08 g Magazine insight for business leaders

The role of in Finding a new mergers and acquisitions Africa’s new potential, and balance shifting challenges The rise of indirect tax Building deeper ties with the rest of the business Imprint Publisher: Ernst & Young EMEIA Tax Maagplatz 1, 8005 Zurich, Switzerland

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A part of this issue will be distributed as an insert in the Financial Times across Europe, Middle East, India and Africa in June 2012. By Stephan Kuhn Editorial The growing global momentum toward indirect tax

Dear Reader

Indirect are booming. As governments around the world continue to struggle with the fall-out from the fi nancial crisis, they are increasingly turning to increases in VAT, and other indirect taxes as the most straightforward ways of raising additional revenues. They are also using indirect taxes to infl uence behavior by taxing consumption of certain goods such as fuel, tobacco, snack food or alcohol.

This highly dynamic indirect tax environment poses many challenges for businesses, particularly those that operate across borders. Rates of VAT, excises and duties vary from country to country leading to errors easily arising on the classifi cation of sales and purchases and uncertainty over Stephan Kuhn how some transactions should be treated. Therefore companies must deal with the risk of non-compliance and ineffective processes by spending an increasing amount of time managing their indirect taxes and focusing on the changing regulatory trends to manage such complexities.

Supply chain complexity adds to the challenge. In many industries, companies have multiple tiers of suppliers producing components that will cross national borders many times before fi nal assembly. They will often source manufacturing in low-cost jurisdictions, where tax regimes are often more complex and uncertain. This creates serious risks for corporates, which must ensure that they keep up with obligations, comply with rules for invoice formats and meet payments when they are due.

In the past, companies could afford to see indirect tax as an administrative issue. But the scale of the challenge has now become so great that many are rethinking this approach and ensuring that there is much closer co-ordination between the tax function and the business. But as well as managing the risks, companies should also consider the opportunities. By taking a proactive approach to managing indirect tax, and including it as a factor in their strategic planning, companies can gain an important advantage over their less agile competitors.

In this issue of T Magazine, we examine current trends in indirect tax and explore their impact on business. We look at the role of indirect taxes in addressing fi scal challenges, and examine how different countries are approaching key policy issues. But fi rst and foremost, we look at the impact of these trends, as well as decisions which business leaders should take. We show how leading companies are managing their indirect tax burden, and look at the skills and capabilities that are required to manage the risks, and seize the opportunities from effective handling of indirect taxes.

We hope you fi nd the publication valuable and stimulating.

Stephan Kuhn

Stephan Kuhn is Area Tax Leader for the Europe, Middle East, India and Africa (EMEIA) region at Ernst & Young.

Ernst & Young Issue 08 T Magazine 3 Contents Credits: Jos Schmid, Reuters / Handout, Jason Larkin / LUZphoto; Cover: Simone Perolari / LUZphoto

8 27 38

Features 8 __ Managing the dynamic landscape of 32 __ Logical beginnings; extreme conclusions indirect tax T Magazine profi les a brief selection of unusual Discover more content, Indirect taxes have risen to become the biggest type taxes, both historical and contemporary, to gain news and features on of tax that businesses deal with today. But few are some insights as to where future taxes might go. the T Magazine website at fully prepared for this. www.ey.com/tmagazine 38 __ Getting serious about Africa 14 __ Prices at the pump The continent has had a good decade, with Indirect taxes lead to huge variations in the price falling political and economic risks. paid for petrol from one country to the next. But new administrative challenges are emerging policies vary widely around the world. for multinationals on the ground.

16 __ Striking the right balance Management The OECD’s Pascal Saint-Amans and Piet Battiau on 42 __ Unilever’s indirect tax management Access the App Store indirect tax trends and the implications for business. challenge on your iPad to download Exploring the systems, processes and skills the free T Magazine app 20 __ Improving India’s competitiveness needed for companies to effectively control Making the case for India’s intended introduction their global indirect tax requirements. of a goods and services tax (GST). 44 __ Navigating indirect tax 24 __ Rethinking GE’s approach toward Marina Wyatt, Chief Financial Offi cer of TomTom, indirect tax talks to T Magazine about her company’s Chris Needham, GE’s Global VAT and GST Director, approach to indirect taxes. on how the multinational deals with its tax risk. 45 __ Building deeper ties Focus Indirect tax can have a signifi cant bearing 27 __ A coming-together over on a company’s sales and profi tability, but close Managing an increasingly mobile workforce relationships between tax teams and the rest presents a new set of challenges to meet associated of the business are rarely found. tax obligations for employee and employer alike. Outlook 30 __ Deal-makers under fi re 48 __ Europe’s failing VAT system Indirect taxes may be the difference between Professor Ben Terra on the challenges of success or failure within mergers & acquisitions. VAT reform within the European Union.

Magazine 08 Tax insight for business leaders Cover

“The main challenge for governments right now is the question of how you address the fi scal consolidation needs

The role of indirect tax in Finding a new mergers and acquisitions Africa’s new potential, and balance shifting challenges The rise of indirect tax of government with a tax system that is good for growth.” Building deeper ties with the rest of the business Pascal Saint-Amans, Director of the OECD’s Centre for and Administration (see page 16).

4 T Magazine Issue 08 Ernst & Young News

Global tax news A roundup of recent developments from major governments and tax administrations

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1 Angola 0%, 10%, 20%, 30% and 40%. Government is considering The superannuation guarantee April 2012 This will abolish the rates of measures to cap access to tax (a mandatory payment to New tax incentives will support 18% and 25%, which favored reliefs for individuals, with employees’ private pensions) Angolan oil companies whose mainly low- and average- consultations to follow. will also be gradually increased capital is entirely held by income taxpayers. All tax to 12% by 2019. Angolan individuals. Those exemptions will be abolished 4 Australia with a production sharing under the new system, as will April 2012 5 India agreement with the national many deductions, such as The Minerals Resource Rent March 2012 concessionaire, Sonangol, those for life insurance, social Tax (MRRT) became law and is The Finance Bill, introduced in will see their oil security contributions and effective from 1 July 2012. the Parliament as part of the rate reduced from 50% to 35%, medical expenses. Company tax rates will be budget proposals, contains the standard corporate income reduced to 29% in 2012–13, far-reaching tax proposals for . Those in joint venture 3 United Kingdom from 30%. It is current amending the Indian tax laws. operations will have their rate March 2012 government policy that the Its key proposals include cut from 67.75% to 35%. The 2012–13 budget cut the rate for other companies will taxation of offshore asset sale All Angolan oil companies will corporation tax rate from also change from 2013–14. transactions, retrospective also enjoy exemptions from 26% to 24%, falling to 22% in A number of other amendments to the defi nition payment of signing bonuses, 2014. The publication of the changes for small businesses of royalty, amendments to certain fi nancing obligations Finance Bill took forward were also enacted. These provision to and the required contributions the new CFC rules and the include an increase of the asset expand the scope, introduction to social programs. introduction of a Patent Box write-off threshold from of advance pricing agreement regime. For individuals, the AU$1,000 to AU$6,500, and introduction of General 2 Greece top rate of tax has been cut to a simplifi cation of tax Anti-Avoidance Rule (GAAR). April 2012 45%, from a prior maximum depreciation pooling On 7 May, the Finance Minister A new national personal income rate of 50%. At the same time, arrangements and the proposed to defer the tax system has been proposed the personal allowance will be introduction of an accelerated implementation of GAAR by including fi ve tax brackets: increased to £9,205. The depreciation for motor vehicles. a year.

Ernst & Young Issue 08 T Magazine 5 News Credit: EP / REA / Laif European Union 2010 PE

Tax reform in the spotlight

__ Countries around the world are Rising average of VAT rates striving to reduce tax complexity across the EU-27 and increase revenues. The sweeping approach to this is to broaden the 22 21 VAT base and move to a single rate. 20 A less dramatic alternative is about 19 simply tidying up, or as the UK’s 18 recent budget described it, “address 17 borderline anomalies.” But these 16 15 can be controversial. Removing 14 Average standard VAT rate VAT standard Average zero and reduced rates for certain 13 goods and services (like pasties, for

example) is the removal of a measure 2000 2002 2004 2006 2008 2010 2012 that is typically set up to protect EU-27

low-income groups. But there is now Source: Developments in Indirect Tax in 2012, Ernst & Young a growing consensus that better Algirdas Šemeta, EU Commissioner for Taxation ways exist to help low-income and Unions, Audit and Anti-Fraud. populations. An increase in VAT revenue, for example, could be used Value added tax (VAT) to increase support payments. After the crisis revenue Standard rate in selected countries Countries like New Zealand also across the EU-27 continues to fall while 2010 2012 show that broad-based, single-rate indirect moves upwards Hungary 25% 27% VAT systems generate more revenue with less administration. As such, 16 Sweden 25% 25% many countries are now looking for 15 United Kingdom 17.5% 20% routes to improve the complexity of Germany 19% 19% their VAT systems. The European 14 Russia 18% 18% Commission has recommended since % of GDP % of

South Africa 14% 14% late 2010 that EU Member States 13 move to a broad-based VAT system, Switzerland 7.6% 8% ideally with a single rate. The 12 Singapore (GST) 7% 7% question that remains is how likely

Japan () 5% 5% such reforms are, not least amidst 2000 2002 2004 2006 2008 2010 United Arab Emirates 0% 0% the wider challenges being faced Taxes on production and imports Current taxes on income, wealth, etc. within the Eurozone today. Source: Ernst & Young Source: European Commission, Tax revenue statistics, 2011

1950 1970 1990

The age of VAT

1954 1967 1973 1986 1989 1991 France is the fi rst Brazil and The UK introduces a New Zealand Japan introduces a South Africa and country to introduce Denmark introduce VAT, as do Austria introduces a goods VAT system, Canada introduce a VAT system. VAT systems, soon and Italy. By 1979, and services tax, bringing the total VAT, followed to be followed by 27 countries will with a broad base number of countries during the 1990s Germany, Sweden have a VAT system. and a low single to 53. by Poland and and the rate. Switzerland, among Netherlands. others. By 1969, eight countries have a VAT.

6 T Magazine Issue 08 Ernst & Young Credit: alliance / photoshot / Andy Barnes, Keystone / Xinhua / Landov YAO DAWEI

“It’s an extraordinarily complex situation when you are having to check with the 20% Meteorological Offi ce on whether or not to The United States could add add VAT on pasties.” an estimated US$1t tax revenue if they adopted a European-style VAT system UK Labour MP John Mann with a standard rate of 20%. commenting on new VAT rules introduced with the UK Budget The US budget defi cit in 2012 during a government Select Committee hearing. is US$1,327b.

New Zealand Six global indirect tax With a broad base, a low single standard rate and few trends exceptions or exemptions New Zealand scores the __ According to the recent 1,700 highest on the OECD “VAT revenue ratio.” This Ernst & Young’s Indirect Tax The number of submissions measures the gap between the theoretical revenue that in 2012 report, six common received by the European would arise from a single rate with full compliance and global trends for indirect Commission from businesses, full tax collection, and the actual revenue collected. taxes can be identifi ed that academics, citizens, tax are likely to be signifi cant authorities and professional in 2012 and beyond: services providers in response China to its Green Paper on VAT On 26 October 2011, 1. Increasing VAT/GST rates reform. the Chinese Premier 2. Broadening of the VAT/GST Wen Jiabao tax base announced that from 3. Re fi nement of consumption 1 January 2012, tax systems Shanghai would start 4. Increased focus by 156 the VAT pilot tax administrations VAT systems including goods arrangements to trial on compliance and tax and services taxes (GST) now the convergence of VAT and Business Tax (BT) avoidance, using advanced exist in 156 countries around progressively. The current VAT and BT regimes have technology the world, with seven more caused cascading effects and improvements have to be 5. A continuing rise in considering implementation made in order to support the development of modern duties by 2013, according to services. VAT accounts for approximately one-third of 6. Decreasing customs duties the World Trade Organization. the Chinese government’s tax revenue. from increasing

2000 2010 2011 2012

2001 2006 2009 2010 2011 2012 Worldwide, 129 A European Council VAT receipts The European Hungary announces Some form of VAT/ countries now have Directive requires represented on Commission that the standard GST now applies a VAT system. Member States to average 7.4% of releases a rate of VAT will rise in 156 countries have a minimum the GDP of a EU Green Paper to 27% in 2012, the worldwide, VAT standard rate Member State in recommending highest in the EU. accounting for of 15% and one or 2009, an increase “a broad-based an average of two reduced rates of almost 10% from VAT system, ideally one-fi fth of total tax not to be below 5%. 1995. with a single rate.” revenue.

Ernst & Young Issue 08 T Magazine 7 Feature The rise of indirect : Jos Schmid

Managing the dynamic landscape of indirect tax Indirect taxes have risen to become the biggest type of tax that businesses deal with today, especially those operating globally. Although often a hidden burden, the impact on the bottom line is very real.

