Over the past several years, indirect tax leaders have become increasingly aware of the impact of indirect taxes on their companies’ working capital. However, there is a rising perception that the impact of indirect tax on their cash situation is negative.
While this is true for organizations that are unable to claim recoveries (e.g. financial services companies), most organizations stand to see a potentially significant working capital benefit from indirect taxes. In addition to the net indirect taxes paid to and recovered from governments, indirect taxes flow through the organization from customers and to suppliers, and businesses have to account for and pay for the tax before they receive it. While these flows are complex, the general impact of indirect tax on working capital should be neutral — not negative — as long as the right amounts are ultimately collected and remitted.
Moreover, the impact can be tipped to positive by effectively managing the timing of credits and payments — claiming recoveries as soon as possible, paying the right amounts when due and avoiding errors in transactions — and by taking advantage of some relatively simple opportunities that can improve the organization’s cash position.
Perceptions that indirect tax has a negative working capital impact might suggest that organizations could be managing indirect taxes more effectively. Alternatively, these perceptions could indicate that indirect tax leaders do not have enough information about their organization’s indirect tax inflows and outflows to determine exactly how net working capital is being affected.
This knowledge can be gained by setting metrics to measure the effectiveness and results of the indirect tax function’s performance. However, less than half of global organizations with over USD20 billion in annual revenues have established such metrics, while less than a third of smaller organizations have done so
For those larger organizations with over USD20 billion in annual revenues that do have metrics for indirect tax, managing indirect tax cash flow is the measure most commonly chosen, showing that these organizations see the benefits of highlighting the magnitude and impact of indirect tax’s working capital impacts.
The second and third most common metrics for larger organizations — minimization of interest and penalties and timely and accurate submission of indirect tax returns — relate to compliance activities, which are important but which indirect tax teams should be fulfilling as a matter of routine.
Nevertheless, these metrics highlight the contribution to compliance of other key areas within companies, such as IT and internal control, and help determine that ownership of compliance processes is shared and aligned in ways that promote indirect tax compliance overall.
Business partnering is the fourth most common metric, which is also important given the proportion of indirect tax processes that occur outside the function and the benefits of monitoring and improving how the indirect tax team interacts with the broader business.
Less common are metrics that could help the organization understand what is driving the movement of working capital and take steps to improve it. Given the huge amounts of working capital tied up in indirect tax processes, the absence of specific key performance indicators on working capital impacts for some companies — or, in many cases, the relative absence of indirect tax metrics at all — may be causing indirect tax teams to miss opportunities to improve cash flow, reduce costs and enhance the bottom line.
Continuing a trend observed since this survey’s first iteration in 2011, 2017 saw a rise in the proportion of global organizations that have appointed a global head of indirect tax. This trend suggests that more organizations are recognizing the need to appoint a leader dedicated to managing the risks and cash flows associated with indirect tax. Centralizing indirect tax leadership can help determine that accountabilities are clear, the right mix of dedicated and shared resources are available, and processes and technologies are leveraged to improve consistency, quality and efficiency globally.
The past several years also saw increases in the number of global heads of indirect tax who report having visibility over indirect tax returns prepared locally. This increase has been enabled partly by the centralized accountability and also by the use of tax technology and workflow tools for monitoring local compliance. For some organizations, the establishment of metrics for timely and accurate indirect tax compliance may have spurred efforts to improve global visibility.
As this global approach to indirect tax has highlighted the need to balance central oversight with local indirect tax knowledge and experience, a more recent trend has emerged toward the appointment of regional heads of indirect tax. Regional leadership enables specialized local coverage, improved partnering with the regional business units, and better relationships with local tax authorities. At the same time, regional heads of tax can be valuable nodes in a network for sharing information, identifying issues and replicating solutions across the organization.
Regional heads of tax are most prevalent in Europe, reflecting the relative maturity and stability of the region’s indirect tax regime, followed by North America. Recent years have seen more regional heads of tax being appointed in the Asia Pacific and Latin America, following on the establishment and expansion of more complex regional business structures in these regions and on the increasing complexity and maturity of their indirect tax systems.
Finally, 2017 also confirmed a longstanding trend regarding who has ultimate accountability for indirect tax within the company. Indirect tax reports directly to the finance function in a dwindling proportion of organizations. In most organizations today, indirect tax now clearly comes under the purview of the broader tax function. This shift mirrors the higher profile given to tax in general in recent times, as governments, tax authorities and the broader public have taken more interest in the amounts of tax that companies pay and how their tax matters are governed. The shift may also reflect the two-decade impact of falling corporate income tax rates globally, as tax functions broaden their focus to all tax types.
In the area of risk identification and controls, indirect tax functions increasingly say that they have identified key indirect tax risks across regions. These risks include risks embedded in processes that involve cash inflows and outflows, such as ‘order to cash’, ‘purchase to pay’, and ‘record to report’.
