, 2019, for most U.K. VAT registered businesses.
The MTDfV measures form a crucial building block in the U.K. government’s 10-year strategy to make the tax system more resilient and effective, aiming to boost business productivity and support taxpayers.
MTDfV represents a significant change to the U.K. VAT compliance process. HMRC gave a period of time (known as the “soft landing period”) during the first two years of Making Tax Digital to help businesses put digital links in place between all parts of their functional compatible software. Businesses were not required to have digital links in place until their first VAT return period, starting on or after April 1, 2021.
One challenge has been how to deal with calculations made outside of the software used to keep the digital records. For example, partial exemption special methods and capital goods scheme adjustment calculations done in a spreadsheet may need some form of manual input. HMRC state that if the adjustment requires a calculation, this calculation does not need to be made in functional compatible software. If the calculation is completed outside of functional compatible software, digital links are not required for any information used in the calculation. However, businesses seek further guidance and clarity as to where such exclusions start and finish.
There have been some issues with HMRC systems recently, and businesses have had difficulties viewing their accounts and using MTDfV services. HMRC are working to resolve these concerns. There were also some recent issues when data was transitioned from HMRC’s old systems to the new Enterprise Tax Management Platform (ETMP) system.
Since the introduction of the regulations, HMRC have been engaging with taxpayers on MTDfV, including it as part of Business Risk Review discussions and audits. HMRC are discussing tax technology, systems and processes more than ever and have an increased focus on assurance, governance and controls.
Going forward, HMRC are expected to expand the regulations further, leading to greater disclosure of transactional-level data and more transparent tax systems and processes.
Extension of Making Tax Digital for VAT
In their Policy Paper “Extension of Making Tax Digital for VAT,” HMRC announced the measures that will extend MTDfV requirements to smaller VAT businesses from April 2022.
MTDfV requires VAT registered businesses to keep digital records and use third-party software to submit their VAT returns to HMRC. From their first VAT period starting on or after April 1, 2022, VAT registered businesses (including self-employed and landlords) that are not already required to operate MTD under the requirements applying from April 1, 2019 will have to:
- keep their records digitally (for VAT purposes only);
- provide their VAT return information to HMRC through MTD compatible software.
The requirement for VAT registered businesses to keep digital records will likely involve an initial spend in terms of time and/or money for those businesses not already set up. Businesses will need to purchase, or obtain a free version of, software and learn to use it effectively. At a minimum, for those using spreadsheets, bridging software will be required to submit the returns. Other businesses may opt for fully integrated accounting software.
Use of Technology in Bridging the Gap
Businesses should readily be able to meet digital records criteria if they are already using appropriate accounting software or systems to store their transactions. However, it may be necessary for some businesses to enhance their systems and/or introduce new solutions to deal with the regulations.
Over the next couple of years, it is expected that businesses will move towards more sophisticated methods of VAT return preparation, bringing the advantage of improved processes and controls and a reduction in the risk of manual errors. HMRC are carrying out systems-based audits and there is a move towards increased use of technology and digitization. There has been a significant increase in the use of technology by businesses, including use of analytics automation platforms and external solutions.
However, navigating the changes is complex and many businesses have sought, or are still seeking, advice from external VAT specialists. Typical areas of assistance required include post-implementation reviews to assess compliance, end-to-end process reviews and gap analysis, and assisting with the design and implementation of new systems and software.
Companies are investing time in ensuring that indirect taxes are carefully considered in enterprise resource planning (ERP) implementation projects from the outset, to avoid having to build exception reports and solutions at a later date. With the advance of digitization, manual workarounds are no longer a viable option and companies are increasingly investing in technology and tax software to ensure effective automation of processes.
Some businesses have had difficulties in meeting the regulations due to multiple feeder systems resulting in a complex system set-up. The use of multiple systems is commonplace in certain industries and many companies are using bespoke software to bring the systems together using application programming interfaces (APIs). In such situations, it is vital to review and determine where VAT records are held and to monitor interfaces and data transfers to ensure compliance.
Further challenges are also caused by the quality of reports extracted from some accounting systems. Some “off-the-shelf” reports do not contain the required data fields and can be in the wrong format for the purposes required.
How Important are ERP Solutions in Meeting Reporting Challenges?