Summary The deepening and widening of indirect tax • By Gerri Chanel of complexity for multinationals, who must regimes has become a simultaneously deal with the many indirect tax widespread tax policy hough taxes are implications of increased global commerce, trend around the world. described in many ways, deeper scrutiny by tax authorities, and the This in turn is leading T“extraordinary” is not internal challenges of obtaining visibility over to a rise in complexity usually one of them. But the indirect taxes. for the tax functions of story of indirect taxes is truly companies, with new an extraordinary one. Consider From newcomer to star player risks to consider. the value added tax (VAT): Globally, indirect taxes include a wide range Never before in tax history, of taxes imposed on consumption rather than as far as historians know, has a profi ts or income; thus the term “indirect.” completely new type of tax arisen and then Some apply to a broad range of transactions, spread around the world to become a prime such as VAT/GST and sales and business taxes; source of global tax revenue in little more than other indirect taxes are assessed on specifi c 50 years. transactions, such as excise taxes and customs Indirect tax amounts are huge; they now duties. make up about 75% of all taxes remitted by Excise taxes are as old as the pyramids: The businesses globally, by far the largest type of tax fi rst tax on alcoholic beverages was imposed under management by businesses. And the 3,000 years ago when the Egyptian pharaohs numbers are likely to go even higher: Both the levied a tax on beer. On the other hand, even the OECD (see “Striking the right balance” on page idea of a VAT is not documented prior to the 16) and the majority of policymakers polled by 1920s and the fi rst national VAT, enacted by Ernst & Young in 2011 expect governments to France in 1954, was a limited one. Yet VAT is generate even more revenue from indirect taxes now the most widespread general consumption in the future. tax in the world, implemented by over VAT, or goods and services tax (GST) in 150 countries, including all 34 OECD member some countries, is being introduced in new countries bar one (the United States). Only fi ve jurisdictions virtually every year, while at the countries have ever repealed a VAT, and all but same time there is a constant rise in rates one (Belize) later reintroduced it. worldwide. Excise tax rates are also on the rise, This overwhelming enthusiasm led one IMF along with new excise taxes on items such as author to consider VAT as the tax world’s Mata energy, carbon and even snack food. Hari, the famous exotic dancer and courtesan of This new landscape is creating multiple layers early last century, noting that “many are

8 T Magazine Issue 08 Ernst & Young Robert Langham __ During the last 10 years, he has headed Philip Morris International’s indirect tax group, providing guidance on compliance and strategic tax issues regarding VAT, excise tax and customs duties to its management and affi liates around the world.

Ernst & Young Issue 08 T Magazine 9 Feature The rise of indirect tax Credit: Council of European Union / Bjarke Ørsted

European Commission President José Manuel Barroso and Danish Prime Minister Helle Thorning-Schmidt are leading efforts to change the sources of income for the EU budget over the rest of this decade, with a greater reliance on VAT.

VAT contributions tempted, many succumb, some tremble on the increases far less visible to the consumer and The EU budget is chiefly funded brink, while others leave only to return, thus also less likely to affect consumption. (99%) from the EU’s own resources: eventually the attraction appears irresistible.” Generally there is no difference in the tax What is it about VAT and other indirect taxes outcome for foreign or domestic entities; an 73% that makes them so appealing to governments? import is taxed in a similar way to a domestic GNI-based resource “Revenue authorities like them,” says sale, reducing the incentive for companies to 15% Dr Philip Robinson, Ernst & Young’s Global seek ‘low-tax’ jurisdictions. Economists also VAT-based resource Director of Indirect Tax, “because they are a favor broad-based consumption taxes. For 11% more secure source of revenue. One reason is example, they are considered more neutral Customs duties / sugar levies that consumption tends to be more stable compared to other taxes in terms of affecting than profi ts, even in a weak economy, so revenue spending habits, investment decisions and the The main source to fi nance the EU budget is a resource based on the streams from consumption taxes are not as natural allocation of resources. Member States’ gross national volatile as those of income taxes.” There’s a downside, however: Consumption income (GNI). This has grown to Another reason is that VAT, given its taxes tend to have a greater impact on lower- surpass the other sources: VAT- cascading nature from original inputs to fi nal income individuals, who spend a bigger share based resources and the traditional product or service, is better able to plug of their income. “In principle,” says Robinson, own resources, mainly customs collection gaps than a retail , as every “if every type of consumption was taxed, the tax duties on imports from outside the EU and sugar levies. business in the supply chain has a strong, would in a sense be regressive. But in most simple incentive to collect output tax on its systems, basic goods and services are either Source: European Commission 2011 sales: If it does not, it cannot recover the input exempt or subject to reduced rates to help taxes it has paid. Another advantage of reduce the impact.” Because these reductions indirect taxes, at least from a government apply to everyone and also make tax perspective, notes Gijsbert Bulk, EMEIA Indirect systems more complex, economists tend Tax Leader for Ernst & Young, is that rates to favor other means of offsetting regressivity, are generally easier to increase than for direct such as tax credits, direct payments and taxes. For example, in most jurisdictions, the VAT various forms of social support for affected is already included in the sales price shown to households. But as indirect taxes have boomed, the fi nal consumer, making incremental rate so too has their impact on businesses. “However,

10 T Magazine Issue 08 Ernst & Young that impact is often underestimated since most companies look at indirect taxes simply as fl ow- The many faces of indirect tax through taxes,” says Robert Langham, Director of Indirect Taxation at Philip Morris International, Excise duties on the rise a global tobacco company. With VAT, a company typically pays input tax on purchases, then simply subtracts it from the __ When broad-based VAT systems while Hungary has introduced a tax output taxes it collects from customers before were implemented in many countries on goods with high fat, sugar and salt remitting the difference to the tax authorities. in the 1970s and 1980s, many content, including soft drinks. “In reality, though, there is a huge administrative product-related taxes were Denmark and several other European burden, much more so than for corporate income eliminated. These taxes are now countries already have taxes on these tax. Also, because these taxes don’t show up in making a comeback – and the rates types of food items. that bottom line tax number, they’re generally are going up – in areas where Another new high-profi le excise hidden from the business – if the input tax is not governments see them as a tool for tax category is environmental or recovered, then it effectively becomes part of infl uencing consumer behavior. For “green” taxes aimed at reducing cost of goods sold or the cost of doing business,” example, there have been constant pollution and climate change. says Langham. increases in excise duties on alcoholic Langham says that “over the last Robinson says that “even if the company beverages, mineral oils and tobacco three or four years, there has been miscalculates a fraction of their VAT/GST on the products. an exponential rise in the number of sales volume, the amount can be huge.” A number of other new taxes are countries implementing taxes on Part of the complexity arises simply from the being introduced as well. One category things like carbon emissions, fact that there are very few, if any, jurisdictions aims to improve eating habits. France packaging, and other types of with a base or a single rate. Errors recently enacted a new soda tax, w a s t e . ” can arise on the classifi cation of both sales and purchases, especially for activities that are subject to different rules in different countries. Input VAT/GST may not be recoverable in some countries quite simply because they due to payments that are not supported by don’t have information on their websites, or the correct documentation, or incurred in foreign website is in a local language. In some countries, jurisdictions that make recovery diffi cult. it’s impossible to obtain rulings and in other Alternatively, there may simply be genuine countries, it’s even diffi cult to obtain the VAT uncertainty about the correct VAT treatment of forms.” (Read the full interview with GE’s Chris a transaction – and where and even if VAT is due. Needham on page 24.) “All these tasks become even more Rising complexity challenging in emerging markets, whether in “The management of indirect taxes has changed Asia or Latin America or elsewhere,” Robinson fundamentally in recent years,” says Tamara says. “In such markets, companies often have Berger, Global Head of Indirect Taxes and less familiarity or expertise with the local Tax Technology at Agilent Technologies, consumption taxes – and some of the indirect tax 69% a manufacturer of measurement tools. “There regimes, such as Brazil’s, are extremely In Ernst & Young’s 2011—2012 are increased numbers of jurisdictions, and many complicated.” Tax Risk Survey, 69% of tax are imposing changes in their transaction taxes. policy-makers surveyed expect Just keeping up with all these changes has been The challenges of decentralization – and to generate more revenue from a challenge in itself. Other challenges arise as centralization indirect taxes in the future. supply chains become more complicated, as Complexity also arises internally. In many companies ship from anywhere to everywhere.” companies, a variety of departments and local New types of services and the internet are offi ces spread around the world administer the also complicating factors, particularly in company’s indirect taxes. Even in one location, countries within the EU, where VAT frameworks indirect tax authority may exist across logistics, were developed many years ago, says Claudio IT, corporate control and assurance, and of Fischer, of Ernst & Young’s EMEIA Tax Policy course tax and fi nance. Moreover, compliance Development team. The issue is that online often depends on disparate enterprise resource transactions, among others, were not planning (ERP) systems, many of which are contemplated in the original legislation. ill-equipped to generate the data required for Fischer points out that there are also today’s surge of indirect tax obligations. Tax challenges in meeting the disparate rules among engines have been brought onto the market to jurisdictions for invoice formats. “For any given bridge these gaps, but these require substantial country, there can be up to 15 or 20 items investments. that must be mentioned on an invoice in order to As multinational companies move increasingly be allowed a particular tax treatment.” to shared service center models, the Even apparently simple tasks can be responsibility for indirect taxes migrates with complicated. Chris Needham, Global VAT/GST them. But when indirect tax functions are Director at GE, the global conglomerate, points transferred to a faraway service center, the out that “it’s very hard to know what’s going on company loses the on-the-ground talent that was

Ernst & Young Issue 08 T Magazine 11 Feature The rise of indirect tax Credit: Thomas Jantscher

Interview Indirect tax management at Philip Morris International

Based in Lausanne Philip Morris International (PMI) has a signifi cant presence in Switzerland, employing approximately 3,000 people. The city of Lausanne is home to PMI’s worldwide Operations Center, where over 1,500 people work to support the company’s business across more than 180 countries.

As Director of Indirection Taxation for PMI deals with a wide range of indirect taxes. Philip Morris International (PMI), the global How does this fact impact management of the tobacco fi rm, Robert Langham is responsible tax function? for all aspects of the company’s indirect tax VAT, which most people think of as “the” indirect management. Here, he speaks to T Magazine tax, is sort of in the middle of the fi eld for us in about how the company’s approach to terms of its size. Administratively, it’s defi nitely indirect taxes has changed in recent years one of the most burdensome taxes, but and how the company manages its indirect obviously, dealing in excisable goods, there’s an tax risk profi le. administrative burden for the excise and other consumption taxes as well. We look at them T Magazine: In what ways has PMI’s approach somewhat together, since excise is nothing but a to indirect taxes changed in recent years? glorifi ed VAT on a particular good. One challenge Robert Langham: It comes down to two things. is that the bases, trigger points and reporting First, a desire to manage indirect taxes more requirements for each of these different taxes effectively. Second, we’ve gone through a lot of can be quite different. One of the most diffi cult business process change and centralization that aspects is trying to manage the business has required us to take a look at how we’re processes so that you pick up all these tax trigger managing a lot of these taxes, as we move points and bases and can reconcile them. back-offi ce fi nance functions to shared service centers. This basically requires you to reassess At PMI, how does the indirect tax function how those transactional taxes are being interact with the rest of the business? administered. We’re quite lucky here; we have one tax department that covers all taxes. And we’re What are some of the things you’ve done to extremely lucky in that the business unit affi liates manage indirect taxes more effectively? look to us for guidance when they’re entering We’ve placed all of our taxes within a strong new lines of businesses or launching new kinds of tax risk management and control framework products or setting up businesses. They’re quite so that we have good risk assessment responsive to our input. Part of that is probably processes, decision-making and escalation because of the high profi le that compliance takes processes and internal control review at our company. But we’ve also done a lot of mechanisms to see how things are working. stakeholder outreach over the years, to try and And we have been able to improve processes make sure that we build and maintain those links. over time. We have implemented a lot of Also, as new business lines and new operations enterprise resource planning (ERP) tools and get developed, we actively go out and try and non-system tools as well, such as a global make sure that they know who we are and what database that provides guidelines on best we’re doing and how it might impact them, indirect tax practices, benchmarking against or how what they’re doing might impact PMI’s other companies and so on. overall tax risk profi le.

12 T Magazine Issue 08 Ernst & Young familiar with local compliance requirements. And although there is much uncertainty about the the service center must deal with countless likelihood of major change, given other economic transactions that originate in multiple countries distractions. Nevertheless, the European and languages and fall under the auspices of a Commission is currently drafting new VAT variety of cultures and authorities. legislation, due to be published in 2012, with the “Whatever a company’s reporting framework,” intention of simplifying the system and cutting says Robinson, “companies not only need to down on fraud. make sure they get the rules and fi lings right in And some specifi c areas of progress can be every jurisdiction, but also that they implement found: Several countries have recently modifi ed those rules correctly into their process and their rules to take modern technologies into 21% systems.” account, for example. Iceland and Luxembourg The average rate of VAT across Another hidden risk in indirect tax have aligned the VAT treatment of electronic the EU in 2011, which will management is its impact on cash fl ows. These and print media to reduce the distortions caused continue to rise in 2012. The may be affected by a specifi c item, such as when, for example, a printed newspaper is increase began in 2008, after when a company incurs VAT/GST in foreign taxed at a reduced rate but buying the same remaining at an average of jurisdictions that is not refunded quickly. newspaper online is taxed at the standard 19.5% for many years. But even within a single country, the overall rate. working capital cost of VAT/GST cannot be Given the increasing scope of indirect taxes, underestimated, especially where a business tax administrations around the world are putting has a high ratio of outstanding sales, or a low a greater focus on indirect tax compliance. ratio of outstanding purchases, or both of “We’re seeing a much more aggressive approach these. In short, the greater the amount of from tax authorities,” says Berger. “This has indirect tax “throughput” fl owing through the been changed quite fundamentally in the last system, the greater the demand placed on the fi ve years. They very much want everything to be company’s working capital. 100% correct or otherwise they will assess VAT liabilities or deny an input VAT refund; for them Rates go higher, tax bases get wider this is low-hanging fruit.” In recent years, the global fi nancial crisis has Tax authorities are also intensifying their accelerated a worldwide trend toward higher audit activities, often using new, more indirect tax rates. This is propelled in part by the precisely-tailored methods – many of them ongoing struggle of many countries to balance technology-based – to detect tax abuse and budgets, but also the desire to fund social avoidance. Many countries have also broadened initiatives and in other areas. the scope of indirect tax penalties and are This trend has been particularly strong in imposing higher penalties. Europe. The VAT rate across the members of the One bright spot in the indirect tax picture is EU hovered for many years around 19.5%, then the overall pattern of decline in customs duties started to increase after 2008. The average EU as countries conclude a growing network of free VAT rate has now passed 21%, and this trend and preferential trade agreements, plus looks set to continue in 2012, with Italy, Ireland, programs granting -free treatment to many Cyprus and Hungary already having announced products from developing countries. Langham rate increases. Hungary’s new standard rate of notes that, as a result of these agreements, the 27% has broken the “magic barrier” for the top effective import duty burden is starting to EU rate, which for a long time was believed to be become relatively low. “There is a lot of 25%. Reduced rates are also going up in a administration that goes around ensuring that number of countries, both within the European customs duties are negligible,” he says. Union and globally. Furthermore, the range of goods and services Dealing with reality subject to indirect tax is also being extended. Governments around the world are increasingly For example, Finland now taxes subscriptions to looking to indirect taxes to balance budgets, newspapers and periodicals, which were fund tax reforms in other areas, promote and previously exempt, while Belgium has removed regulate trade, and support green policies the previous exemption for services of notaries and other social initiatives. This movement is and bailiffs. Elsewhere, various new or increased being supported by the World Bank, the OECD excise duties are also being applied. and the International Monetary Fund (IMF), all of which favor indirect taxes, rather than direct Systems poised for change taxes on income. Many countries are in the process of refi ning The landscape for indirect tax has clearly and/or expanding their indirect tax systems, shifted and that shift appears to be a long-term some in fundamental ways, says Robinson. one. In response, tax and fi nancial executives will These range from India’s proposed introduction need to increase visibility over how the of a new nationwide GST to a VAT pilot program company’s indirect taxes are managed, as in Shanghai. In the EU, where VAT has existed several articles in this edition of T Magazine for many years (and is mandatory for EU detail. These taxes may be “hidden” but their membership), reform is also on the horizon, impact on the bottom line is quite real.

