The Intersection Of VAT And Shared Service Centers. A Site For Global Savings Or A Source For Worldwide Risk?
The world has changed and so has the way the world does business — some say irrevocably, whether for better or for worse. An arguable upside of the global credit crisis is that it has provided many companies with an added impetus to look for ways to improve processes, manage costs, increase functionality and customer satisfaction, eliminate redundancies and extract additional value.
One approach that is growing in popularity is the migration to a shared service center (SSC) model. About 27% of the respondents to a Ernst & Young survey of global executives indicated that they plan to increase their use of shared service centers over the next year for functions ranging from property management to customer service, from IT software and network management to HR and accounting.
As varied as the drivers for and uses of the SSC model may be, there is one common denominator that is too often missing from the strategic or planning elements of the shared service discussion — indirect tax. And although these tax considerations may not be among the issues that drive a shared service decision, tax can certainly give rise to some significant and costly challenges. That is particularly true of value added tax (VAT), which hits a number of disparate points within the enterprise as diverse as finance, procurement, IT or HR.
For multinational companies (MNC), these touch points can arise in a wide range of countries and taxing jurisdictions as well. As MNCs move more and more to the shared service model to meet their varied objectives, the responsibility for indirect taxes migrates with them, especially in the case of VAT and goods and service tax (GST). Also, complexity in managing these taxes increases exponentially when cross-border activities are involved, especially in today’s VAT environment, where all too often controls are external, processes are manual and procedures are not documented.
Historically, the activities around transactions giving rise to indirect taxes have been handled by in- country entities that are more familiar with local regulations and compliance requirements and accustomed to the rules and obligations for invoicing, liability, rates, accounting and reporting specific to each of the myriad jurisdictions.
But what happens when VAT and GST functions are transferred to an offshore SSC in some faraway location? How complex will the operational requirements be when one SSC is dealing with countless transactions that originate in multiple countries and languages and fall under the auspices of a variety of cultures and authorities?
Getting ahead of possible problems at the planning stage before they arise in practice is one critical way to make sure that the company reaps the benefits intended from an SSC migration. VAT needs to move to the top of the priority list whether a new SSC is being designed or an existing one evaluated.
A look at the risks and rewards
Since cost savings is one of the most common reasons for an SSC, companies often go to what are considered low wage countries such as the Philippines, Hungary, Poland, India or the Ukraine. An additional upside of these countries has been the availability of educated and multi-lingual talent. However, what is often missed in the business case, planning and execution is a full understanding of the processes and controls needed to effectively and efficiently manage indirect tax. This knowledge gap can give rise to some important considerations:
Inability to comply with local VAT rules — Although the root cause will vary from one company and country to another, the risk is likely to arise because of the fundamental lack of resources with local knowledge, clear VAT policies and procedures, technology enablement and controls and metrics to facilitate and monitor compliance. In most cases, there is some combination of these causes.
System incompatibility — It isn’t uncommon to find that the ERP system or other available technologies do not support SSC staff as fully or effectively as required in making sound decisions related to VAT.
Processes not clearly defined
— SSCs sometimes find themselves operating without clear descriptions or instructions as to how certain processes should function internally. That typically includes specific division of duties and defined responsibilities for every task and the person assigned to perform it, as well as the protocols for communicating with the tax office to receive updated information, escalate issues and solicit valuable feedback.
The more pieces missing, the greater the risk.
Non-existent or inadequate processes and documentation — Since indirect tax guidance is not typically part of the SSC brief, SSC staff may not have access to VAT training, manuals or web-based technology to support their decisions and activities relative to VAT.
Insufficient communications — Staff may also be hampered by inadequate or unorganized communications between the SSC and other operational business units (e.g., IT, logistics, group tax department) within the organization, making it very difficult to identify and address any crossover issues relating to VAT.
Non-existent or inadequate compliance controls — An indirect tax control framework and key performance metrics that focus on relevant indirect tax risk must be in place to provide the stability and transparency required to both enable and sustain compliance.