ERP systems have a crucial role in business operations, and tax processes are intrinsically linked. The development of an efficient and reliable ERP system that meets business needs for tax reporting is vital. When introducing a new ERP system, considerable effort is required to ensure the proper implementation of tax requirements. A well developed and implemented ERP system with a tax determination logic developed to reflect the business operations and comply with reporting requirements is a key asset of a business.
For global ERP systems, it is important to understand the varying requirements in different territories, and businesses may need to adapt their approach and ERP system configuration globally.
It is crucial to look at the end-to-end process to ensure there are no gaps in compliance. If a process involves manual steps, this does not necessarily mean it cannot be MTDfV compliant. However, it places reliance on individuals to carry out these manual steps on a regular basis, and businesses should ensure that individuals carrying out manual processes as part of the VAT return compilation fully understand the regulations, in order to ensure that they are both compliant and also able to show evidence of compliance where required.
Tax determination is a means of ensuring that the correct VAT treatment is applied to transactions. This is normally carried out by capturing information within a business’s accounting systems. It is far quicker and easier to compile a VAT return if a business is confident that the tax codes are making the correct determinations.
Most accounting packages come with a standard bank of tax codes, for example, standard-rated sales (20%). Many businesses use manual tax code selection, whereby staff within accounts payable or accounts receivable teams will select the correct tax code as they process the sale or enter the purchase.
Manual tax code selection comes with a level of risk, and is heavily reliant on general finance and sales teams having up to date and accurate tax code knowledge. Furthermore, with the move towards digital reporting, both by HMRC and other tax authorities across the world, manual processes are not generally the preferred method. Tax authorities increasingly look to see businesses using technology to make these decisions and not being reliant on manual decision making.
Some common solutions used by businesses without manual intervention are as outlined below.
Finance and Accounting Systems Such as SAP, Oracle
A number of these systems have system capabilities already built in that will carry out tax determination. If the solution within the existing finance system is not fit for purpose, it may be possible to build additional rules within the system; for example, if a company is selling a widget in the U.K. to a U.K. client then it charges U.K. VAT and assigns tax code XYZ. Using either off-the-shelf tax determination or leveraging VAT functionality to add bespoke tax coding enables the system to make decisions and removes manual error.
Often with the help of advisers, businesses map out and build the required VAT functionality. This requires detailed transaction mapping to determine where a business is buying, and selling to, what products it is selling, and at what VAT rate, etc. With a built-in tax determination logic, if there is a VAT rate or regulatory change, the business will need to update the functionality and logic accordingly.
A tax engine is a third-party system that integrates with the ERP system and replaces the inbuilt VAT functionality of the ERP system. As with the above, it makes the tax decisions for the business. However, in this case, rather than being inbuilt, the tax engine works as a plug-in or add-on to the system.
For example, when someone goes to a cafe and buys a coffee, the tax determination is made in real time by the Electronic Point of Sale (EPOS) system within the till. As the sale of the coffee is entered into the till, the system determines that the sale of the coffee is subject to VAT at 20%, the sale is coded accordingly, and the receipt can be printed immediately showing the applicable VAT treatment.
A tax engine can significantly improve VAT determination accuracy, and the benefit of using a tax engine rather than a finance system to determine VAT logic is that ongoing maintenance is provided by the third-party system provider. This eliminates the need for in-house ERP updates, as if there is a change in VAT rate, these updates should be made by the third-party provider.
Microsoft Excel or Similar
In the short term, some businesses have continued to use Microsoft Excel or similar programs to prepare their VAT returns. They may have made a move towards digitization by using improved data extraction tools or automation platforms such as Alteryx.
Whilst these processes can be compliant when done correctly, businesses are relying on the individuals preparing the returns to ensure that the MTDfV requirements are met. Process notes should be detailed and up to date and regularly maintained and reviewed. Any changes in personnel or processes should also be monitored for MTD compliance.
In the long term, it is expected that more and more businesses will move towards a greater level of digitization and the use of tax technology and ERP systems.
How Should Businesses Prepare?
- Review the business’s systems and processes to ensure that they are adequately controlling risk and providing information in the format that the tax authorities (globally, if applicable) wish to see.
- Where possible, make use of tax technology to make tax decisions for the business.
- Review the business’s existing tax engine if applicable and ensure that it is fit for purpose and providing the correct results.
- Ensure that tax technology or tax engine implementation is adequately prepared for and resourced, and seek help from external VAT specialists if required.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Sarah Shears is Head of the VAT Group at Andersen in the UK.
The author may be contacted at: firstname.lastname@example.org