A high majority of organizations that have identified regional tax risks also say they have instituted processes and controls for managing them. As European Union countries are among the more evolved jurisdictions when it comes to indirect tax enforcement, it is no surprise that organizations are more advanced in identifying risk in the region and establishing controls to mitigate them. A slightly lower proportion of organizations have similarly engaged in identifying risk in North America.
Moderate increases in risk identification in the Asia Pacific region and Latin America correlate with the rising regional focus, as indicated by the increasing prevalence of regional heads of indirect tax noted earlier. However, a sizable minority of organizations have yet to take steps to identify their exposures to indirect tax risk in the two regions, which could adversely affect their cash positions.
Of course, identifying risk and establishing controls are not enough. Organizations also need to make sure the controls are effective in achieving their intended goals. Global organizations of all sizes have been making significant strides forward in their verification of internal indirect tax controls embedded in their underlying business processes:
While the trend toward self-assessment is encouraging, organizations stand to gain more strategic insight and value from more active testing and independent external review.
This growing interest in assessing and improving the effectiveness of indirect tax controls is being driven in part by tax authorities. The Organisation for Economic Co-operation and Development’s (OECD) Forum on Tax Administration is promoting the establishment of tax control frameworks for ensuring the accuracy and completeness of tax returns and disclosures, characterized by enterprise-wide controls, documented governance processes, and regular monitoring and enforcement. Organizations in the European Union could soon be required to establish compliance management systems that give tax authorities visibility over taxpayers’ underlying controls and processes. The tax authorities or trade associations of France and Germany, for example, have already issued voluntary guidelines for such systems.
In this environment, organizations not only need to establish processes for determining their controls are effective, they also need to regularly re-evaluate their indirect tax controls and overall control frameworks as tax authorities’ requirements and market conditions evolve.
The past several years saw a trend toward the centralization of indirect tax compliance activities for transactional taxes, driven in part by the latest round of finance transformation projects aiming to cut costs and boost efficiency by centralizing the coordination and performance of transaction processing work. Currently, most global organizations prepare their indirect tax returns in-house, primarily locally but with a rising proportion prepared centrally in shared service centers or global business services centers.
With this phase of finance transformation nearing completion, many organizations are taking a closer look at their centralized activities to assess which of them to keep in-house and which to outsource. Many organizations see indirect tax compliance as a top candidate for outsourcing, given the specialized resources and significant technological investments required to manage an organization’s global indirect tax obligations. Indirect tax functions can also manage the ebb and flow of indirect tax compliance activities by replacing the fixed costs of full-time employees with the variable costs of third-party service contracts.
In the next 3 years, a majority of organizations say they plan to re-orienttheir compliance models to rely significantly more on outsourcing, allowing them to exploit economies of scale that third-party service providers can bring and focus more on their own core activities.
Companies that are moving toward more outsourcing also have a new range of locations to choose from as new outsourcing centers for indirect tax have emerged in Eastern Europe (e.g. Poland, Hungary), Latin America (e.g. Costa Rica, Bogotá) and the Asia Pacific (e.g. Kuala Lumpur, Malaysia).
Another recent development has seen the tax employees of large global companies move into global professional services firms — in one case, into member firms of KPMG — followed by the outsourcing of indirect tax work to those firms in order to leverage their investments in people and technology.
Over the 3 next years, indirect tax leaders say they intend t make technology their top priority for investment, both overall and for companies having a turnover above USD20 billion, signaling a significant shift in focus.
Until recently, indirect tax functions were concerned primarily with increasing head counts and improving processes. The latest rounds of finance transformation, however, aim to drive down costs, putting more focus on efficiency and less focus on people. Given the significant reductions won through post-2008 financial crisis finance transformations, cost-cutting mandates today are more difficult to achieve. Already lean indirect tax departments have few options to cut costs and improve efficiency. Their leading opportunities are to reduce costs through outsourcing (discussed earlier) and technology, particularly through the automation of error-prone, manual processes related to input credits and expenses.
This shift in focus also shows indirect tax functions are recognizing that technology is becoming ever more critical as governments move toward digital data delivery and direct access to organizations’ tax and financial accounts. To prepare for real-time demands for detailed information that is driving the next generation of compliance, indirect tax functions need more control and visibility of their organization’s transactional data. And as governments and the broader public seek more transparency and responsibility from global organizations when it comes to tax, indirect tax leaders need to understand the details of their tax data and how it is governed. In the near future, technology may offer one of the only viable solutions for verifying the accuracy and completeness of transactionlevel data.
Despite the growing imperative to invest in technology, some indirect tax directors may be ambivalent, perhaps feeling under threat from the ways technology may change their jobs. Advances in robotics, artificial intelligence and machine learning are changing necessary skill sets. Future indirect tax executives will need to supplement their depth of technical indirect tax knowledge with technology skills. Increasingly intelligent software will not only be able to interpret and apply indirect tax rules across the world’s regimes, it will also be able to adapt its understanding, for example, in response to new court decisions or legislative change. Embracing tax technology, automation and data analytics can enable indirect tax leaders to bring a more evaluative understanding to their organization’s risks and opportunities for adding value.