None of these “risk drivers” are insurmountable or prohibitively complex to overcome. That said, there are some equally significant VAT-specific rewards in migrating to a well-run and well-founded SSC:
Performance improvement — Companies have seen a reduction in both manual effort and error rates in VAT processes from automating VAT decisions in an ERP environment and (or) using technologies available on the market such as tax engines and certain web-based applications.
Better time management — More time is available to tax staff to set up and implement VAT strategy and planning. Since part of the VAT functionality is transferred to the SSC, problems can be anticipated at an earlier stage and action taken to pre-empt or solve them.
Process improvement — With the SSC doing a good portion of the “heavy lifting,” the organization has more time and resources to review, adjust, structure and optimize existing VAT processes. It may also lead to the development of a VAT team to operate as part of the overall international tax team.
Consistency and flexibility — An efficient and effective SSC/VAT relationship can provide the company with a consistent operating model as well as flexible organizational design to support growth, profitability and compliance.
Once the company has evaluated the risks and rewards and conducted any other due diligence, the processes begin for identifying the VAT-critical functions, diagnosing the current state and designing the structure that will enable the effective migration of VAT to SSC.
Identify, diagnose and design — steps for getting an SSC that works
VAT should be considered in every aspect of the migration process, from concept through completion and beyond. Although we’ve identified the three mega-steps as identify, diagnose and design, these are not necessarily discrete elements that take place only once. These same steps can — and should — be applied from time to time to an existing SSC to make sure that it is optimized and functioning as efficiently as possible and that it remains consistent with enterprise objectives in the event of changes in the business profile.
VAT-critical functions are among the most common transaction-handling processes to migrate to an SSC. That typically includes such functions as accounts payable, general accounting, intercompany settlements, travel and expenses, tax filing, customer billing and order entry.
This is essentially the time for defining the scope of the SSC – documenting the current VAT processes for the various local business units and determining what countries the SSC will support and the processes for which it will be responsible. Underpinning these decisions should be a realistic perspective on the available technologies and talent pool, coupled with reporting and metrics for measuring performance.
Another important element built into making these choices is identifying their impact and any changes they could have on current processes. Centralizing functions into an environment like a SSC entails a shift of responsibilities, which then requires establishing and documenting new protocols and new lines of communication. This early stage is the time for surfacing potential problems and identifying the time frame and approach for addressing them (e.g., further integration of ERP systems, tax engines, procedural guidance and controls).
The complexity of change that comes with implementing an SSC and its various support systems gives rise to some critical considerations, so the company must fully understand the degree of change that’s about to occur and communicate and manage it across the enterprise.
The goal is to make sure that the outsourced VAT processes and functions are transferred and continue operating as effectively and efficiently as possible. That means determining whether the current processes operate satisfactorily as is or need to be improved, factoring in any potential or existing differences and taking into account the complexity of the existing processes and the variations between these processes in each of the business units to be supported by the SSC.
One of the potential actions that may be taken is optimizing the VAT functionality of the ERP system. For example, some systems and tax engines include the option of using a condition table or decision tree to determine the appropriate VAT action without human involvement. This virtual VAT manager establishes the VAT qualification for each transaction by allocating a tax code to yield a specific VAT result.
It is essential that any process functioning or being drawn up to function will reflect such changes as new customers, flow of goods, legislation, etc. and then is entered into the system accurately and in good time. The system also must include adequate controls to ensure that transactions not within the scope of the condition table/decision tree cannot be completed without the involvement of an internal or external VAT expert.
If different applications are used, integrating multiple ERP systems into one ERP system could be an option, so this is the time to diagnose the current conditions in light of the actions to be taken, their timing and feasibility. Keep in mind that ERP implementation immediately prior to the SSC’s go-live date is not realistic. Systems changes involve various stakeholders, are time consuming and realistically take months to complete, so they should be considered as a medium- to long-term objective.