Ernst & Young Issue 08 T Magazine 13 Feature Fuel taxes Prices at the pump

Fuel tax policies vary widely around the world. Just within OECD countries, the tax component of the petrol price ranges from around 13% in the United States and Mexico to just under 60% in the UK, Norway and Greece. This makes tax the primary reason for the variation in fuel prices globally, well ahead of other costs, such as refining and distribution. Regionally, Western European countries have the highest rates of fuel tax worldwide, with an average of 55% of the pump price paid in tax.

Norway Price: US$2.56/l The Netherlands Tax rate: 59% Price: US$2.34/l Germany Tax rate: 55.7% Price: US$2.22/l Tax rate: 57.5% Japan Price: US$1.91/l Tax rate: 42.3%

Petrol consumption in 2012 of the world total 0.3% 0.8% 3.3% 6.5%

CO2 emissions from oil combustion in 2012 of the world total 0.2% 0.6% 3.3% 4.9%

Motor vehicles per 1,000 people

575 515 554 593

Sources: Australian Government, Department of Resources, Energy and Tourism; Economist Intelligence Unit; International Energy Agency / Graphic: Käthi Dübi

14 T Magazine Issue 08 Ernst & Young Global oil demand 14.58 Millions of barrels per day 14.27 13.94

23.77 Former Soviet Union 23.50 23.38 4.80 4.69 Europe 4.46

North America Middle East 8.17 8.02 7.82 Asia Africa 20.82 3.51 20.20 3.34 19.50 Latin America 3.39 6.66 6.50 6.30 Global oil demand growth

2012 Year mb/d Growth 2011 2010 88.32 3.2% 2010 2011 89.08 0.9% Sources: International Energy Agency 2012 2012 89.90 0.9%

Poland Price: US$1.75/l Australia Tax rate: 51.1% Price: US$1.51/l Tax rate: 35.7% Canada Price: US$1.29/l Tax rate: 30.6% USA Price: US$0.99/l Mexico Tax rate: 13.2% Price: US$0.73/l Tax rate: 13.8%

Saudi Arabia Price: US$0.13/l Tax rate: 0%

0.8% 1.1% 2.7% 24.0% 3.1% 3.1%

0.8% 1.2% 2.2% 19.0% 2.4% 3.3%

495 687 605 809 264 432

Ernst & Young Issue 08 T Magazine 15 Feature Global guidelines Credit: Simone Perolari / LUZphoto Striking the right balance The OECD’s Pascal Saint-Amans and Piet Battiau talk to T Magazine about the trend toward indirect taxes globally and the implications this holds for business. Interview by James Watson

Pascal Saint-Amans __ Director of the OECD’s Centre for Tax Policy and Administration. Saint-Amans took charge of the centre in February, following the retirement of Dr. Jeffrey Owens. He previously led the OECD’s Global Forum Division, which worked on the transparency and information exchange. Credit: Xxxxxx / NameVorname Estonia Feature

Piet Battiau __ Head of the OECD’s Consumption Taxes Unit. Battiau leads a growing focus on consumption taxes, especially in the development of international VAT and GST guidelines. The Unit also considers the economic impact of taxes and related best practices.

Ernst & Young Issue 06 T Magazine 17 Feature Global guidelines

enforcement versus creating an environment for business to operate and grow within? Pascal Saint-Amans: The straight answer, based on the usual tax prejudices, is that you need to have a broad base fi rst. Second, you need to have low rates. Third, you need to avoid exemptions or any kind of loopholes. When you have such a system in place, then compliance is Summary easier to ensure. That said, based on our work As governments around taxes that are pro-growth, we think that around the world the move toward indirect tax is probably better rethink the balance for growth than direct taxes. And, of course, between growth and VAT is a pretty good candidate there. revenue, much T Magazine: Pascal, since taking In terms of compliance, we’re doing work to attention is being paid over the leadership of the OECD’s improve this, which extends to indirect taxes. to indirect taxes. work on tax policy and administration But, basically, what we advocate is an approach The OECD is working to in February, what are the main tax that would guarantee the revenue collection for provide useful global issues you’re focusing on? the government and neutrality for the agent, guidelines on these. Pascal Saint-Amans: I have three while promoting guidelines internationally to priorities for my job, which I think avoid . relate to the most important issues on the international tax agenda. My fi rst priority, Many multinational businesses are battling in line with our work on setting standards, to gain certainty on country-specifi c indirect guidelines and principles for the international tax tax rules amid a great deal of market community, is to engage with non-OECD uncertainty. What advice do you offer corporate countries to ensure a global approach to tax directors trying to grapple with this? international tax issues. One example is in Piet Battiau: One of the key objectives of our indirect tax, where one of my goals is to put in work on the development of VAT/GST Guidelines place a global form of VAT. is to signifi cantly reduce uncertainty related to The second priority relates to direct taxation. the application of VAT in an international The most challenging issue we’re facing right context. We have done a lot of work to now is transfer pricing. We need to explore how understand the differences in approaches we can provide the international tax community adopted by countries that operate VAT, such as with rules that are acceptable by government how they treat international services. We’re and implementable by business. These rules now working toward a convergence in approach must ensure , but also the between those countries. The issue is not so elimination of double taxation for business. much about the basic principles of VAT, So we’re working on how to address this issue but about the number of approaches used in through international tax instruments, such as practice and varying defi nitions on taxation OECD standards, rather than by unilateral issues. So, it is about implementing tax principles defensive measures or other more aggressive in practice. approaches. In terms of advice to tax directors, we’d The third priority is tax policy. In the current recommend they ensure that indirect tax risks economic environment, governments need have been properly identifi ed and managed and money, but also new economic approaches that that they keep track of what the OECD is doing promote growth. There are many dimensions to in addressing the risks that result from current this. Such policies need to reconcile a focus on uncertainties in the international VAT area. growth with the reduction of inequalities, for We also encourage them to support us in example. VAT is included in this work, because fi nalizing that work by giving their input on the it’s a key tax for growth, so we’re working on particular issues that they face, on the solutions developing guidelines for . that we propose and any issues that may still But beyond that, we also need to explore further need to be addressed. Many businesses are the economic merits of VAT, including when is it already actively involved in our work, which is appropriate, what is the best framework for extremely valuable for both tax administrations business, and so on. We have 153 countries and businesses. using VAT, but they currently have no forum to Pascal Saint-Amans: The risks relating to talk about the issues they face in dealing with indirect tax have been growing. When you talk to related issues. I would like to see the OECD tax directors, specifi c issues around VAT often offering that kind of forum. crop up as one of their key concerns. The tax director of a large US corporate told me that Tax is clearly in the spotlight for many one of the major issues he faces is double administrations, especially within Europe. taxation in the area of VAT, as one example. What balance do you think governments need Another example is from the tax director of a to take between higher tax rates and tougher multinational company who says the fi rm’s

18 T Magazine Issue 08 Ernst & Young indirect tax risk was far bigger than its direct non-taxation. Of course, when we look at best tax risk. practices, some of these are easier to implement than others and that’s basically what we’re To what degree does the OECD see any working on. prospect for better harmonization of indirect taxes across regions, including across the EU? The OECD highlighted the growing importance Pascal Saint-Amans: Harmonization on indirect of VAT in a recent report. What do you see as taxes within the EU is quite well advanced, the main VAT-related trends in the international but is also a bit blocked right now in terms of environment? further progress. This is a diffi cult agenda to 33.9% Piet Battiau: The fi rst key trend is the progress, given the need for agreement across The average ratio of tax as a continuous spread of VAT, which is now operated 27 countries. So there is still work to be done percentage of GDP across the in twice as many countries as in 1992, combined and we very much support the EU’s ambitious OECD in 2010, up slightly from with its continuously increasing importance as review of the European VAT framework that was 2009, but down from a recent a major source of revenue for governments. launched with the publication of its Green Paper high of 35.2% in 2007. A considerable number of OECD countries have on the future of VAT in 2010. increased standard rates over recent years, I do not see similarly advanced harmonization or have announced to do so, to address fi scal processes in other parts of the world. What I can consolidation pressures. This has resulted in an see is that there is a trend toward indirect taxes, unprecedented increase of the unweighted such as VAT, in a large number of countries, average VAT rate within the OECD, from 17.7% in driven by the need to collect revenue. Can we see 18.7% 2009 to 18.7% at the beginning of 2012, regional groups with harmonized VAT? No, not The average proportion of total whereas this average had remained stable during yet, even though the six Gulf Cooperation revenues across OECD the 15 years before that. VAT now accounts on countries in the Middle East may be moving in countries accounted for by average for one-fi fth of total tax revenues in the that direction, as are the 15 African countries VAT in 2012, compared with OECD and worldwide. It has become the third that form the South African Development 8.8% in 1975. largest source of revenue for OECD countries as Community (SADC) Free Trade Area. What we a whole, behind personal income taxes and social need to focus on at this stage is establishing security contributions. guidelines that will reduce and, if possible, A second trend is the renewed interest in eliminate the risk of double taxation. Beyond more fundamental reform of VAT systems, to that, we need to fi x the defi ciencies in some tax improve their effi ciency and revenue raising regimes through the sharing of best practices, capacity. We mentioned the review of the EU VAT which is where we can make progress. system before. Also Brazil, China and India, for example, are seeking to reform their VAT Piet, is there much consensus globally around regimes to remove the cascading effect of taxes how a VAT system should run? on top of taxes, and provide more uniform Piet Battiau: The question of harmonization in taxation of goods and services. terms of VAT or indirect taxes is quite different than with direct taxes. Broadly speaking, there is What do you see as the key areas that international consensus on how a VAT system countries should be doing better at in terms of should be designed and operated. For example, tax policy and ensuring tax compliance? there is broad agreement on the principle that Pascal Saint-Amans: I would say the main VAT should be neutral for business and that it challenge for governments right now is the should be a tax on household consumption, question of how you address the fi scal levied at each stage of production. In an consolidation needs of government with a tax international context, taxation of cross-border system that is good for growth. This is a very transactions in the country of destination, where diffi cult challenge, because if you need money the consumption takes place, is the generally immediately, the best leverage is to raise the accepted standard. VAT rate. That’s the easiest solution. But the question, in practice, is how to But then I would add another layer of implement many of these features so that they complexity. Governments need a tax system that interact consistently in an international context. is good for growth, but which includes all the As long as a government operates its VAT system other aspects of a tax system, such as the within its national boundaries, this is not a huge reduction of inequalities or the employability of issue, but there are some differences in the way people. It’s not simply about growth versus all in which these general principles are applied in an these other social aspects; they all need to be international context. For instance, how do you carefully balanced within this. So how do you defi ne destination? One country would defi ne it combine all that? as where consumption actually takes place. This is what the OECD is trying to cope Another would defi ne it as the country where the with in its new economic approach. I think it’s consumer is established. We need to achieve quite challenging and interesting and that’s some consistency in how we apply these broadly where I think tax policy work can be of critical accepted principles in practice, in order to avoid importance, which is why it is one of my or minimize the risk of double taxation or double priorities.

Ernst & Young Issue 08 T Magazine 19 Feature India’s tax reform Credit: Keystone / AP

Indian Finance Minister Pranab Mukherjee announced the introduction of the country’s GST by August 2012 as part of his budget speech.

20 T Magazine Issue 08 Ernst & Young Improving India’s competitiveness India is edging toward the introduction of a goods and services tax (GST), amidst much political debate. Dr Vijay Kelkar, the chief architect of the tax, makes the case for reform to T Magazine.

