The changing face of VAT.

• Author: Walsh, Chris
• Position: Value added tax

Introduction

Did you know that more than 120 countries around the world employ a Value Added Tax (VAT) or VAT-derived system as their primary method of levying consumption taxes? Over the years it has become almost impossible for a U.S. multinational company to operate without being affected by this taxation.

What Is the Effect of VAT on Your Company?

Currently, the United States has the only significant economy in the world that does not utilize a VAT-type regime, so the concepts and processes involved in managing and controlling this tax are somewhat foreign. This has led many companies to conclude that these tasks are best handled by local subsidiaries, which is understandable inasmuch as VAT is a notoriously complex tax with Draconian penalties commonly attached to getting it wrong. Additionally, because VAT is generally considered a "wash-through" tax, it tends to assume a lower priority in the minds of senior management, who consider it no more than a cash flow issue. But consider this:

* On average, the global rate of VAT is around 18 percent, which applies to both sales and purchases made overseas.

* Even excluding items not subject to this tax, it is common for VAT to represent 20 to 30 percent of a multinational's overseas total cash flow (i.e., the sum of all inflows and outflows of cash in overseas operations).

With those points in mind, it should be expected that, if a U.S. multinational's overseas subsidiaries have net revenues of $20 million a year, they are likely to have a total VAT cash flow in the order of $5-6 million a year. If annual overseas revenues are $100 million, then a total VAT cash flow of $25-30 million should be anticipated. Furthermore, for companies involved in making overseas supplies of financial or insurance services, healthcare, education, or real estate, VAT does not wash through the business's records and generally represents an additional tax cost. In the light of the high rates that apply, VAT often has a far greater effect on these types of businesses than any other tax.

Why Is VAT So Neglected?

Even though VAT can and does have such a significant effect on U.S. multinationals' overseas businesses, most fail to do anything about it in terms of taking central management control of the position. Many U.S. accounting systems do not even recognize VAT as a separate item, leaving it virtually invisible to finance managers. Next time you talk to your finance or accounting colleagues, ask how much VAT is paid each year globally and how much VAT passes through the books of your overseas subsidiaries in respect of both purchases and sales. You can be assured that they will not be able to tell you. This, in itself, is a serious knowledge gap and should be a cause for concern, particularly for any CEO or CFO who may, under Sarbanes-Oxley, be called upon to attest to the company's internal controls at year-end.

The Effects Of VAT

So You Think You Have Control of Your VAT--Think Again!

Some U.S. multinationals believe their Enterprise Resource Planning (ERP) systems can provide answers to the VAT problems. Unfortunately, this belief rarely has any basis in fact, even though such systems do have varying degrees of native VAT functionality. When an ERP system is initially implemented, its VAT tables are optimally populated with the correct rates of VAT that apply to the company's particular products and services. The system, however, relies upon manual intervention for updating each time a VAT rate changes, a new product or service is introduced, or the VAT rules change; or a new country market is being supplied. Further, the native functionality of ERP systems is not sufficiently comprehensive to handle many of the more complex transaction processes, in part because these systems were originally designed to cope with flows of goods and are not quite as strong when handling services, which can often be more complex in their structure. This means that somebody needs to be actively managing the VAT functionality to ensure the system's ability to achieve VAT compliance. In reality, this responsibility is usually assigned to a staff member with little or no particular VAT expertise and who, often, has neither the inclination nor the resources to keep track of the plethora of legislative and business changes occurring in several territories. The result is that, in short order, the data tables contained within the ERP system become out-of-date and unreliable.

It is not only the day-to-day business and legislative changes, however, that affect a company's VAT position. Every business experiences certain key, one-off, or occasional events in its life when it becomes essential to reexamine its entire VAT position because something fundamental is changing. The changes in question tend most often to be of the business's own making, such as merger or acquisition activity, implementation of new accounting systems, entry into a new market, or restructuring the business model. On the other hand, the changes may be imposed upon the company through external factors, such as tax rule amendments or global economic conditions, which may force a revision of the company's cost structure. But why and how do these events affect a company's VAT...