Management of indirect tax: how to make that change

Indirect Tax Risk Management
KEY Group: a Phenix Consulting company
By Richard Cornelisse
November 2015

KEY Group: a Phenix Consulting Company
Table of contents
2
Step Topic Page
Methodology 3
Executive summary - senior management buy-in 4
Define Indirect tax objectives 5-11
Measure Zero measurement methods 12-20
Measure Review by internal audit 21
Analyze Zero measurement findings and root cause 22
Control Design VAT risk matrix 23
Control Design VAT control matrix 24-25
Improve Write business case and problem statement 26
Improve Tax strategic plan 27-32
SME Who we are 33

Methodology
• Define - high level process and objective(s)
• Measure - data: collection plan and implementation
• Analyze - zero measurements findings and root cause analysis
• Control - control methods
• Improve - solution: selection and implementation
3

 
Executive summary - senior management buy-in
4
If you want to improve quality, you have to first understand what senior management thinks is
important, and what senior management thinks of you

Define - indirect tax objectives
• The indirect tax objectives should create, protect and optimize value in the range of
company ’s business objectives
• The tax function should ascertain proper implementation and determine the impact of
changes in businesses, laws and regulations on implemented tax planning
• VAT should be considered in every aspect of a migration process, from concept through
completion and beyond
• Technology-related tax risk: understand and address the potential harms and benefits of
(new) technology
• Commit to pay tax in accordance with all relevant laws and regulations in the
territories of operation
• The objective of the indirect tax department is to minimize unnecessary cash out flow of
output VAT and the complete deduction and reclaim of input VAT where possible
• When executing this objective the cash flow position must be taken into account and no
additional risk on VAT audits must be created that exceeds company’s risk appetite
• Sustain a good and honest working relationships with the tax authorities
5

 
Define - risk management objectives
6

 
Define - business risks translated to indirect tax
7

 
Define - strategic risks
8
• Non-routine and significant business transactions that are always a high risk area from an
indirect tax perspective:
• Share issues or sales
• Migrating to a new jurisdiction
• Reorganisations
• Acquisition or disposal of any business or part of a business
• Acquisition or disposal of real estate
• Financial transformation
• Part of the business is outsourced (e.g. a Shared Service Centre or accounts payable/receivable
to a third party service provider)
• Other financial transactions
• VAT should be considered in every aspect of the process, from concept through completion
and beyond
• 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

 
Define - financial and compliance risk
9
• The correctness of VAT reporting is checked only afterwards by the tax authorities
• Non compliance could result in that over many years an assessment can be levied
• Depends on country’s assessment period: NL is five years
• Increased with interest and penalties
• Penalties for incorrect invoicing can be a percentage of the turnover
• Take for example the risk when incorrectly the zero VAT rate is applied
• The supplier is responsible for ensuring that all the conditions for applying the zero VAT rate are
met
• If not, the tax authorities will seek to recover tax due from this supplier via a levy of a tax
assessment
• If the applicable VAT rate is 25%, the tax assessment will be 25/125 of the consideration charged
• This assessment has to be increased with interest and penalties to determine the total tax burden

 
Define - operational risks
10
• Hidden factory or hidden operation definition:
• The rework and cover ups, the hours and days of wasted time in a company of people
who constantly correct mistakes (unnecessary rework)
• It is about extra man-hours, additional costs due to rework (credit/debit notes) and
retrospective corrections and/or disclosures
• During assessment of any solution:
• Determine the amount of increase of workforce efficiency
• How much rework is avoided
• Risk exposures are decreased

 
Define - materiality of indirect tax risks
• Materiality and size of tax risks:
• Absolute amounts, VAT complexity and change
• Reputational risks:
• Tax authorities (e.g. horizontal monitoring agreement)
• Public domain (e.g. response of the public when failure is disclosed)
• Suppliers (e.g. impact on commercial relationship when invoices are not paid)
• Customers (e.g. impact on commercial relationship when invoices are incorrect)
• External auditor (e.g. impact of errors on financial reporting and shareholders’ value)
• Tax risk appetite
• What amount of assessment is still considered an acceptable tax audit outcome
• Having defined acceptable levels of risk leads to resources not having to spend time on further
reducing risks that are already at an acceptable level
• Zero measurement - identify key indirect tax risks:
1. VAT throughput
2. Statistical sampling
3. Data analysis
4. ERP review
11

