In this newsletter we will highlight one of the methods for zero measurement of tax risks: 'statistical sampling' to exactly determine the amount of risk or saving.
Why is the exact amount important?
We will illustrate this using a due diligence investigation as an example. Such investigation not only serves the purpose of identifying the material risks, but also the quantification of these risks is essential. A traditional due diligence investigation normally involves completion of standard questionnaires and retrieval of standard information, which is provided by the vendor via a specially designed data room.
When for example possible incorrect VAT determination is detected, a rough estimate of the magnitude of the VAT risks (or savings!) is made on the basis of turnover and sales figures. This is not ideal for both vendor and purchaser, as it involves a lot of guesswork and thus usually provides an insufficient framework in price negotiations.
The question is whether there is a more accurate method for determining the potential additional tax assessment (or saving!) in an efficient and effective way.
In order to quickly gain insight into the level of tax risks (i.e. calculation of the potential assessment), statistical sampling can be used. By selecting a few elements (euros), the reliability of the composition of tax items can be determined with a high degree of certainty, and on the basis of identified errors in the sample, the exact amount of additional tax assessment can be calculated.
Supportive to the strength of this method is the fact that statistical sampling is the preferred tax audit method used by the Dutch tax authorities in their tax audits. This method is explicitly approved by the highest Dutch court.
Defining the scope, designing, drawing the sample and evaluating the results requires a multidisciplinary approach. In addition to indirect tax knowledge, expertise in statistical sampling is required.
In case of a due diligence such a sample is not solely relevant for the purchaser. Also the selling party can benefit from sampling with regard to preparatory work for a prospective takeover. When a statistical sample is drawn and the results are acceptable, the conclusions can be proactively taken into the data room. This can serve as additional evidence of implementation and maintenance of an effective (tax) control framework.
Moreover, in the Netherlands the possibility exists to align and discuss the results of the observed findings with the tax authorities, which provides more certainty regarding the adopted tax position.
All this can positively contribute to the sales negotiations, including the amount of guarantees and/or discounts that are to be provided.
Via the 'single audit' method, it is possible to extend the scope from VAT and/or GST to other tax areas such as 'corporate income tax' and 'wage tax'. Click on 'Go to Flyer' below if you want to learn more about 'zero measurement of risks and savings' or select 'single audit' method for debrief.
A Tax Control Framework (TCF) is an internal control instrument specifically aimed at the tax function within a company and an integral component of a company’s business control framework, which is different for every organization. It is a system (process) to identify, mitigate, control and report tax risks.
The ultimate objective of a TCF is to be in compliance with tax laws and reporting requirements and manage the risks that exceed the companies' risk appetite.
A TCF should prevent tax errors, identify opportunities in a timely manner and perform correct filings at the right moment.
A company's VAT control framework system is adequate if it provides insight into where material VAT risks may arise in the company (awareness), while the degree of risk tolerance is established internally and where appropriate control measures are taken with respect to these risks.
Below video will provide further details about an effective setup of such a controls framework and the importance of aligned to the company's business framework. The pictorial overview shown first, provide the key definitions.
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Phenix Consulting, a joint venture between LiNKiT Consulting and the KEY Group, specializes in the delivery of a range of SAP consultancy and implementation services from a tax, financial and control perspective.
Phenix Consulting comprises 6 partners and a team of 30 consultants all with strong, international business experience across a variety of SAP environments. The strength of Phenix Consulting is built on bringing together two businesses with different - but complementary - strengths to provide integrated business solutions for clients.
The KEY Group’s strengths lie where business control, information technology and tax come together, whereas LiNKiT Consulting has particular expertise in finance and control - specifically in business consulting, SAP implementation and the development of innovative business and software solutions.
The establishment of Phenix Consulting strengthens our position in the SAP consultancy marketplace. All of our clients benefit from the synergies realized by LiNKiT and KEY Group working together – more so than either company could provide individually.
These synergies result from our ability to exploit economies of scale, focus resources & expertise and with a critical mass that supports broader geographic delivery.
The combined resources of the two companies allow us to deploy not just experienced, talented consultants but also draw on our intellectual property & copyrights, and the strong leadership skills from both the LiNKiT and KEY Group leadership teams.
Phenix Consulting continually strives to develop innovative SAP products and broaden our product lines. Examples of our innovative products include:
eBilanz Cockpit - This is a solution for the mandatory filing of the German e-tax balance and has now been successfully implemented at 60 medium-sized and multinational companies.