Ernst & Young Issue 08 T Magazine 21 Feature India’s tax reform

the tax by April 2012. But this required the agreement of the states and an amendment to the constitution to empower both the center and the states to levy the GST. The constitution currently says that states can tax goods, but only • By Nigel Holloway the center can tax services. The center can also impose excise duties on goods at the time they are 23.9% ndia is on the threshold of a fundamental manufactured – not at subsequent stages in the The year-on-year percentage reform of its indirect taxes. The changes will supply chain. This is an awkward tax regime: The increase in indirect taxes Itransform the economy by replacing a large center can tax goods only at the manufacturing collected in India in the fi rst number of levies with a comprehensive goods and stage and the states cannot tax services. fi ve months of the 2011–12 services tax (GST) that will affect every business in A GST would do away with this regime entirely, fi scal year. India, domestic and foreign, small and large. The enabling the states and the center to tax both key question is how long it will take to implement. goods and services at each stage of the supply The reform will centralize tax administration, chain. But this does not mean that national and and many states are resisting the partial loss of state governments would necessarily be in fi scal autonomy. concordance. The states want to be able to decide The chief architect of GST, Dr Vijay Kelkar, says which items to exclude from the GST and at what the proposed tax measure “is the next big thing in rate. But the Finance Commission opposed this, 9.5% India’s reforms.” He says it will take “at least arguing for a fl at GST rate of 5% for the center and The tax revenue (% of GDP) 12 to 24 months” to implement, despite already 7% for the states, and allowing only a tiny number in India was 9.5 in 2010, having experienced long delays. Even this may of exempted items. according to a World Bank seem optimistic in view of the scale of the reform Until now, no agreement has been found on the report published in 2011. and the complexity of the politics. Yet, the basic rate of GST and what goods and services Tax revenue refers to arguments in favor of GST are strong and Indian should be exempt. But as the reforms have stalled, compulsory transfers companies generally support the changes. old-fashioned politics has intervened. Certain to the central government As the name of the tax implies, all goods and states, led by the opposition parties, are holding for public purposes. services will be brought under it. Leaving aside a back their support to negotiate additional fi nancial few items, such as alcohol and tobacco, which compensation from the center or other would attract a surcharge, all goods and services concessions. The national opposition Bharatiya will be subject to just the GST, consisting of a state Janata Party, which was originally in favor of the component (SGST) and a central component GST, is also not yet coming out fi rmly in favor of (CGST). GST will replace a number of central and the tax. According to Kaushik Basu, the state-level taxes, including the excise duty, service government’s Chief Economic Advisor, the tax, VAT, central sales tax and luxury tax. opposition, having realized that the GST is a good reform, is now reluctant to let it happen under the Tough politics current regime. Indian policy-makers have been discussing the reform of indirect tax since the 1980s. Dr Kelkar, The argument for GST a former fi nance secretary to the Central Politics is delaying reforms, but the economic Government and director at the International arguments in favor of a GST are powerful. First, it Monetary Fund, recommended an overhaul of will broaden the tax base. By including almost all indirect taxes in 2002, when he was advisor to the services, as well as almost all manufactured then Indian Finance Minister, Yashwant Sinha. But goods, the rate of tax can fall from the current it wasn’t until the 2009 general election that the combined excise and VAT level in the range of push to introduce a GST began in earnest, when 22% to a GST of 12%, without lessening tax both the ruling party and the main opposition revenue. Some economists have argued that the party included a GST in their election manifestos. revenue-neutral rate of GST would have to be a lot A few months later, the 13th Finance higher than 12%, but this doesn’t necessarily take Commission entered the debate. This is a into account the large expansion of the tax base. constitutional body appointed every fi ve years, Second, it will simplify tax collection, which at which aims to balance the fi nancial relationship the moment is so complex that businesses are between the 28 states and the central government frequently unsure as to what taxes they should (the center). Chaired by Dr Kelkar, the Commission pay. For example, fi rms will no longer have to pay made detailed recommendations for a “grand “additional customs duty,” “additional excise bargain” between the center and the states that duty” and “special additional duty.” It would end would enable GST to be implemented. This the confusion over what constitutes consisted of six elements that will be required to manufacturing process, manufactured goods, and put into effect a “model” GST. These include the services. And it would do away with one of the design of the tax, the method of implementation worst aspects of the current regime: cascading and the timeline. taxes, caused by taxation of inputs and The central government, formed by a coalition intermediate goods, as well as fi nal consumer led by the Congress Party (whose election goods. Financial services fi rms, for example, pay manifesto included a GST), wanted to introduce VAT on the goods they buy, but they do not collect

22 T Magazine Issue 08 Ernst & Young Credit: Amit Dey

Fourth, it will allow more effective taxation of services, whose share in the consumer basket is increasing with growth in per capita income.

Keeping an eye on growth Perhaps, most importantly, a GST would help create a single market in India. Right now, interstate shipments attract the Central Sales Tax (CST), which is enacted by the center, but collected by the states. When a supplier ships its products across state borders, the goods attract the VAT in the state where the goods are bought, and also the CST in the state from which the goods are supplied. As the goods manufactured and sold locally would attract the VAT only, the CST acts as an impediment to free movement of goods within the common market of India. A single, nationwide GST would remove the tax disparities between states and, in theory, reduce the need for the border checkpoints that currently slow trade. These checkpoints are supposed to deter , but may provide the opportunity for inspectors to charge additional unoffi cial taxes. Taken together, the removal of these distortions is likely to stimulate the economy. The Finance Commission estimates that a fully implemented GST will enhance India’s gross domestic product by between 0.9% and 1.7%. That’s a sizeable boost, particularly at a time when growth rates have been falling. India’s GDP grew by only 6.1% in the fourth quarter of 2011, high relative to many other economies, but nearly two percentage points lower than in the previous years. With so many arguments in its favor, it may seem surprising that a GST has not been implemented more quickly. But the main stumbling block is India’s constitutional framework for division of taxation powers. The states and the center have the diffi cult task of reconciling fi scal harmonization with fi scal autonomy. A decision on VAT on their fees, so they hide the cost of the VAT Dr Vijay Kelkar the grand bargain for a GST requires an in the fees they charge. These are then passed on __ He is a renown agreement between the center and the states to to the manufacturer that receives the service and economist and academic amend the constitution. The center is keen to have is shifted forward by the manufacturer in the form and the Chairman of India’s these powers extended for only the fully of higher prices, and so on. 13th Finance Commission. harmonized GST that is uniform in all of the states. A GST is more transparent and is collected at Dr Kelkar is one of the The states see this as a signifi cant constraint on each stage of the supply chain. It is therefore more instrumental architects of their fi scal autonomy. diffi cult to evade. If shopkeepers, for example, do the country’s impending One way out of the stalemate, says Poddar, not report a sale, they could only avoid the introduction of a goods and could be to have a harmonized GST with the additional tax payable on the value they add. The services tax. fl exibility to allow individual states to opt out of tax already paid by them to their suppliers (on their the GST, should they so decide. Dr Kelkar is purchases) would then not be recoverable by them. sympathetic to the states’ dilemma: “There is a Third, a GST shifts the tax burden from genuine feeling among the states that they will investment, production and to domestic lose autonomy. It takes time to persuade them and consumption. While there is not explicit tax on so we need to deal with them patiently.” He says exports, taxes on investments and current that foreign multinational fi rms can play their part business inputs, and other forms of cascading, in persuading policy-makers of the merits of GST. do feed into the cost of exports. “The current “They should say how a GST has helped other regime can add 4%–5% to the cost of investment,” countries,” he says, citing examples such as New says Satya Poddar, a leader for Tax & Regulatory Zealand, Australia, Japan and Singapore. India’s Services at Ernst & Young in India, “so GST is state governments, keen to attract foreign likely to have a substantial, positive effect investment and support growth, are bound to on investment.” listen. The question is when.

Ernst & Young Issue 08 T Magazine 23 Chris Needham __ In November 2011, the International Tax Review identifi ed Needham as one of the “50 biggest infl uences in international tax.” He has spent the last 17 years developing GE’s 133-person strong Global VAT and GST team, which helps GE manage its approximately 5,000 legal entities around the world.

24 T Magazine Issue 08 Ernst & Young Credit: Liz Lock & Mishka Henner The indirect tax function Feature

Rethinking GE’s approach toward indirect tax Chris Needham, GE’s Global VAT and GST Director, emphasizes the most important priority for any VAT team is to manage risks. He speaks about how to address new challenges which arise from worldwide indirect tax exposure. Interview by Fergal Byrne

T Magazine: How would you describe the Given all this, how do you approach risk landscape for indirect taxation in Europe management within GE? today? The most important priority for any VAT team is Chris Needham: With the economic downturn, to manage risk. To do that, you have to fi rst governments are looking to protect whatever measure risk. At GE, we measure what we revenues they can. On the other hand, fraudsters call “VAT under management” for each of our are targeting the VAT system, as the current 5,000 legal entities around the world. Historically, model in the European Union clearly lends itself many have focused their risk analysis of a to various types of fraud. Both governments and company’s net VAT exposure, which is the VAT it business are faced with the challenge of owes the government, less what it has paid on its managing this risk. From the corporate own purchases. Instead, our focus is on VAT Summary standpoint, various forces are coming together under management. We start with VAT on sales. Dealing with indirect to make it much more diffi cult for large, well- We then add to the VAT on our purchases, and taxes is not just a known businesses, those who want to comply, self-assessed VAT on things such as imported fi nance consideration, to actually comply. More often, we see EU services. And more importantly, we add the value but a direct risk issue. Member States complaining about carousel fraud of the goods we or we move within the In response, GE has and increasingly holding business to account. European Union. In our view, that’s where the real been evolving the But on the other hand, we also see blatantly risk is in Europe: intra-Community transactions. skills, systems and abusive penalty regimes, which we believe are So we impute the VAT that we haven’t charged organizational clearly in breach of the European principles of back and add that into the calculation as well. structures it uses to neutrality and proportionality. We often see tax Once we have calculated VAT under management, effectively manage authorities raising assessments where there’s no we then need to identify the riskiest areas, to such risks. tax loss. So I think businesses are looking for focus on where we are getting most of our some kind of equity. assessments and face the biggest risks.

Ernst & Young Issue 08 T Magazine 25 Feature The indirect tax function

Given the deeper complexity in all this, what documents and reconciliations online, using a kind of skills are now important for dealing with single portal for every return. And to do that, we 133 indirect tax? had to build some sophisticated technology, Total size of GE’s global When we fi rst started 17 years ago, there were because there was nothing available. We have indirect tax team, up from no VAT people in GE. I was the fi rst one, and now, built very sophisticated internal websites by zero, 17 years ago. 17 years later, we’ve got 133 employees. The country, by business type, by topic, where there’s skills that are needed have been changing over a vast array of information that our businesses time and I have identifi ed fi ve different skill sets now have access to. that are important today. When we fi rst started, we recruited the How do you get the balance right between a traditional Big Four technical experts who had desire for centralization and also being locally probably come from the tax authority as a VAT responsive, in terms of outsourcing and inspector. You can achieve a certain amount – insourcing? giving good advice, helping with acquisitions and Ideally, we would like to be able to prepare our disposals – with those kinds of skills. But VAT returns in-house. However, if we need increasingly, we also need to deal with VAT technical expert opinion, or technical advice, or if questions around compliance, reconciliations and we’re short of people, we’ll get people in on documentation. And to do that, you need people secondment from outside. Indeed, we take more who’ve got more accounting skills and are also external advice now than we’ve ever done before. informed and competent in VAT. Many people who outsource do so to cut costs, Then there is the technology side. We need so that is the upside. But the downside of technology-literate people to build our VAT centralization and outsourcing is that you lose portal to prepare the return, which is our third control, as the service center can be many, many part of the skills puzzle. A more recent thousands of miles away. The result is months of development is on the policy side, which is about rework. So how do you mitigate against those interfacing with government administrations and risks? The answer is centralizing what makes doing the policy work. And, of course, there is sense to centralize. also the corporate side, as the businesses We need centralized tools, but local delivery. themselves need to have their own VAT people. Our whole strategy is to build a central platform These are business VAT managers who’re looking that is scalable, that can provide the same service at the enterprise resource planning (ERP) across any country in the world. You can’t do systems and the transactional side of things. this locally. However, people in Singapore are going to know Singapore much better than How easy is it to fi nd the right talent? somebody sitting in Ireland or the UK – so local It depends on the country. In countries such as language, local culture, dealing with local audits, the UK and the Netherlands and, to a certain knowing when things change locally – it’s critical extent, Ireland where the Big Four have always that you do that locally. We are developing a recognized VAT as a specialism in its own right, central tool, but we have local teams, local it’s not hard at all. However, in Germany and operations teams and local technical teams that France, or across Latin America where you often provide the services locally. have generalists, people who do We’re fortunate that, because we’re so large, and VAT, it’s far more diffi cult as VAT hasn’t been we have the critical mass to enable us to do this seen to be a specialism in its own right. So if on a local basis, whereas in some cases we may you want to recruit somebody there, they don’t need to have a regional hub; for example, in always see it as a profession. certain parts of Asia.

What role does technology play in helping to To what extent do you think indirect tax is manage the indirect tax function? becoming a board-level issue today? I think technology is crucial in two respects for Well, I think it should only become a board issue if VAT. First, at the business level in terms of ERP something’s gone wrong. If you’re doing the right systems and the accounting systems, this is vital. things and you’ve got the right tools and But technology is also at the corporate level. processes and the right people, it shouldn’t be a Head offi ces see that many of their businesses board issue. In fact, I would put it the other way operate across different accounting systems. As round and ask: Is indirect tax increasingly such, you’ve got to have some process or IT tool becoming a government issue? And the answer is: that can integrate information from all these yes. Look, for example, at the UK. There have different systems in a reliable way. been some abusive avoidance schemes in the UK One of the key roles of the corporate VAT team over the years. Most advisers have left these should be providing information to the different behind them, but as a result, the tax authority has businesses, with every business having the same increasingly been addressing boards about access to information. About ten years ago, we controls and processes, asking: “Is this the kind of started to develop a standard process for every thing that you want your business to be seen to country in the world, where you could prepare a be doing?” They’re trying to change behavior at a VAT return online, review it online, deal with board level by changing board attitudes.

26 T Magazine Issue 08 Ernst & Young Credit: Reuters / Handout Customs unions Focus A coming-together over trade How a rising number of customs unions and other trade agreements are affecting imports and exports.

Summit of the Gulf Cooperation Council (GCC) in Saudi Arabia in 2011. Many countries in the Middle East and North Africa are members either of the GCC or the Arab Customs Union.