 
Measure - the key numbers under management
Example of a Dutch MNC
• Total annual NL VAT cash throughput (input plus output VAT): EUR 2.8 billion
• Errors in output and input VAT have a direct impact on EBITDA (margin erosion)
• 1% +/- adjustment is material and impacts shareholder’s value
12

 
Measure - understand the impact
13
Example US MNC

 
Measure - understand the top VAT risks
14
AP VAT example

Measure - understand ERP VAT errors
15
SAP example
• Ineffective use of the proper partner functions in SAP for a supplier who provides services in
multiple countries and invoices VAT locally
• Incorrect derivation of VAT registration numbers for cross-border transactions caused by
incorrect SAP configuration
• Missing/improper VAT registration numbers in customer master data, such that invoicing
requirements are not satisfied for cross-border transactions
• Master data is adjusted and tested in the test environment, but the changes are not reflected
in the production system
• The logic of the tax code structure is disrupted by VAT rate changes. This can be mitigated
using the correct SAP configuration
• When performing reverse charge bookings, VAT rate changes do not get changed. For
cross-border A-B-C transactions, a VAT mismatch between the VAT on procurement and the
VAT on sales arises for party B
• Blocked iDocs (electronic interface documents) because of errors in the OBCD design
• Suppliers with invoices in other currencies and the VAT amount shown in Euro. This results
in an incorrect VAT amount due to an incorrect FX conversion

Measure - understand process errors
16
VAT determination of incoming invoices/SAP example:
• The purchase order (PO) and the vendor invoice are used to determine the VAT treatment of
incoming invoices
• Vendor invoice data is in general not available in SAP
• Incoming invoices are often still processed manually
• AP clerks, who are not VAT experts determine the VAT treatment and reporting
• Detective controls have be set up to check whether this is done correctly
• Labor-intensive and poses a major area for VAT errors
• When an incorrect VAT result is caused by the incorrect data in the PO, the remediation
takes place via updating the PO with correct data and re-processing the related transactions
(goods receipt, etc)
• Workforce inefficiencies due to the hidden factory
• The AP clerk often fully relies on the purchase order and is unaware that this purchase order
might no longer reflect the actual situation
• Vendor decided to execute the transaction differently from what had been initially agreed upon
• Deliver from another country as locally the goods were not in stock

 
Measure - statistical sampling
17
Statistical sampling:
• Quick insight into the level of tax risks by selecting a few elements (euros)
• The reliability of the composition of tax items can be determined to a high degree
of certainty
• On the basis of identified errors in the sample, the amount of the tax assessment
can be calculated (as if performed by tax authorities)

 
Measure - sampling actions
18
The steps to calculate the exact amount of exposure

 
Measure - data analysis
19
• Data analysis on transactional and master data from the ERP system
• Sales, purchase and/or general ledger transactions
• Review of automated VAT decisions by the ERP system or manual VAT decisions by
employees
• Define objectives:
• Cost reduction: by identifying potential cost savings and limiting expenses (for instance
by tracing VAT that was erroneously not deducted)
• Risk analysis: tracing incorrect VAT determination or reporting incorrect returns and/or
saving opportunities
• Compliance: by identifying possibilities to improve the quality and efficiency of internal
control
• Understanding the supply chain model of the organization and the VAT risks and opportunities
that come along with the implemented model
• Irregularities or opportunities in the transactional data is checked by subject matter experts

 
Measure - example SAP review
20
• Define objective: highlight where the VAT configuration could be improved or if additional
control measures should be added to the business’s Tax Control Framework
• Check proper working of the implemented SAP VAT configuration, identify where errors
irregularities occur or opportunities exist in the company’s SAP set up:
• VAT numbers
• Foreign VAT registrations
• Plants abroad
• Tax procedures
• Intercompany/iDoc
• VAT registration number selection for customers
• Tax code structure
• EU code set up
• Tax tolerance
• GL accounts for tax
• Deferred VAT
• VAT condition records