As you begin to diagnose the current state and future objectives of your SSC plans, some of the questions that can help you determine the impact of VAT prior to migration.
Do we have sufficient insight into current VAT processes including all manual adjustments, workarounds and internal quality assurances processes?
- Are the processes specific and well-documented and are they adequate to the new environment?
- Do we understand the scope of personnel changes that may occur as we migrate to the SSC?
- Have we captured all the relevant knowledge from personnel who may decide to leave the organization?
- Are we retaining access to and information about existing manual processes and procedures and offline solutions?
- To what extent do current processes depend on local VAT expertise and technology? How much will be lost in the event of a transfer to SSC?
- To what extent are different processes required from one jurisdiction to another?
- Who has final responsibility for the VAT compliance process at present and who will own it upon transfer to the SSC model?
- Where are the essential process controls being carried out?
- How does the SSC model deal with local VAT risks in terms of internal communication and coordination?
There are no standard solutions, just the central requirement that any solution be VAT-compliant. What the future SSC/VAT interface will look like will depend largely upon the complexity of the transactions to be handled and the type of technology and talent available. If the SSC design will be based upon the organization’s existing ERP system, it’s essential to know from the outset how well its structure and functionality will support the completion of the VAT processes. It’s equally important to know the extent that technology will be used for electronic invoicing, tax engines, tax reports and other VAT-specific processes and to make sure that they are in keeping with any local VAT rules and guidelines.
Fundamental to the ultimate design is whether there is an integrated ERP system in place or the VAT compliance process is based on different applications. If the infrastructure comprises a combination of applications, this increases the chances of manual adjustments having to be made for consolidation or other purposes, which in turn leads to greater VAT risk because of the higher margin of errors. If employees with limited knowledge of VAT end up being responsible for manipulating and entering data, this begs the central question of whether the data can be considered sound.
Following are more questions that can help refine the design of the VAT/SSC intersection for short-, medium- and long-term functionality:
- What kind of supervision is in place for SSC staff responsible for carrying out the relevant VAT processes?
- Is hard copy documentation available on how staff members should carry out VAT processes?
- Alternatively, is technology used to select tax codes and is assistance provided in the form of intranet/internet/tax engines?
- What duties and responsibilities for VAT processes are assigned to the different members of the SSC? The business units? IT, tax, finance or other departments? Have these duties and responsibilities been clearly defined and documented?
- Is everyone aware of the responsibilities in terms of monitoring, delegating duties and establishing efficient and effective communication lines between staff members with varying responsibilities?
- What does the internal control structure pertaining to these processes look like?
- Which controls have to or can be carried out at the SSC and which have to or can be carried out at local level?
A real world example
A multinational company based in France decided to centralize and transfer functions to Switzerland. Not only did they neglect to document the processes and thoroughly analyze the VAT impact, they also lost staff that was familiar with the functions. As a result, the company also lost access to the historical data relating to the preparation of VAT returns and had employees that were unfamiliar with the methods for preparing the returns or making manual adjustments.
At the time the VAT audit was announced, major panic ensued and the SSC staff had to work around the clock to obtain more insight into the original processes and collect information for reconstructing the VAT returns. The company was at risk for the full amount of the VAT and for penalties of up to 100% of the VAT owed. In short, the potential benefits of the SSC migration were largely overshadowed by the additional time and money that had to be spent for this emergency response and the disruption to orderly operations.
Upfront agreement and alignment
Underpinning all the activities that comprise identifying, diagnosing and designing the SSC’s treatment of VAT and GST is transparent communication and a well-defined service level agreement (SLA) that everyone involved understands and supports. That must include the responsibilities both within and outside the SSC, the division of duties and the protocols for communicating, resolving and escalating issues.