Ernst & Young Issue 08 T Magazine 27 Focus Customs unions

Summary The rise in the number of customs unions is having an impact on companies trading across borders. Every differs • By Nigel Gibson country in the region. And many countries in the and there are winners Middle East and North Africa are members either and losers. Companies rom north to south, governments of the Gulf Cooperation Council or the Arab must access the everywhere have signed up to trade Customs Union. harmonization of the Fagreements of one sort or another in the customs procedures hope that their economies will benefi t. At the last Common tariffs to outsiders and the costs of count, there were 300 or so preferential trade Since customs and excise duties still account trading. agreements in force between countries around for up to half of some countries’ total revenues, the world. That amounts, on average, to no fewer particularly in Africa, steps to establish a than 13 pacts for each member nation of the customs union are not taken lightly. Christina World Trade Organization (WTO). Indeed, Horckmans, an executive director for indirect tax successive waves of treaties have seen the and a strategic trade advisor with Ernst & Young, formation not just of a union in Europe, but a until recently in Johannesburg and now in host of others covering parts of North America, Brussels, notes that it is often the strongest or Latin America, Africa, the Middle East and Asia. largest member that benefi ts most from a Why the rush to link up? Partly, this simply customs union. Being in the right place refl ects the shift in the balance of the world geographically and having a port that acts as a economy. As Pascal Lamy, Director-General of gateway to the union can encourage foreign the WTO, recently noted, the share of global GDP investment and so boost trade. contributed by developing economies has jumped “These countries often collect the majority of from just over one-third to nearly one-half since income from customs duties, which is where the turn of the century. In part, it also refl ects discussions may arise about a fair distribution of the quadrupling in export volumes during the the income between the various members of the past three decades, much of it from China and union,” she says. Indeed, for many years, this the rest of Asia. has been a talking point within the Southern Trade pacts are not new. Ever since the African Customs Union (SACU), of which South Cobden-Chevalier Treaty in 1860 between Britain Africa is by far the biggest member. 13 and France, governments have sought, for a Some groups, such as the Caribbean The average number of trade mixture of political and economic reasons, to Community and Common Market (CARICOM), pacts per country for each favor one or more trading partners over another. form customs unions as a way to pool their member of the World Trade The difference today is that the proliferation of markets, coordinate their policies on trade and Organization. agreements has become almost self-fulfi lling: give them clout with the rest of the world. The more there are, the more that nations jostle Others do so in order to reduce what is known as to do another deal. Even though the Doha round defl ection. This can occur when countries gather of world-trade talks stalled in 2008, the fact that together under a simple free trade agreement. Japan is pushing for a Trans-Pacifi c Partnership Since the tariffs charged to non-members may could give such deals even more momentum. vary from country to country, importers tend to Free trade agreements currently account for ship their goods into the one with the lowest about 85% of trade deals tracked by the WTO, tariffs and then transfer them elsewhere within 40% whereas customs unions are more rare, largely the group. If nothing else, this is ineffi cient and The approximate proportion because they tend to involve more countries and distorts trade. of global trade accounted for are tougher to set up (see “Joining the union” on by “south-south” trade, next page). The four main customs unions in Winners as well as losers largely between emerging Latin America encompass almost all the region’s In every trade agreement, of course, there are markets, up from about 10% economies. Those planned, or up and running, winners and losers. Frank de Meijer, a leader in three decades prior. for sub-Saharan Africa, take in virtually every the São Paolo offi ce of Ernst & Young Terco and

28 T Magazine Issue 08 Ernst & Young a specialist in customs and international trade, points out that trade agreements will often lead Customs agreements manufacturers to consolidate production in a single country. This usually means that smaller Joining the union factories in smaller countries lose out to larger ones in countries with bigger domestic markets. __A customs union is a form of trade be geographically distant. Free trade This has worked well for manufacturers in a agreement under which countries agreements are often more pragmatic country such as Mexico. By opening its market grant access free of tariffs to goods in approach, too: They seek to under the North American Free Trade Agreement traded between each other. They also capitalize on complementary traits in (NAFTA), Mexico has become a base from agree to apply a common set of order to boost trade between the which carmakers export worldwide. Brazil, on external tariffs to imports from countries entering them. Customs the other hand, has concentrated on its domestic elsewhere. Countries within the union unions, on the other hand, tend to market. Only 540,000 of the 3.4m vehicles apply the same duties to goods involve a larger number of countries, manufactured there in 2011 were exported, entering the union, regardless of linked within the same region. most of them to Argentina, which is a fellow which country they arrive at. So a By defi nition, customs unions demand member of the region’s Mercosur trade customs union is often a deeper form a loss of autonomy for governments agreement. With the value of Brazil’s Real higher of arrangement than a free trade entering them. So they usually take than the government would like, and other costs agreement that may eliminate tariffs, longer to negotiate. As a result, draining manufacturers’ resources, the country import quotas and preferences on customs unions accounted for less has struggled of late to remain competitive as most (if not all) goods and services than 10% of arrangements for an exporter. traded between its members, but integrating trade that were reported Ironically, too, trade agreements can which involves no common external to the WTO in 2009. Yet, for many sometimes do the opposite of what they were . developing countries, such unions intended for. Companies, says Horckmans, For this reason, free trade remain an effective way to liberalize expect there to be no formalities or delays at agreements tend to have fewer trade and reform their economies border posts within customs unions. But, members (often just two). Indeed, the with benefi ts that go beyond trade because of other taxes such as VAT and excise parties to a free trade agreement may itself. duties, it can take just as long to clear goods. “Whether the customs union works to the advantage of companies largely depends on the level of harmonization of all these procedures within the customs unions,” she says. In emerging market regions such as Africa, Some customs unions also have teething where duties are high, such costs can have a big troubles. Galina Dontsova, a senior manager impact on a company’s trading margins. Changes for customs and international trade with to tariffs can lead to distortions, too. Since Ernst & Young in Moscow, says that the customs Russia’s accession to the WTO, says Dontsova, union between Russia, Belarus and Kazakhstan, the duty payable on some components imported introduced less than two years ago, contains a into the country has risen to a point where it is principle of residence. Under this, only a resident higher than that for fi nished products. of a country member has the right to clear goods Components imported for domestic consumption into the country. As well as hampering trade in escape duty, but fi rms must fi rst apply to the some instances, the rule has led companies to government in Moscow for their products to be open branches in the other countries within listed as such. the union. Indeed, far from reducing the workload for Competition to the fore fi rms operating within them, free trade There are some hopeful signs, though. In a world agreements often increase the bureaucracy. “The of elongated supply chains and rising levels of Latin America region creates many opportunities trade, competition alone should help to reduce as a big market with more than 400m people. bureaucracy within customs unions. Companies However, the burden of compliance is high. The will simply migrate to the place offering the best authorities, on average, take longer to process service or the one that is most “user-friendly,” things than in mature markets. Companies must argues Horckmans. Other nations within a union set up bigger back offi ces to support the complex will then have to ensure their competitiveness or operation,” says de Meijer. risk losing out. Chris Horckmans agrees. “The main concern Nor are such notions lost on the WTO’s Pascal about tax for companies operating in Africa is the Lamy. Not only does he worry that the rules of lack of certainty and predictability. Companies origin, which protect so many preferential trade are willing to comply with the rules and agreements, risk stifl ing trade, particularly since regulations, but they can only do so if the rules the distinction between goods and services has are clear and consistently applied, particularly blurred. He is also concerned that obstacles to within the region. These include the core trade, often at an early stage in a manufacturing elements determining the duty rate, whether or chain, could have effects on business further not goods qualify for a preferential rate between down the line. If you cannot get the components, trade blocs and the overall cost,” she says. then you cannot build a car.

Ernst & Young Issue 08 T Magazine 29 Focus Indirect tax in M&A

Deal-makers under fi re Indirect tax is becoming a key source of risk in mergers & acquisitions (M&A) transactions and may mean the difference between deal success or failure.

M&A volume by region • By David Prosser “HMRC is now far more aggressive,” says Tony Bullock, a VAT partner in Ernst & Young’s ny company that embarks on an M&A transaction tax team in the UK, who warns that transaction understands that there is a addressing indirect tax issues must now be a real 30% 37% Along list of potential pitfalls that can derail priority during any deal process. “Remember that the deal, from overpaying for assets to battling VAT is a tax on turnover, not profi t, so it can be a with cultural integration. Until recently, however, really big cost – 40% of all the money going few executives would have placed diffi culties through the business.” related to indirect tax high on that list. But Nor is this solely a UK problem. Bart Van 33% according to Ernst & Young’s recent survey of the Renne, senior VAT and customs manager for role of tax in M&A, this is changing. The research Europe at Stanley Black & Decker, says that Europe* found that 65% of companies say that indirect tax indirect tax issues are rising up the agenda across Americas planning is now a primary or important the European Union. “Administrations and Asia**, Africa & Middle East component of transaction value. governments recognize that there’s a great deal ** Europe includes Russia So what has changed? In the past, VAT was of money to be made from VAT,” he says. ** Asia includes Australia and India typically regarded as a cash-fl ow issue rather than At Stanley Black & Decker, which has Source: Thomson Reuters 2011 a cost. Companies expected to be able to reclaim completed more than 60 M&A transactions since VAT paid ahead of an M&A transaction by either 2000, indirect tax has become a key part of the party, whether the tax was charged on spending due diligence process. The European Union’s related to the deal itself, or as part of the disparate indirect tax regime, with different rates company’s normal business activities. This is no and rules in every Member State, magnifi es the longer the case in some jurisdictions, because tax complexity. “We’ve had to instill a greater focus administrations have become much tougher within the company on this and get to a better about the way they look at VAT during and after understanding of potential problems,” says Van M&A transactions, even resorting to litigation with Renne. “Indirect tax is now very much on our list increasing frequency. during a deal – it’s a core issue.” Acquirer due diligence of indirect tax issues is Tougher treatment essential in order to prevent an unexpected tax The UK is typical of this shift. The penalties on liability for the purchaser once the deal is done unpaid VAT can be up to 30% of the liability in – possibly several years later. Common mistakes cases where an error is judged to be careless, include failing to ensure VAT group administration rising to as much as 100% if HM Revenue and has been arranged correctly, particularly where Customs (HMRC), the UK tax administration, says companies are multinational. Any recent property there was a deliberate attempt to avoid paying. An transactions will need to be particularly closely increase in the VAT rate, from 17.5% to 20%, scrutinized, since this is another frequent cause of along with an extension of the period over which diffi culty. HMRC has the right to challenge a VAT return If problems do emerge, the way in which they from three to four years, have also focused minds are treated will vary from one side of the deal to on this issue. the other. “On the sell side, if there is an issue, it

30 T Magazine Issue 08 Ernst & Young can be presented as one that is receiving attention Limited (ADIL), a company set up for the purpose and being fi xed,” says Bullock. “On the buy by Ferrovial, the Spanish bidder for BAA. Once side, the same issue is looked at from a 2.7t the transaction was completed, ADIL joined the worst-case scenario perspective – the size of the Global M&A activity for 2011 BAA VAT group and claimed a refund on the VAT potential tax bill and penalties, but also the cost totaled US$2.7t, says a report it had paid on the fees and costs incurred during of management time spent on this.” by deal tracking company the takeover. HMRC rejected ADIL’s claim on From a buyer’s perspective, the hours needed Dealogic. the grounds that it was not a continuing business. to resolve a potential VAT problem are likely to It ruled that there was no link between its jeopardize the deal timelines. And, depending activities prior to the transaction, when it was on the scale of the issue, the theoretical liability simply a “bidco” set up to do the deal, and the might even put the economic viability of the ongoing economic activity of BAA itself, for which transaction at risk. “Often, in the current VAT was recoverable. environment, the acquiring business will be ADIL challenged that ruling in 2010 and won, stretched fi nancially and may be right at the limits 24% but its victory was overturned at the Upper VAT of its banking covenant,” says Bullock. “This International M&A volumes Tribunal. The latter ruling was partly determined means that there simply may not be the decreased by 24% in the fi rst by the timing of the sequence of events in the headroom to deal with an additional VAT liability.” quarter of 2012 compared to takeover and both sides are challenging some Equally, however, some sellers might argue Q4 2011 and were down parts of it. Nevertheless, the case represents a that the buyer is exaggerating the signifi cance 26% compared to the same wake-up call for other companies considering M&A of the problem in order to drive a harder bargain. period last year (Q1 2011), activity. In short, they should not simply assume “Buyers do use VAT issues tactically – to reduce according to Ernst & Young's that a VAT refund on deal costs will be automatic. the price, for example, or to try to secure a better M&A Tracker. In any case, it’s not simply the specifi c issues of deal in some other way, such as the provision of the BAA case that should concern businesses, but post-deal assistance,” says Bullock. the signal of HMRC’s intent, warns Ernst & Young’s Either way, the potential for a VAT problem Bullock. Companies should also bear in mind to destroy value, in the event of the business that other authorities may become involved in being sold, underlines the importance of matters of indirect tax and that, while VAT is the good administration on an ongoing basis. biggest concern, it is not the only issue. In Companies that take their corporate governance 80% multinational deals, companies need to consider responsibilities seriously should be aware that According to an OECD survey import duties carefully. These are generally poor VAT practices may be prejudicial to from 2010, over 80% of payable on goods when they are fi rst brought into shareholders’ interests in the event of a deal. businesses incur more than the European Union and they are not usually US$10,000 of VAT on recoverable, although this is an expense that is VAT pitfalls foreign business expenditure often overlooked. Often, says Stanley Black & Decker’s Van Renne, every year. In certain industries, such as defense, export the biggest problem of all is poor quality controls may also be an issue. It is not just that administration. “We’ve come across companies certain types of goods may only be exported with where there is no centralized department the express permission of HMRC, but also that responsible for oversight of indirect tax across certain types of activity expose businesses to the group,” he says. “Or, we’ve found that reporting regimes in other countries, where the bookkeeping software doesn’t even have an standards may be bureaucratic, time-consuming archiving feature, so there are few records being and expensive. kept.” A second category of potential VAT pitfalls in an M&A transaction relates to costs incurred as Resolving tax disputes part of the deal itself. Until relatively recently, The broader point is that indirect tax has become the rules on the extent to which VAT is a much bigger issue than ever for those involved reclaimable on costs such as legal advice, due in M&A transactions – on both sides of the deal. diligence and other fi nancial consultancy were Often, the only way to resolve an indirect tax relatively straightforward. In most cases, both dispute, where the potential liability may be buyers and sellers were able to reclaim such VAT, diffi cult to quantify, is for the seller to offer which is important since, on the bigger deals, warranties or indemnities. But those are only the refunds may run into many millions of pounds. valuable as long as the seller remains in business, More recently, however, some tax exposing the purchaser to more risk than administrations have complicated the situation, originally anticipated at the outset of the deal. Nor with offi cials taking a tougher line. Their argument is such an arrangement necessarily satisfactory is that a buyer may only recover VAT on deal for the seller, which will be required to make costs where it is able to show some form of provisions for the possibility of having to fulfi ll continuing economic activity, before and after those warranties or indemnities. the transaction. That may be diffi cult, for In such circumstances, there is no clean break example, where a new company is set up to bid. following the completion of an M&A transaction, The takeover of airports group BAA is one which is often an objective for both sides. Indirect high-profi le example of a deal that has fallen foul tax concerns may mean continuing a business of this tougher stance. The deal was done six relationship for longer than was originally years ago by Airport Development Investments anticipated.

