Principles of value added tax risk management.

AuthorWalsh, Chris

Since the enactment of the Sarbanes-Oxley Act and the passage of similar legislation outside the United States, there has been much discussion in professional circles around operational, systems, tax ,and reputational risk management. Little detail and even less practical guidance has emerged, however, from this activity on VAT risk management, even though most multinational businesses are heavily affected by the tax. This article addresses those gaps by looking at how VAT risks have developed and continue to emerge; provides a basic understanding of the principles of risk management; and considers how those principles can be applied to businesses.

VAT is an indirect tax that has its origins in 1950s France and has spread to more than 140 countries around the globe. Today, it is the world's preferred supply chain and consumption tax, with the United States being the only Organisation for Economic Cooperation and Development (OECD) country that does not employ this tax type. There has, however, been much discussion of the VAT in the United States in terms of being a possible solution to the country's debt mountain.

Most risk management principles and processes have their origins in the financial sector, having been developed by banks and other institutions to provide a framework for their lending practices. History teaches that these processes were not well enforced in recent years, but that does not necessarily mean that they were or are ill-conceived or invalid.

The VAT Risk Management Environment

Prefatorily, consider the environment in which VAT has operated for the last 10-plus years. Pressures have been building on organizations to ensure that their various tax positions (including VAT) are well controlled and assured. One of the most obvious pressures is the basic fact that VAT has assumed a higher profile both from the taxpayer and tax authority points of view. Examples of this include:

* There has, for many years, been a global shift away from direct taxes (such as income tax) toward indirect taxes (such as VAT). This has seen many countries reduce their income tax rates and increase their indirect tax rates or introduce new indirect taxes to compensate. This has generally had the effect of bolstering national competitiveness and encouraging inward investment. It also means that the tax authorities have been placing more of their control focus on indirect taxes, so raising their risk profile as far as the taxpayer is concerned.

* VAT rates have been increasing around the world. The average standard rate of VAT in the European Union is now in excess of 20 percent and this increases the VAT throughput (or VAT under management) for most multinational companies. Although VAT is commonly seen as a wash-through tax, effective management of VAT throughput is critical to ensure that position. Weak management of VAT leads to tax assessments, interest charges, and penalties. For these reasons, companies are under greater pressure to build VAT risk management frameworks and make sure they have strong processes around their indirect tax accounting.

* The global spread of VAT (or its cousin, the Goods & Services Tax or GST) has been building for many years. Thus, India has announced that it will launch a GST system in 2012; China will be greatly expanding its VAT system in 2013 (pilot scheme) and 2015 (full launch); Malaysia will start its GST system in 2013; and the Gulf Cooperation Council countries...

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