 
Measure - review by internal audit
21
• One of the objectives of Internal Audit is via a risk based methodology to provide
comprehensive assurance to the Board and senior management that companies’ material
risks areas are managed efficiently and effectively
• Built the internal business case for change via an objective review by internal audit

 
Analyze - root causes
22
Some benchmark examples
• After measure the magnitude of the problem(s), determine now why the problem exists, and
generate a set of solutions to avoid future issues
• Set up a risk register that contains all identified inconsistencies (number, name of the risk, risk
definition, risk category and the risk owner)
• Identify the root cause of the problem(s) and add to risk register

 
Control - design VAT risk matrix
23
AP VAT example

 
Control - design VAT control matrix
24

 
Control - VAT control matrix
25
• The designed VAT risk matrix shows the risks that need to be managed
• Design VAT control matrix:
• Control objective
• Risk that is managed
• Guideline control
• Testing
• Process ownership
• To illustrate high level examples ‘sales system’ and ‘working trade capital’ controls

 
Improve - business case and problem statement
26
• When sponsorship is needed from the business or senior management in order to implement
solutions
• The risk register and the solution selection should be used to write:
• a business case
• a problem statement

 
Improve - tax strategic plan
27
A plan or method for obtaining some goal or result. Identify key processes and measure their
effectiveness and efficiency, and initiate improvement of the worst performing processes: 
• Group business strategy and indirect tax objectives
• Risk management
• Governance and performance
• Strategy oversight and sponsorship
• Management reporting of indirect tax risk
• Relationship with tax administration
• Indirect tax objectives and key performance indicators
• People and organization
• Roles and responsibilities and reporting lines
• Resourcing
• Training
• External tax advisors
• Alignment with business units

 
Improve - tax strategic plan
28
A plan or method for obtaining some goal or result. Identify key processes and measure their
effectiveness and efficiency, and initiate improvement of the worst performing processes: 
• Process and controls
• Indirect tax planning and significant business transactions
• Indirect tax compliance and financial reporting
• Internal auditing of indirect tax
• Technology and data
• Finance and business systems and data
• Indirect tax systems
• Workflow information and management
• Reporting and work-papers

 
Improve - a roadmap for a tax strategic plan
29

 
Improve - examples of strategic tax objectives
30

 
31

KEY Group: a Phenix Consulting Company 32
 

Core team for integrated approach
Senior Managing Director 
Phenix Consulting
Richard Cornelisse
Robbert is a chartered accountant with more than
30 years experience and worked at the Dutch tax
authority and then moved to Shell where he had a
lead role working on indirect tax process and
technology across the group globally. He has
managed numerous global projects and has worked
extensively in designing Sarbanes-Oxley control
frameworks, implementation of multinational SAP
systems, implementing global SAP/Sabrix
implementations.
Richard is a tax lawyer with more than 22 years
experience in advises multinational businesses in
improving the efficiency and effectiveness of their
Indirect Tax Function and Tax Control Framework.
Richard started his career working as manager at
Arthur Andersen and then became a partner in EY
where he led the indirect tax performance team for
Netherlands and Belgium. He specializes in the tax
aspects of financial transformations, shared service
centre migration, and post merger integration work.
Ferry Geertman holds a Master Degree in applied
mathematics and is a certified IT Auditor with more
than 20 years of internal IT control experience. Ferry
has vast experience in data analysis, including the
design and evaluation of statistical samples as part
of internal and external control. Ferry is member of
the Steering Committee Statistical Auditing. Ferry
was an Executive Director at Deloitte in the IT audit
and data analytics practice.
33
Role: Account Leader
Richard is a thought leader in VAT management
and is change management leading expert;
financial transformation; set up SSC; business
model change
Role: ERP and Data Analytics
Robbert is a VAT & Systems world leading expert;
technology; migration
Phenix Consulting
Robbert Hoogeveen
Ferry Geertman
Phenix Consulting
Role: Control Framework Specialist
Ferry sets up smart VAT controls both automated
as manual

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