SAF-T Filing – Across the globe many multinational companies are facing challenges in complying with the mandatory SAF-T filing requirements. SAF-T is the OECD's Standard Audit File for Tax Purposes that is being adopted as common practice for tax administrations and will be the basis for IT-based audit tools to help to combat fraud and tax evasion. We developed a lean and flexible solution which extracts relevant data directly from SAP systems and transforms the data into the XML format in compliance with the legal requirements.
eBilanz Cockpit and SAF-T integration - With access to the full capabilities of the eBilanz Cockpit we are currently developing a SAF-T cockpit which will be fully integrated with SAP. It includes individual templates that satisfy the data and format requirements of each country and provides an analytical reporting library to support monitoring controls for finance and tax. This will subsequently be the basis for development of an ERP independent solution.
Determining the VAT liability and VAT recovery of businesses’ transactions (the system’s indirect tax functionality) can be automated within Enterprise Resource Planning (ERP) systems such SAP and Oracle, or by way of a manual processes.
Multinationals run often various versions of ERP systems without harmonization. The ERP set-up is often per business unit and thus multiple kernels per country are more likely than not. In the last decade, companies have increasingly automated their business processes. The most common method is by using an Enterprise Resource Planning (ERP) system. Such a set up can be hugely complex. This is definitely the case where it relates to European based indirect tax.
As manual processes are subject to human error, automation could - under circumstances - result in performance improvements and savings.
A third party tax engine might be a solution than improving the indirect tax functionality of its own ERP systems when the organization uses multiple ERP systems. Interfacing via a bolt-on could be an alternative.
In practice, configuration (the amount depends) is needed when companies deal cross border and/or complex business model are set up such as a centralized principal structures. This could cause difficulties in running exception reports to look for missed opportunities, under claimed VAT and potential fraudulent transactions. A lot of (manual) work is required when reconciling the periodic VAT compliance reports from these different sources (divisions, different systems).
As the ERP systems do not have flexible reporting solutions, multiple spreadsheets are often used to reconcile VAT numbers. Manual processes are subject to human error and often inefficient due to the amount of rework (‘hidden factory’).
'Remediate own ERP system' or purchase a 'third party solution’
Indirect Tax functionality can be automated (full or to a certain extend) in a company’s own ERP system. The problem might be that multiple ERP systems are used and that interfacing via a third party tax engine is considered an alternative.
That option means that part of the system functionality is actually outsourced.
Some important questions from a tax software selection to ask
Data analyses of various market players are generally standard analyses that are generated by a data dump from SAP. Extracting data from a SAP environment is often not possible due to lack of the proper authorization. Moreover, the extraction of data is limited to a specific number of document numbers per extraction. This requires the same extraction to be executed over 30 times when an extensive amount of data is to be retrieved.
Retrieving data in multiple steps brings the risk of the format of the data not always being identical. As a result, there are no unequivocal results available and many manual adjustments are necessary.
In the case of extensive data, SAP often breaks off the analysis, because runtime limits are exceeded. In addition, due to restriction of the size of reports in SAP, created data files cannot always be copied to a pc.
Solely standard analyses are possible, which does not sufficiently take into account the complexity of business models and specific risk domains.
Best practice data analytics
The risk domains should be salient. Knowledge for enabling fully automated VAT determination and building an integrated Tax Control Framework is crucial in data selection. Besides that it is important that only VAT relevant data is retrieved that is necessary for this analysis. Providers of data analysis use for example third party software tools, so the data can be extracted from SAP in a uniform manner.
With this, problems regarding performance, format of reports and interpretation of data could belong to the past and guarantees the quality and integrity of data by means of:
Standard SAP itself is only processing a transaction within one specific company code and the consequence is that standard SAP VAT determination logic and functionality for VAT determination should therefore only work for:
Cross border intercompany
AB scenarios: electronic invoices via EDI/iDoc
Local ABC scenarios (e.g all legs in France)
ABC scenario with a static business model (for instance leg B-C triggers always the same VAT treatment)
Any standard SAP gaps could be resolved with limited adjustments the overall VAT determination improved via standard design of VAT condition tables, access sequences, tax codes, tax sensitive master data, configuration of customer VAT registration number.
When is Standard SAP insufficient?
However, standard SAP VAT determination logic and functionality for VAT determination does not work for complex dynamic business models (e.g. Principal-Toller-Agent model) with for example multiple VAT registrations, pick up and drop shipments, chain transactions between legal entities (ABC / ABCD scenarios).
Further explaining the root cause
The SAP VAT determination logic was developed a long time ago (1980s) and except for the “plants abroad” logic, SAP’s VAT determination logic has not changed much. This stands in con-trast with the VAT rules and business models as these have changed significantly.