Ernst & Young Issue 08 T Magazine 31 Focus Unusual taxes Credit: Getty / Universal Images Group

Beard tax Russia, late 17th century

Body parts United States, money received for donating blood In the late 17th century, the Russian Tsar Peter and body organs is subject to tax. Case law the Great implemented a beard tax, as part of a holds that if the donations are frequent enough, series of measures to regulate the appearance of donors may treat this as a business and claim his subjects. But it was also an early example of related expenses, such as specialized health food body parts being subject to taxation. Today, in the to enrich the blood.

32 T Magazine Issue 08 Ernst & Young Logical beginnings; extreme conclusions The evolution of tax rules over time has often led to seemingly bizarre items being taxed. But in assessing how such rules came about in the fi rst place, business can gain insight into what future taxes might be faced.

• By Dr Paul Kielstra owners, for example, took to bricking in windows, just as Peruvians today often leave parts of their ists of unusual taxes abound. Typically, houses incompletely fi nished, in order to avoid a such lists are designed to draw humor tax on fully built houses. Today’s tax planners, Lfrom levies that show particular however, need to be more careful as complying inventiveness or greed on the part of with the letter of the law may not be enough. In governments. However, beyond the laughter lie recent years the European Court of Justice some basic lessons about what, and how, taxes has supported this approach in its landmark will be assessed. The following is a rough guide decisions on the “abuse of law” concept. for business: The search for consistency is often the source Taxes follow economic activity or assets, no of the strangest taxes. matter how novel or unusual. The most unusual taxes are often not imposed by Most lists of unusual taxes refer to the Roman legislation but by the courts seeking to interpret Empire’s urine tax. In context, though, there is the law consistently. The taxes on income from little remarkable about it. Collected urine left by items such as donated blood and haunted houses users of the city’s baths was a are just two such examples. Any company If you drive a car, I’ll tax the street. raw material used by a number operating in an obscure area that seems to not If you try to sit, I’ll tax your seat. of industries. A tax on it be subject to tax should be prepared – it almost therefore differs little in certainly will be upon closer examination. The If you get too cold, I’ll tax the heat. concept from that on any good news, though, is that the search for If you take a walk, I’ll tax your feet. other input. The broader consistency can also allow unexpected – George Harrison lesson of the tax is that deductions. In the United States, for example, governments seeking income the costs of a swimming pool can be treated as are unlikely to leave any material or activity medical expenses under certain circumstances, exempt indefi nitely and fi rms should probably such as if it is purchased on a doctor’s advice. plan accordingly. For example, if America’s sales Sin taxes are only bizarre if you don’t think it on out-of-state internet sales is a sin. endured as the volume of this activity increased, Governments have always tried to shape it would be more of an oddity than a urine tax. behavior by taxing activities they want to Apparent absurdity often refl ects an attempt discourage but fi nd hard to criminalize or to fi nd a taxable substitute. otherwise deter. As a result, many taxes from Other common entries on lists of unusual previous eras appear strange today because taxes were duties, imposed at various times the activities they attack seem perfectly normal in England, on the number of windows a house now. At the time, however, they were no stranger had. Richer homes had more windows, and so for people than duties on tobacco appear to this made for a useful – and easy-to-measure us today. The broader lesson for business is – means of gauging the approximate value of a to appreciate that, as attitudes change, so might home. In essence, it was a substitute, or proxy taxes. Today’s efforts to levy taxes on things measure, for what eventually became a house such as carbon emissions or even fat are a case tax in 1851. in point. George Harrison’s lyrics describe the use of Of course, although context can explain many such proxies clearly, as well as refl ecting the of history’s unusual taxes, there remains common annoyance with it. But these create scope for creativity. The items depicted on the problems for both governments and tax following pages are just some examples that planners. For example, their apparent simplicity show how creative offi cials are willing to become also made tax reduction easier – English house when seeking to fi ll government coffers.

Ernst & Young Issue 08 T Magazine 33 Focus Unusual taxes Credit: Shutterstock / R.A.R de Bruijn Holding BV

Wind tax The Netherlands, around 1800

The weather Australia is now on the cusp of imposing a charge In the Netherlands before 1800, millers had to pay on the use of rainwater collected by farmers and ’windrecht’, a tax on the wind, to the local lord. The then used by them for their own commercial latter, in return, would prevent the construction of purposes. Meanwhile, Riverside County, California, high buildings or the growth of trees around the is imposing an acreage-based fee on solar power miller’s windmill. Today, the Adelaide region in facilities – effectively a tax on the sun.

34 T Magazine Issue 08 Ernst & Young Credit: Private collection Peter Endebrock

Card tax England, 16th century to 1960

GreaterPlaying pressure cards on tax compliance withthat protestors could be in trimmed particular back arguing as the for edges greater got worn MultinationalEngland taxed companies playing cards, are coming and dice, under from as taxesto onextend banks. their Combined lifespan. with The wider US kept protests its card tax increasingearly as the pressure 16th century,to disclose right activities through of to their 1960. againstuntil government 1965, which cutbacks, was paid allfor this by buyinghas served stamps of subsidiariesOther countries in every followed country suit, where with they the cardoperate, tax in to raisean appropriate the issue of value to paste onto in the the public pack. asAustria part of gettingwider pressure so high atby one governments point that tolocal consciousness,The state of makingAlabama it astill far retains more high the taxpro today,fi le raisemanufacturers revenue. This started has growing producing public oversized support packs issue.applying a levy of 10 cents on all packs.

Ernst & Young Issue 08 T Magazine 35 Focus Unusual taxes Credit: 123rf.com / Tom Fakler

Window tax England, France, the Netherlands and Scotland, 18th and 19th century

Home design cropped up. But the idea behind this was simple: Window taxes were a major part of life in England, fi nding a readily visible item to use to gauge France, the Netherlands and Scotland, leading to property value. In theory, it should be hard to hide a many windows being closed up. This wasn’t the only fi replace, although enough people apparently aspect of home design subject to tax. At times, a tried to do so that revenue agents were allowed to on wallpaper, as well as a fi replace tax, enter any dwelling in the country to check for these.

36 T Magazine Issue 08 Ernst & Young Credit: Reuters / NASA Space tax United States, 1986 — current

Space commerce use in calculation of foreign tax credits. So far, Since passage of the US Tax Reform Act in 1986, efforts to reduce the tax burden in space, such any income earned in outer space by American as the proposed Zero Gravity, Zero Tax Act of citizens is deemed to have been earned in the 2001, have failed to secure Congressional United States itself. This has the drawback of approval. Just one more risk for those exploring removing such revenue’s previous eligibility for the fi nal frontier.

Ernst & Young Issue 08 T Magazine 37 Focus Africa Credit: Jason Larkin / LUZphoto

Getting serious about Africa A decade of strong growth has seen Africa come onto the radar of many multinationals seeking new opportunities. But as the political and macroeconomic risks fade, new administrative challenges are emerging.

• By Andrew Sawers income countries without major natural Summary resources, the OECD calculates that indirect frica has long been written off by Over the past decade, taxes can make up around one-third of total business, but a shift is now underway. Africa has become tax revenue. AErnst & Young forecasts a growth rate of a market of rising Moreover, while a range of goods and services 5.5% in 2012, with foreign direct investment importance to are currently exempt or zero-rated, the indirect into the continent expected to almost double multinationals looking tax net is getting wider. Kenya, for one, is from US$84b in 2010 to US$150b in 2015. for growth. But reversing a trend that has seen the list of zero- To capture this opportunity, reform efforts are the traditional rated and exempt products gradually expand underway, with the continent’s key economies macroeconomic risks over the years. By broadening the scope of VAT, working to develop a more stable and predictable faced are now evolving its government hopes to take in enough tax business environment. Governments are also into administrative revenue to afford to cut its VAT rate. transforming tax structures and growing the tax ones, such as on tax. base to provide the revenues needed to create VAT's rising popularity more sustainable economies. There are two reasons why VAT is proving Indirect taxes, especially VAT, play a growing attractive across the continent. For one thing, part in all this. Two decades ago, only a handful it is a relatively easy tax to collect, with the of African countries had introduced VAT, with burden of collection pushed onto all companies South Africa (1991), Kenya (1990), Tunisia in the supply chain. Secondly, at least in theory, (1988) and Morocco (1986) standing out it has a fairly good compliance record, with as forerunners. The pace of adoption picked up reduced scope for evasion. through the 1990s and 2000s. Today, fewer than “Governments are certainly committed as a dozen African countries have not yet part of their reform programs, and also as part implemented a VAT. of the IMF and World Bank programs, to develop This has steadily shifted the proportion of better fi scal revenue machinery, particularly indirect tax revenue that Africa’s economies taxation,” says Pratibha Thaker, Regional collect, from around 2.5% of GDP in sub-Saharan Director for Africa at the Economist Intelligence Africa in 1980, to about 5.5% in 2005, according Unit (EIU). Indirect taxes in particular are part to the IMF. As a share of national income, this of this reform agenda. As one example, Egypt remains low, but clearly shows the direction expects to replace its current sales tax with a in which it is heading. Furthermore, in lower- VAT system, at the behest of the IMF.

38 T Magazine Issue 08 Ernst & Young Etienne Louw Rudi Grobbelaar __ Head of Group Tax at __ Absa’s Head of Indirect Absa Group, South Africa Taxes

Ernst & Young Issue 08 T Magazine 39 Focus Africa

Just as importantly, Africa needs to grow its governments are setting up specialist Large indirect tax base so as to reduce its reliance on Corporates Offi ces (LCOs) within their revenue highly volatile revenue streams from fl uctuating authorities. Such offi ces already exist in South commodity and mineral prices. Similarly, the Africa, with others being set up. The idea is that continent’s ongoing shift toward ever-greater these are staffed with the most skilled tax trade liberalization is reducing the tax take from offi cials to deal with the most complicated tax excise duties and tariffs. As a 2009 IMF report issues being handled by the largest taxpayers. on revenue mobilization in sub-Saharan Africa These will also equip tax authorities with the describes it, “A shift towards consumption ability to target companies more directly, with taxation [in sub-Saharan Africa] thus appears to the necessary skills to do so effectively. provide a simple strategy for recovering revenue This highlights the changing situation faced by without jeopardizing the welfare gain from trade multinationals on the ground, as the tax net is liberalization itself.” widened, but often with new issues emerging along the way. One trap to watch out for is that Contradictory laws many African countries do not make cash But there are problems, and these affect refunds in VAT refund situations, which is where businesses of all sizes and sectors operating in companies don’t collect more VAT on their sales Africa. Chief among them, arguably, is the or supplies than they pay on their purchases. plethora of jurisdictions. As the OECD highlights Instead, authorities simply allow an offset in in its international VAT/GST guidelines, this subsequent periods. This effectively means that can result in multinational businesses being the money might not be seen again, “or you confronted with contradictory laws and might wait years before your amount is actually administrative requirements from one country to refunded,” explains Rudi Grobbelaar, Head of another. In turn, this results in undue burdens, Indirect Taxes at Absa, a South African banking uncertainties and double taxation. It can also group. disrupt corporate efforts to create shared tax From a government perspective, the rationale service centers serving several African countries. here is twofold. One is that the prevalence of Charl Niemand, Partner for Indirect Tax Africa fraudulent claims is often a major reason for at Ernst & Young in Johannesburg, says that delaying payment of refunds. Another is that there is a lot of simplifi cation that could be less-advanced tax administrations often introduced. In particular, the “place of supply” pursue time-consuming processes to verify rules, which determine the jurisdiction in which claims before approving refunds. Kenya has goods or services are delivered and hence where been struggling with a US$177m backlog of the trade is subject to VAT, need to be fi xed. VAT refunds, which the government hopes A related issue is simply the lack of certainty to address with its VAT simplifi cation program. in many places. This can be as basic as the fact that, as in the case of the Democratic Republic of Putting the right systems in place 20% Congo, which has just introduced VAT, the For a multinational seeking to operate and thrive The current standard rate statute isn’t easily available. “The area where across African markets, all this makes good of VAT is 20% in Morocco, you can make the quickest progress is to release systems critical. “If you don’t have visibility of 16% in Kenya, 14% in South guidelines and interpretation notes and rulings your indirect tax value under management then Africa and 5% in Nigeria. – all the explanatory memorandums that aren’t in you don’t know what you’re managing,” says legislation,” Niemand says. “Guidelines really Niemand. “For indirect taxes and customs there give the taxpayer a fair chance to get things are a lot of details required. You need to know right. But in the absence of those guides, you are you using the right tariffs codes – do you never know whether you’re right or wrong.” have exceptions, variances, those sorts of things. Much of this is due to a lack of skills and People just don’t have those systems.” experience across these countries. “It goes hand The need for such systems is most apparent in in hand with the quality of the labor market,” South Africa, the continent’s largest economy. says Thaker. “It’s really very much dependent on The South African , or SARS, the quality of education and training. If one key has steadily developed its own systems and criterion is missing, the other will not happen sophistication, with growing demands on overnight. It is going to take a decade to corporates as a result. This is a clear risk for develop.” those that are not suffi ciently prepared. “They’re This lack of harmony and even the lack of requesting data from companies, interrogating basic tools and skills are issues that the Africa this and then asking the fi rms to respond to the Tax Administration Forum (ATAF) is trying to outcomes,” Niemand says. address. The body was established in 2009 “We have done a lot of work to develop and and now has 34 countries in its membership. incorporate a number of system, reconciliation, It not only shares ideas on emerging tax issues verifi cation and other controls, including SOX or best practice in administration, but is (Sarbanes Oxley) controls, new product approval also discussing how to share information about processes and implementation reviews in our tax taxpayers between various tax authorities. risk framework,” says Etienne Louw, Head of As part of the response to the skills gap, some Group Tax at Absa. “If you look at the sum of our

