Tax functions, particularly today, need to adapt to a changing world. As organizations are going through financial transformations the tax departments have to also define their long-term strategy and align with the corporate and finance vision of the organization. One of the challenging transformations that companies may face is the replacement of an outdated ERP system, for example the upgrade from legacy SAP to S/4HANA. The migration to a new ERP system has an impact on the entire tax department including Direct tax, Indirect tax (VAT and Customs) and Transfer Pricing. In this blog we focus on the indirect tax considerations of an ERP implementation.
It is obvious that ERP systems play a pivotal role in business operations, and tax processes are incorporated into it. Based on our experience the development of a well-working, reliable and efficient tax workaround within an ERP system is not a routine task. Similarly, to all other business areas, considerable implementation effort is needed to meet this objective. The success of the proper implementation of tax requirements depends on the expert knowledge involved, especially when the issues become more complex. In order to efficiently manage all the complex situations in these fields the different financial modules, data warehouses, applications (built-in or add-on), tax engines and customs management systems should properly be fed with appropriate data. Moreover, a tax determination logic has to be developed carefully to reflect the business operation and comply with legal requirements.
International organizations operating in different markets or expanding into new markets are facing rapidly changing legal requirements. KPMG support clients in identifying local and legal requirements using regulatory databases across countries worldwide. Regulatory complexity and the need for higher tax revenues are still on the agenda. Furthermore, the change in customer habits or in the general business environment (e.g. product lifecycle, competitor behavior, market maturity) is also forcing companies to adapt to new business models, the tax and customs implications of which must also be reflected via customization in the ERP system.
If a company is operating on a domestic market, the indirect tax landscape is less complex compared to an international organization operating on a global level. However, complying with the domestic indirect tax requirements requires also attention in the fields such as digital reporting requirements (real time VAT reporting), invoicing regulations (eInvoicing in B2B or B2G), tax point date determination (e.g. selling, renting, leasing), domestic reverse charge rules, VAT deduction, differentiating B2B from B2C business models, VAT rate determination (standard, reduced, exempt, temporary regime, out of scope), customer incentives, etc. These rules can still vary from country to country, even within the European Union where the VAT rules are harmonized by the VAT Directive.
As indirect tax is a transactional tax, the risk of a wrong configuration can easily spread and lead to a potentially high penalty and interest. In many countries the limitation period is between a minimum of 3-5 years which further broadens the risk range. However, an ERP implementation is more than risk mitigation. When a company decides to upgrade for example from SAP R3 to SAP S4HANA, tax and other impacted departments have the opportunity to rethink their target operating model, validate outdated processes and create a new basis for the internal compliance framework. Therefore, indirect tax experts have to be involved in such a project in a timely manner so that they can address their requirements and those requirements could be harmonized with the demand of other stakeholders. Our experience is that investing at the beginning of an ERP implementation project into indirect tax planning is, in the long term, much more cost effective than building the ad-hoc exceptional solutions later.
The upgrade to S/4HANA can support indirect tax functions in several aspects:
- validate and finetune earlier unknown indirect tax relevant SAP processes
- harmonize indirect tax databases
- enhance automation, reporting efficiency and thus decrease certain risk patterns
- standardization and reducing of manual interventions
- extension of data analytics possibilities
As a result of an ERP migration project, the focus of the tax department from the processing of tax-relevant figures can be shifted to the actual source of those figures. In this way, the tax department has the chance to influence the tax-relevant process from the beginning and use its expertise at the tax determination stage.
Type of Integration
In an S/4HANA project there are different types of integrations ranging from Greenfield to Brownfield. An organization may either totally redesign (e.g., Greenfield) or convert (e.g., Brownfield) it`s existing process from legacy SAP to the new S/4HANA environment. Another approach is where a company is replacing its non-SAP ERP system to S/4HANA, where the tax relevant processes must be redesigned in SAP and all the source data must be migrated into the new environment as well. Further, we can distinguish a hybrid solution where the tax-relevant processes are partially migrated from SAP modules and partially from other non-SAP ERP instances (developed in-house or in-sourced) into one single S/4HANA platform, which supports the availability and consistency of tax relevant data management as a single source of data.
The ERP transformation follows KPMG`s Powered Enterprise transformation methodology:
- Vision & Validate
- Construct Deploy
The involvement of the indirect tax function is not equally intense during all the steps of the whole transformation phase. However, there are key milestones during the project when the involvement is crucial. Every ERP transformation project, such as a migration to S/4HANA, has a point when there is no more possibility for a re-design; i.e. for a return. Consequently, the engagement of the indirect tax function is key before this point-of-no-return, ideally already from the beginning of the project.
SAP S/4HANA will be able to process much more information automatically than we know from today's R3 systems. SAP's own add-ons, such as SAP Tax Compliance will also benefit significantly from an improved information and data situation. However, until the underlying technologies – such as machine learning or even artificial intelligence – are fully developed and available, established third-party solutions such as Alteryx or Power-Bi will continue to be used.
Automation of tax decision-making processes was always part of indirect taxation. Tax determination and, thus, the decision on the VAT treatment of business transactions is often located outside the tax or finance function in upstream processes (e.g. purchase, sales) and, thus, indirect tax in SAP S/4HANA projects should focus on these. It should also be noted that the new functionalities embedded into SAP S/4HANA create the opportunity to meet the increased requirements e.g. comply with SAF -T and Real Time Reporting.
In addition, there are currently many substantive changes to be taken into account in the area of VAT such as the implementation of the so-called quick fixes, Brexit, the upcoming eCommerce changes as of 1 July 2021 on distance sales and low value imports, temporary VAT rate changes, along with several other global trade requirements (e.g. country of origin, tariff classification).
What they all have in common is that they mostly have a direct impact on the process and system landscape and their country-specific design. Since the SAP S/4HANA standard package only covers these topics in a rudimentary way, customizing settings are still required in most of the cases.
In order to meet future demands on the control function, it is essential that tax departments are involved early and intensively in the SAP S/4HANA implementation. This is an inevitable part of our KPMG Powered Enterprise Transformation methodology.
In principle, for all tax types, it is a matter of making data available in the required level of detail very early in the process. This is the only way to prevent the subsequent, costly correction of insufficient or incorrect data.
The simplification and automation potentials initially identified must be systematically tracked in the implementation project and then subjected to a cost-benefit analysis. This paves the way for acceptance of the tax requirements within the company and ensures that the implementation costs will generate a corresponding return on investment.
Please also check our document which provide a generic overview about VAT, Customs and Global trade considerations of an ERP implementation with a focus on the benefit of SAP S/4 HANA. In the document we collected current trends that have an impact on the way of approaching tax compliance, we summarized why VAT and Global trade should play an important role in an ERP journey and how our team could help you in this.