Before the processes are transferred over, each one should be thoroughly vetted to confirm:
- Overall efficiency and functionality
- Feasibility within the SSC model
- SSC resources required
- Impact on current state and ongoing processes
- Impact on ongoing processes
- Critical success factors and performance measurement
Rollouts should be reviewed holistically from a portfolio perspective in order to understand and effectively manage the demands upon corporate and SSC resources and the return on investment for each major initiative. Likewise, the VAT work stream should be integrated with contingent technology and finance projects. This may prove challenging as a number of initiatives, particularly those that deal with systems development and technology enablers, are often not visible to the tax function — another point that underscores the need for transparency and upfront communications.
Failure to align with initiatives that can intersect with VAT can result in a VAT design that is inefficient from a process perspective and not a “best fit” for the business.
Underrating VAT — some cautionary notes
Global indirect taxes can amount to as much as 75% of the overall corporate tax burden, with VAT and sales/use tax outlays nearly 40% of total business tax expenditures — almost twice as much as corporate income tax. And the more taxing jurisdictions around the world focus on taking in VAT revenues, the more prevalent will be VAT audits.
For a company that underrates the impact of VAT and fails to factor in its implications throughout the SSC design, the financial consequences can be huge:
- An oil and gas company had to pay $2 million in VAT instead of getting the refund they expected in the same amount.
- A mining company was assessed $500 million in taxes and penalties because they lacked the proper documentation.
- A consumer products company missed out on a $20 million VAT refund.
- A Fortune 100 company saw its officials put in jail because of personal liability.
Granted, not all these outcomes arose from the shared service model, but they were a direct result of failing to properly handle VAT. When SSCs are vested with the responsibility for VAT, the potential for risk at this level follows.
Managing by design — last words and leading practices
The levers for performance improvement that must be addressed to comply with VAT also help to fully optimize shared services and enhance the sustainable value they deliver. So with proper planning for an SSC that manages VAT appropriately and proactively, the pain of noncompliance can be replaced with the gain of a leading practice shared service model. And that means managing by design — looking at any process or transaction from end to end and factoring in all the requirements and controls essential to designing and optimizing a compliant VAT process. It also means addressing the roles and responsibilities connected not only with the processes being moved to the SSC but also with those that are being left behind, fully and accurately capturing local and tribal knowledge about how things actually get done.
Companies that efficiently and effectively integrate VAT into their shared service model will have these leading practices in common:
- They know that VAT is far more than a simple “wash” as a consumption tax but needs to be proactively managed throughout the buy and sell end-to-end processes.
- They look at the upstream and downstream processes connected with any transaction that carries VAT and have a transparent end-to-end perspective into the controls and metrics for each.
- They leverage the capabilities of their ERP systems to automate VAT processing wherever possible, and design their solutions so the decision is made at the right time by the right resource.
- They know that an SSC is not the end result of a one-time initiative. Rather, it’s a vehicle for continuous improvement, with the built-in ability to flex with the changes in company, industry, marketplace, business and the global regulatory environment.
- They know that VAT is not an add-on to the SSC model, it’s a critical requirement that if proactively managed brings an additional slate of benefits to the SSC.
Co-written By Richard Cornelisse: The Intersection Of VAT And Shared Service Centers. A Site For Global Savings Or A Source For Worldwide Risk? The views expressed herein are those of the authors.
- Taxmarc™ Purchase Engine – With use of standard SAP functionality the VAT treatment of incoming invoices can be determined and verified real-time in a fully automated way
- Taxmarc™ Basic – Fully automated VAT determination of outgoing invoices (AR)
- Taxmarc™ Tax Code Solutions – In Taxmarc™ Tax Code Solution’s time stamp design, no new VAT codes are required and only the effective VAT rate needs to be changed in SAP. The risk of a shortage of tax codes is eliminated and the name and description of the tax code in de SAP pricing procedure remain the same.
- Taxmarc™ VIES Solution – Taxmarc™ can automatically check the VAT numbers when a VAT number is added to the customer master data. A real time link to VIES is made to validate the entered VAT number.