40 T Magazine Issue 08 Ernst & Young Credit: Absa Group

Eco-friendly and futuristic: the Absa Group’s head offi ce building in Johannesburg. input taxes and output taxes which we have to however, requires a local presence. This is partly About Absa manage, it’s quite a signifi cant amount – far in due to having to more closely manage less The Absa Group Limited (Absa) excess of our corporate tax charge. In many sophisticated tax authorities in many is one of South Africa’s largest African countries the combined effect of high jurisdictions, but also to watch out for various fi nancial services groups reverse VAT charges and withholding taxes is specifi c risks—possible withholding taxes on offering a complete range of substantial, often exceeding the pre-tax profi t of management fees, for example, or reverse VAT. retail, business, corporate and certain transactions,” he says. Grobbelaar adds All this makes it more challenging to set up investment banking, insurance, that the key factor is the ability to rely on regional shared service centers, as many and wealth management systems, controls, processes and procedures. multinationals are doing in other regions. “You products and services. At “As far as possible, considering the large need expert local knowledge on those countries 31 December 2011, the Group volumes of transactions and sometimes as well,” says Grobbelaar. “It’s a transactional tax had assets of R786.7b, complicated legislation, you need to automate and you rely inter alia on systems and external 12.1m customers and 35.200 and document the processes to make sure that advice where necessary, as legislation and permanent employees. Absa is human intervention is kept to the bare minimum practices differ in each country.” a subsidiary of Barclays Bank and all risks are properly managed. You also Furthermore, given the skills challenge faced PLC, which holds a stake of need to continuously train people,” he says. across the continent, Niemand advises fi rms to 55.5% in the Group. think very carefully about who looks after such Going local issues internally. “Indirect taxes often constitute This strong focus on controls backed by regular quite a signifi cant value in a company if you get implementation reviews and a transparent it wrong. But you then want to go to a person approach also helps lead to a better working who is responsible for the mistake. From a relationship with SARS, giving Absa greater governance perspective I think indirect taxes are authority in any technical discussions with the not put in the right place. Often it is a very tax authorities. “We pick up an error in one of junior person managing the process. Yet often our reviews and we go to SARS and say, ‘Here’s a the risk – the indirect tax under management – is payment.’ They appreciate that approach. But more than a company’s earnings before interest the reviews go both ways and are mostly to our and tax,” he notes. As multinationals start to benefi t. This makes implementation reviews an take Africa’s promising emerging markets more important part of our tax risk framework,” says seriously, closer management of their indirect Louw. Getting this kind of approach right, tax systems will also be needed.

Ernst & Young Issue 08 T Magazine 41 Management Finance transformation Unilever’s indirect tax management challenge Effectively managing indirect tax requirements in a global marketplace calls for a deeper consideration of how corporate processes, systems and skills need to change and adapt.

• By Phil Davis indirect tax throughput is massive,” says Gainda. In 2009, an internal survey revealed an indirect nder the designation of indirect taxes, tax throughput of €12b-13b. “Given the growth there are a wide variety of taxes levied, of the business, this fi gure has increased since Uincluding value added tax (VAT), goods then and will do so even more in the next few and services taxes (GST) and customs duties. In years,” Gainda adds. “This has considerable addition, governments are increasingly looking impact on working capital and cash fl ows.” at particular local indirect taxes, such as food The growth of international business and the and environmental taxes to promote certain mushrooming of indirect tax regimes are preferred behavior. While indirect taxes are combining to call corporate models of tax proliferating across the globe, there is not much management into question. Companies uniformity in how they are implemented, in are starting to reexamine whether they have the particular outside Europe. Each country has its resources and skills to effectively become tax own rules about how, when and where tax is collectors on behalf of governments. As Gainda charged, and the related documentary and notes: “There is a global trend for governments reporting requirements vary widely. to increase revenues through indirect taxes As companies refocus their sourcing and sales by both increasing VAT rates and broadening the activities toward emerging markets, particularly VAT taxable base. Governments often tend to the BRIC countries, this only serves to increase think that VAT is relatively easy to levy because the challenges. Rishi Gainda, Director Global companies act as tax collectors.” Indirect Taxation at Unilever, says: “Brazil and There is little reward for effi cient tax 12 India, for instance, have complex indirect tax collection, but stiff penalties for failure. The number of Unilever brands, regimes which are not similar to those in Compliance with indirect tax regimes is critical out of its portfolio of more Europe.” Meanwhile the current indirect tax because taxpayers falling foul of them can incur than 400, which produce more system in China does not exist in a form a penalty, as well as suffer retrospective tax than €1b in sales each year. recognizable to many European companies, but assessments and a loss of reputation. At the it is likely to do so during the next few years. “A same time, indirect taxes can provide VAT pilot is being launched in Shanghai as a opportunities for companies with vigilant and groundbreaking step to reforming the indirect proactive indirect tax functions. Gainda says the tax system in China,” Gainda says. growing trend of levying or increasing indirect While the indirect tax challenges are taxes on unhealthy foods, for example, could be signifi cant, overcoming them does not only a stimulus for a company manufacturing food ensure compliance, but can enhance the products to revisit its product portfolio. “If there standing of a business, reduce tax penalties and are taxes on foods with high sugar or salt improve cash fl ow and revenues. “Managing concentrations, companies in that sector may indirect tax is very challenging, particularly in develop low-sugar or low-salt products that meet emerging markets,” says Gainda. “But doing it the standards at competitive prices. This could properly can differentiate your company from also support a wider business goal of developing competitors.” healthier products.” The same principle and solution can be Indirect tax models called into question applied where green taxes are levied. Gainda The indirect tax burden on multinational notes that Unilever’s vision is to double the size companies inevitably grows in line with the size of its business while reducing its environmental of the business and its revenue trajectory. impact. By properly managing green taxes there Unilever is a case in point. With 171,000 staff will not only be a positive fi nancial impact but it and turnover of €46b derived from sales in more could support Unilever’s commitment to reduce than 190 countries, the scale of the challenge is its environmental impact. This demonstrates considerable. “With this amount of turnover, the that indirect tax teams can do considerably more

42 T Magazine Issue 08 Ernst & Young Credit: Imaginechina / Corbis, Unilever

Lipton tea, one of Unilever’s most widely recognized global brands, is available in over 110 countries, from Asia to the Americas. than manage indirect tax risks and VAT changing indirect tax systems in these regions.” compliance. As well as optimizing cash fl ow, While communications and human resources are which helps the company’s funding needs, important elements for companies to assess and indirect tax specialists can help develop or control their indirect tax risks, technology also further strategic aims. “We should use indirect has a critical role to play. Many multinationals tax to support business priorities,” says Gainda. have implemented enterprise and resource “In that sense, indirect tax can be a true partner planning (ERP) systems and are now deciding to the business.” whether to update them or add costly advanced indirect tax functionality to deal with growing tax End of the silo? complexity. There is growing recognition that, to manage the In addition to dedicated indirect tax resources risks and take advantage of opportunities, the and advanced indirect tax technology, Gainda indirect tax management structure must refl ect cites a third key enabler for optimizing the the impact across all of a company’s activities indirect tax function as a valuable business from sourcing to sales. partner: managing indirect tax via a Rishi Gainda Of course, only those indirect tax specialists comprehensive indirect tax control framework. __ Based out of the with experience and relevant skills will be able to Unilever is currently working on a project to Netherlands, he is Director ask the right questions and make the leaps of review its indirect tax compliance processes and for Global Indirect Taxation understanding required to create useful links build an indirect tax control framework. The at Unilever, responsible for with the key business units. These people are framework outlines the processes, including managing the company’s thin on the ground. “You need to have talented indirect tax risks and controls, and shares indirect tax workstream people specialized in indirect tax and you also information about how indirect taxes can be and strategy. need to have them in the right place” in order to managed effectively. In addition to indirect tax partner with the business effectively, says compliance processes, there is a link to other Gainda. “Traditionally, Europe has had a large business processes that are impacted by indirect pool of indirect tax specialists. But this seems tax. “The framework will also address how the less true of Asia and even less so in Latin indirect tax function should get involved in America. This is where the people challenges lie, business change and how it adds value to the particularly given the growth of business and the business as a whole,” says Gainda.

Ernst & Young Issue 08 T Magazine 43 Management Finance transformation Credit: Ton Koene 35 The number of countries in which TomTom has offi ces for its 3,500 employees. It sells its products in more than 40 countries. Navigating indirect tax Marina Wyatt, Chief Financial Offi cer of TomTom, the world’s leading supplier of in-car location and navigation products and services, talks to T Magazine about her company’s approach to indirect taxes. Interview by Phil Davis

T Magazine: How is the global move company is networked. It’s easy, you don’t have toward increased indirect taxes affecting to set up a video conference if you want to talk your company overall? to someone by video. Marina Wyatt: The trend today is clearly away from corporate tax and toward raising revenues To what extent is indirect tax a consideration from VAT. Customs duty also continues to be a in your key business areas? major topic. Since we are selling consumer Indirect tax should be a key consideration when electronics goods, these issues have an impact launching new products and pricing has to be on our business strategy, particularly on pricing. planned on a basis that includes indirect tax. In general, retailers can’t pass on increases in This is a big issue when doing business in VAT to customers and yet prices tend to fall countries such as India, for instance, which has when VAT goes down. There is little you can do very high customs duties compared with in this respect and we share the pain with European countries. That is a real challenge retailers. But there are other ways in which we when planning in different regions. So when Marina Wyatt are impacted, such as the need to regularly we launch new products, various departments, __ Chief Financial Offi cer update our systems with different tax rates, including the tax function, all look into the of TomTom, the world’s which entails a lot of work. potential profi tability of the product. leading supplier of in-car location and navigation Do you have a discrete indirect tax team to Could you give an example of how your shared products and services. deal with this increasing burden? service center for tax has added value to the We do have people who are specialized in indirect business? tax within the tax function, and we automate as Our shared service center was able to help with much as possible. While some of the work has the tax migration issues after the acquisition of been moved to our fi nancial shared service Tele Atlas in 2008. We took immediate control of center, the indirect tax team carries out the the acquired company’s tax affairs and specialist work. centralized them without the need to expand our tax team. We were able to keep compliant with How do you keep tabs on changes to indirect all the indirect tax even after we had bought in a tax regimes around the world? different type of product. Our tax team is very proactive. They talk to their advisors regularly and expect their advisors How have you reacted to the greater need for to be proactive too. It is critical for the tax team tax compliance and to increasing aggression by to have close relationships with the business many tax authorities? units so they can inform us about relevant Above all, we need to be compliant. The key to developments. To do this, we have regular, this is to have the right governance and informal meetings with our heads of competencies in the company. I have Board level departments. Meetings are face to face, via responsibility for the tax area so it needs to be conference calls, by telephone and we also have set up in the right way to give the other directors video over IP on our computers so the whole comfort.

44 T Magazine Issue 08 Ernst & Young Credit: Laif / Hollandse Hoogte / Jan Boeve Tax management Management

Innovative and transparent: ING House in Amsterdam is the head offi ce of ING Group.

Building deeper ties Indirect tax can have a signifi cant bearing on a company’s sales and profi tability, but close relationships between tax teams and the rest of the business are rarely found. This needs to change.

• By David Bolchover have to navigate. In the UK, the standard VAT rate is 20%, but then there is a reduced rate of ndirect tax can have a signifi cant bearing on 5%, a zero rate (where no VAT is charged but the profi ts, but business managers often seller can still recover its input tax, or the VAT Iunderestimate its importance in the rush to that it incurs on its own purchases) and there are launch new products or expand into new VAT exemptions (where no VAT is charged but territories, leading to wildly inaccurate sales the seller cannot recover its input tax). projections. A strong relationship between these Products can’t necessarily be placed neatly managers and indirect tax experts, either within into categories; they can have different VAT or outside the company, can therefore lead to rates depending on the form in which they are more prudent and measured commercial sold, and may have different elements, some of decision-making. which carry VAT charges and some of which Determining what the indirect tax rate is for a don’t. For example, paper books are zero-rated in particular product is the fi rst issue businesses the UK, but electronic versions of the same book

Ernst & Young Issue 08 T Magazine 45 Management Tax management Credit: Getty / Daniel Berehulak are not. The European Commission is currently investigating the VAT treatment of e-books for the whole of the EU, but is struggling with this issue. International variations in VAT treatments further complicate this. Even within the EU, member states can apply very different rates to the same product. “There is often a confl ict between national legislation and EU legislation on VAT treatment for a particular product,” says Richard Teather, Senior Lecturer In Tax Law at the UK’s Bournemouth University. “This is complicated enough when you just have to deal with one country. But of course you have to bear in mind that this complexity is replicated for each of the member countries.” Expansion outside the EU becomes tougher still for companies trying to factor all this into their planning.