The VAT landscape and rules have gone from fairly simple to rather complex. Cross-border transactions changed from solely export to a new category within the EU: Intra community transactions (goods and services) with distinct rules and new formalities to manage.
New business models have resulted in an increase of intercompany transactions, the use of chain transactions, drop shipments and pick up transactions.
These are causing IT bottlenecks to implement as Standard SAP VAT determination logic and functionality do not work for these complex dynamic business models.
The root cause is that both Standard SAP and bold-on tax engines exclusively focus on transactions within a single company; it only assesses the underlying individual transactions and fails to link the current transactions to the VAT results of previous transactions.
When more than 2 parties are involved, the VAT treatment depends on the VAT treatment of the prior transactions:
ABC (D) transactions involving supplies of goods and which are transported to another Member State or Member States. In that case it is important to identify in which part of the chain the intra-EC supply and local supply or supplies take place (see below 'Cross border drop shipments')
ABC transactions involving 3 parties in the supply-chain, which are identified for VAT purposes in three different EU countries, and for which the goods are transported directly from EU country A to EU country C. Under certain additional country specific requirements (not harmonized amongst the EU member states) such a transaction may qualify as triangulation, so that the re-spective “simplified triangulation rule” would be applicable
ABC (D) transactions involving a supply of goods which are exported to a place outside the EU. In this case, it is important to identify in which part of the chain the export takes place in order to determine the impact on the VAT qualification of the other parties in the chain transaction (see Import / Export transactions ABC transactions)
ABC (D) transactions involving a supply of goods which are imported to a place inside the EU. Again, it is important to identify in which part of the chain the export takes place in order to determine the impact on the VAT qualification of the other parties in the chain transaction (see Import / Export transactions ABC transactions)
When we take the first bullet as an example of the complexity, one could think of the possibility that the invoice flow and physical flow of goods have a mismatch.
That could be the case if party B request party A to deliver the goods directly to party C in another Member State (i.e. see below drop shipments). Standard SAP will determine the VAT qualification based on the ‘ship-from’, ‘ship-to’, ‘material’ and ‘customer tax classification’ information in SAP.
It will for instance not take into consideration the multiple VAT registrations from party B.
That would mean that not only the transaction A-B but also B-C cannot be derived correctly. From a legal perspective only one transaction can qualify as a zero rated intra-EC supply. In such ABC cases, one of the 2 transactions should be charged with local VAT.
An exception exists - second bullet above - when the supply chain fulfills all requirements of the simplified triangular. Under these strict conditions both transactions could be zero VAT rated.
The supplier is responsible for ensuring that all the conditions for applying the zero VAT rate are met.
If not the supplier does not meet the conditions for using the sero VAT rate, the tax authorities will seek to recover tax due from this supplier via a levy of a tax assessment.
If the applicable VAT rate is 25%, the tax assessment will be 25/125 of the consideration charged and thus impacts the business KPI EBITDA (profit margin erosion). This assessment has to be increased with interest and penalties to determine the total tax burden.
Without adjustment of Standard SAP setting, an incorrect VAT treatment would be determined causing non compliance risks.
Specific areas of attention
Cross border drop shipment
Specific considerations about triangulation
DK company code sells to DK customer
Stock is not available and is purchased from NL Company code with NL stock location
Direct shipment from Plant NL01 to customer
Result: wrong VAT treatment with potentially twice an 0% rated intra EU supplies Root cause: Standard SAP is not able to link the VAT treatment of AP and AR as data is gath-ered at company code level and cannot be linked to AP and AR
Specific considerations about drop shipments
Country specify rules apply when triangulation is allowed (country by country deviation). Different local rules apply when Party B is VAT registered in ship-to country where the customer receives the goods
If the supplier (plant or third party) is not set up in SAP the ship-from location will not be known during billing and sales
Standard SAP requires manual intervention
Import / export transactions ABC transactions
Specific considerations about export/import
Define the correct legal partner for VAT
Determine the correct ship-to country
Differentiate between export/import and out of scope
Customer pick up
Specific considerations about customer pick up
Country specific rules apply when a customer picks up the goods and the goods leave the country
0% VAT rate for intra EU is only allowed if supplier can prove that goods have left the country
If proof is not available the tax authorities could assess the supplier for VAT
Specific considerations about services
Default place of supply rule should be the country of establishment of your customer
Standard SAP: place of supply is by default ship-to
Default rule has exceptions (e.g repair services connected to immovable property)