Business implications As the relevant level of indirect tax will infl uence a customer’s ability to buy a product, it will clearly impact on a company’s sales and profi ts. Firms therefore have to determine the ideal price to maximize revenue while still complying with legislation. “If companies don’t factor VAT costs into their pricing of a product, then their eventual results are going to look very different from original forecasts,” says Andrew Bailey, a leader at Ernst & Young who specializes in VAT issues in the fi nancial services industry. Failure to comply with legislation can lead to substantial retrospective payments to the tax authorities, with potentially disastrous consequences for smaller, more vulnerable companies. Several years ago, Debenhams and some other retailers in the UK introduced a VAT-exempt card-handling fee of 2.5% of the value of goods paid by customers, but prices Several years ago, the British retailer Debenhams introduced a VAT-exempt were nevertheless the same, no matter whether card-handling fee of 2.5% of the value of goods paid by customers. the customer paid by cash or card. In 2005, the courts eventually ruled that Debenhams would have to pay VAT on that 2.5% because the card- A key source of risk handling fee was introduced “in order to produce Ernst & Young’s 2011-2012 a position whereby less VAT is paid than was paid survey on tax risk and previously and for no other reason.” controversy shows tax Without ongoing specialist advice on what is a administrators and constantly changing legislative environment, taxpayers view indirect such misjudgments are inevitable. “Business taxes as a key source of managers are often operating at great speed in a risk in the coming one- and highly competitive marketplace,” Teather three-year periods. Tax explains. “The tax department might intervene administrators all over only after the deal has been done. In small the world are putting a companies that don’t have a tax department, stronger focus on enforcing external accountants may only review their indirect tax compliance. operations after the year-end when the damage has already been done. Without tax specialists who are fully integrated and embedded in the business, it becomes extremely diffi cult to understand the full implications of all the complexities of VAT.” Moreover, only the largest companies tend to employ experts focused solely on indirect tax.

46 T Magazine Issue 08 Ernst & Young But with the sheer quantity and complexity of a product goes from exempt to taxable, for indirect tax legislation continuing to grow at such example, and we decide that we can’t raise prices a rapid pace, even tax generalists may fi nd it ever because of a competitive market, we have to 2012 more challenging to keep abreast of discuss whether to swallow the cost ourselves.” In the Netherlands, a stricter developments, leading to potential problems. ING also pays attention to offshoring and VAT penalty regime may allow “Dealing with indirect tax can be like speaking in outsourcing projects, as well as major purchases the tax authorities to apply a foreign language, even for accountants and by its procurement division to ensure that they punitive sanctions to VAT general tax advisors,” says Bailey. “They should are carried out in a tax-effi cient way. errors in the case of gross have processes in place so that they know when negligence, even if a default to seek specialist advice. Without that input, they Building relationships penalty has already been will undoubtedly make errors.” Perhaps an even greater threat to the company applied. In 2012, similar At a high level, ensuring seamless integration than changing legislation comes when business developments may be seen in of tax issues into the business strategy requires managers decide unilaterally to amend an the United Kingdom, Slovakia board-level intervention. However, despite the already approved product or launch it in a new and Romania. risk that VAT can pose to the bottom line, it often territory without fully understanding the indirect does not fi gure in the minds of directors. tax consequences. Advisors must thereby Andreas Funke, at Ernst & Young’s indirect tax communicate with frontline departments on a practice in Germany, says board-level interest is constant basis. “Business managers can think, usually only aroused when there is likelihood of a ‘I’ve got a sign-off, so there’s no need to do loss being sustained. “When indirect tax impacts anything,’ ” says Bailey. “The onus is on the the bottom line, it makes it to the boardroom but indirect tax department to fi nd out what’s it might be too late by then,” says Funke. “I’ve going on. You can’t be a passive background seen cases where the sales department entered fi gure; you have to build relationships with the into a transaction, calculated a margin of 10% but business.” then the VAT wiped out the entire margin.” To do so, indirect tax experts have to demonstrate that they understand their everyday Increased focus priorities and pressures. “We need people to feel But there is a growing mindfulness within the comfortable with us as a fully accepted business corporate world about the dangers of partner and trusted and respected advisor,” says downplaying the importance of indirect tax. One Voets. “We must give them proper tax and industry that pays particular attention to indirect commercial advice, explain that we can improve tax is fi nancial services. Products are generally the fi nancial performance of their department by exempt, and companies therefore need to making them more tax-effi cient.” examine in great detail how to maximize their Voets believes that indirect tax advisors can input tax recovery. establish credibility by developing their industry “There is a great deal of awareness in our knowledge and their understanding of how company,” says Michel Voets, Senior Indirect Tax complex products work so that they can converse Adviser at ING, a bank headquartered in the fl uently in the language of the overall business. Netherlands. “For most companies in other To that end, ING sends its tax experts on internal industries, indirect tax is principally a plus-minus courses to learn about particular business areas situation, charging VAT on their supplies, but within the fi nance industry. getting it back on their purchases. But if we incur However, even in fi nancial services, where VAT in a VAT-exempt environment, it’s mainly a indirect tax specialists are likely to be employed, cost to us.” fi nding out exactly what is going on in a large Companies in other industries who are now organization will always present a challenge. just beginning to focus more on the VAT Bailey believes that the most effective indirect implications of their commercial operations can tax managers treat the broader business as if perhaps therefore learn from the experience of they were dealing with a large client company: fi nancial services companies about how best to “You need to fi nd out who the decision-makers organize themselves internally to make their are, who the infl uencers are, who can help planning as effective as possible. you do your job. For example, build a relationship According to Bailey, companies in banking and with the head of legal and tax generalists within capital markets generally have a committee that the company, and educate them suffi ciently so will look at new products and ventures into new that they can alert you to relevant developments territories. Various functions, including tax, are in the business which you may well not yet represented, and all must give their approval know about.” before any launch can take place. In other words, indirect tax advisors cannot Of course, as VAT legislation is constantly afford to wait to be invited into discussions that evolving, such an approval might need to be could affect the company’s VAT position. They reassessed further down the line. “As soon as we must constantly be developing contacts and see new laws, proposed legislation or published using their instincts to avert problems. Even if case law, we have to assess how different units the company has access to the best indirect tax are impacted, and whether to change an advice available, it may well not have the desired individual product or its pricing,” says Voets. “If impact if it is not fully integrated.

Ernst & Young Issue 08 T Magazine 47 Outlook The European VAT system Europe’s failing VAT system

Biography he EU VAT system is in a mess. It is a companies to account for VAT due in all Member Ben Terra is a dizzying mix of rates with a huge number States via a central website, a portal, in their home professor of law at Tof exemptions and special cases across its country. This sounds very practical, but in reality will the Universities of 27 countries. The VAT gap is now a stunning be hugely diffi cult, given that a business operating in Amsterdam in the €100b, which is steadily rising due to fraud all 27 Member States will still need to know the Netherlands and Lund resulting from the fact that there is no taxation different rules for each state – from different invoice in Sweden. Until on EU cross-border purchases by businesses. At rules and rates, through to different exemptions and 2003, he was Head of the same time, companies, which effectively act varying sanctions. It does nothing to resolve the Ernst & Young’s global as unpaid tax collectors, are facing a growing underlying issues within the system. indirect tax practice. compliance burden. While governments agree A lot could be learnt from outside the EU. Take In 2007, he became they should reduce such costs and obligations, New Zealand, which has a simple and effective VAT doctor economiae many are adding more compliance obligations system, with virtually no VAT gap as a result. It has honoris causa at the and implementing disproportional sanctions, one rate, few exemptions, and compliance is very University of Lund. as they increasingly rely on VAT to help plug their simple. There are other good VAT systems in fi scal gaps. Australia, Canada and South Africa, too. It is a bad combination: endemic fraud, an increased compliance burden, disproportional o we can see what a top-class VAT system sanctions, and an increasing reliance on VAT as should look like. Moreover, a perfect solution a source of revenue. In turn, this has serious Sto today’s fragmented system has long been economic and fi nancial consequences, with a large, proposed. This would allow charging domestic VAT but unpredictable, impact on competition. to all economic operators in the EU and provide for centralized multilateral clearing between Member urope’s current VAT system was meant to be States. The system is very straightforward, a transitional one, but there are no signs of especially when it is understood that 60% of the Eany alternative emerging. Indeed, most trade in Europe is conducted between related European governments are dragging their feet and parties and there is therefore no reason to charge don’t seem to want to do anything to get to the VAT on cross-border transactions between root of the problem. The popular solution right now pan-European groups. essentially involves putting a sticking plaster onto But this idea has been ignored. Underlying all this the problem, by simply seeking to increase VAT is a fundamental unwillingness of national rates, rather than fi xing the underlying system. governments within the EU to agree to a proper There is no doubt that is an solution. There is a lot of distrust right now, with little important goal. We need to have a VAT that suits an sign of any real solutions emerging. The OECD internal market, with a single rate across the understands that the system needs to be overhauled community. This should ideally do away with multiple and they have, for example, agreed on guidelines of rates across Member States. But such a move seems neutrality in VAT and GST. But it is not able to force unfeasible, not least due to legislation needing to be through any direct change by itself. accepted unanimously by all 27 members. It also All this is a pessimistic message. I’m a genuinely seems to be the case that the EU is not willing to take optimistic person, but it is hard to see light in the the fi nal consequences of what a true internal market tunnel with regards to Europe and VAT right now. implies, which is one that makes no distinction Notwithstanding the gravity of the situation, few between domestic sales and sales to the rest of the politicians appear to have the will to deal with this internal market. Until that recognition is made, we problem. What will be needed is a change of attitudes will only ever get stopgap solutions. within Member States and for leaders to fi nd a new The European Commission has had all kinds of resolve to deal with VAT problems. Let’s just hope it ideas to deal with these VAT problems, but these doesn’t come too late. focus more on politically realistic solutions rather than on ones that would repair the situation. The results are not only costly, but also simply not what Ben Terra, business needs. As one example, the Commission is Professor of law at Amsterdam and looking at “a one-stop shop” system for VAT, allowing Lund Universities

48 T Magazine Issue 08 Ernst & Young Credit: Ben Terra

Ben Terra

Ernst & Young Issue 08 T Magazine 49 Publications

Issue 10 | April 2012 Indirect tax in 2012 Managing indirect taxes A review of global indirect tax developments and issues in the supply chain Supporting growth and reducing cost and risk

Tax Policy and Controversy Briefing

Indirect Tax in 2012 1

Indirect tax in 2012 Global Tax Policy and Managing indirect taxes Common Corporate Tax Indirect tax in 2012 provides Controversy Briefi ng in the supply chain Base (CC(C)TB) and a high-level overview of recent Ernst & Young’s quarterly In this report, we look at the Determination of and expected changes in value briefi ng is aimed at helping indirect tax supply chain issues added tax, goods and services companies keep pace with a that multinationals face when The EU Commission released a tax, excise duties, customs rapidly evolving tax policy operating in today's world. We long-awaited proposal for a duties and environmental taxes environment. It provides examine how they tackle these Council Directive on CC(C)TB. around the world. This year detailed and practical advice on issues in practice, drawing on Our leading study explores the we identify key trends and their current tax issues, as well as some of the lessons they have proposed taxable income in implications for global viewpoints on topical themes learned and the “leading contrast to prevailing corporate businesses. and proposed changes. practices” they have developed. tax accounting regulations.

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Comments Ernst & Young If you would like to contact Assurance | Tax | Transactions | Advisory relationships — wherever you operate. Our the editorial team of technical networks across the globe can T Magazine, please send an email About Ernst & Young work with you to reduce ineffi ciencies, to [email protected] Ernst & Young is a global leader in mitigate risk and improve opportunity. Our assurance, tax, transaction and advisory 29,000 tax professionals, in more than services. Worldwide, our 152,000 people 140 countries, are committed to giving you are united by our shared values and an the quality, consistency and customization unwavering commitment to quality. you need to support your tax function. It’s We make a difference by helping our how Ernst & Young makes a difference. people, our clients and our wider communities achieve their potential. © 2012 EYGM Limited. All Rights Reserved. Ernst & Young refers to the global EYG no. DL0587 organization of member fi rms of Ernst & Young Global Limited, each of This publication contains information in which is a separate legal entity. summary form and is therefore intended Ernst & Young Global Limited, a UK for general guidance only. It is not company limited by guarantee, does not intended to be a substitute for detailed provide services to clients. For more research or the exercise of professional information about our organization, judgment. Neither EYGM Limited nor any please visit www.ey.com. other member of the global Ernst & Young organization can accept any responsibility About Ernst & Young’s Tax services for loss occasioned to any person acting or Your business will only achieve its true refraining from action as a result of any potential if you build it on strong material in this publication. On any specifi c foundations and grow it in a sustainable matter, reference should be made to the way. At Ernst & Young, we believe that appropriate advisor. managing your tax obligations responsibly and proactively can make a critical The opinions of third parties set out in this difference. Our global teams of talented publication are not necessarily the people bring you technical knowledge, opinions of the global Ernst & Young business experience and consistency, all organization or its member fi rms. built on our unwavering commitment to Moreover, they should be viewed in the quality service — wherever you are and context of the time they were expressed. whatever tax services you need. www.ey.com Effective compliance and open, transparent reporting are the foundations of a ED 0912 successful tax function. Tax strategies that align with the needs of your business and recognize the potential of change are crucial to sustainable growth. So we create highly networked teams who can advise on planning, compliance and reporting and help you maintain effective tax authority

Ernst & Young Issue 08 T Magazine 51 Take charge with tax insights, now on your iPad Insights that elevate tax to a strategic level and add value to you and your organization are now available through the T Magazine iPad edition. www.ey.com/tmagazine/app