Data is generated, stored, and made available today like it has never been before. Gradually, data has become big data, typically characterised as being high volume, high velocity, and high variety.
Data analytics, i.e. where technology meets data, has largely been considered and recognised as a value-creating element in a wide spectrum of sectors, starting with science and healthcare, and continuing with business and finance. However, the relevance of data analytics to the tax function, and more specifically to indirect taxes, is often neglected.
Tax authorities go big... data
Tax authorities around the world are increasingly employing data analytics to increase the efficiency of their tax collection and tax audit systems and processes, especially in the area of indirect taxes which are often the states' largest or second largest source of income. In some cases, tax authorities have been using innovative technical solutions to implement sophisticated fraud detection strategies using socio-demographic data and taxpayers' behaviour predictive analytics.
Initiatives by the OECD and the European Commission have led to an unprecedented mutual commitment of states to exchange information automatically or on request. Electronic filing of tax returns is now a legal requirement in most developed and developing countries. The tax authorities' digitalisation is far more complex than the e-filling of tax returns, however. With big data and innovative technological solutions, tax authorities can perform tax data analyses and calculate risk profiles—in some cases in real-time. This translates into better targeted and more detailed tax audits, as well as increased compliance by the taxpayers and a reduction in fraud.
We see this evolution in tax authorities' requests for more [electronic] data. In Luxembourg, the FAIA file, for example, has required certain taxable persons to automatically generate a standardised audit file containing all the information required for the authorities to audit VAT returns.
By carrying out automated and systematic detailed checks on a large amount of data, they have increased the quality of their controls and the efficiency of their resource use, while streamlining the process. For the taxable person, this automated audit also provides for a greater level of impartially and fairness as the audit is, to some extent, uniform.
Like taxer, like taxed
For businesses, the digital evolution of the tax authorities raises mirrored concerns, starting with fulfilling these new compliance and reporting requirements in an often complex IT environment. The challenge of understanding the authorities' requests, identifying which data falls within the scope of the audit file, and producing a structurally correct file should not be underestimated. To keep with the pace of digitalisation, multinationals need to be proactive and invest accordingly in performant ERP systems, and to effectively merge tax and IT skills.
For taxpayers, these constraints constitute an opportunity to carry out pre-audits and detect any incorrect application of the VAT, for their own benefit.
Why it's important to get with the times
While tax authorities are implementing complex data analytics solutions, many taxpayers may still be managing their VAT obligations or performing internal tests with elementary spreadsheets or other outdated methods. Those who rely exclusively on VAT modules enabled in ERP systems or VAT determination engines may fail to recognise the limitations of these tools: the set of data may be too narrow for tax determination, nothing stops the rules from becoming obsolete, and master data is harder and more effortful to properly maintain. If unsuitably managed, tax engines can therefore be the source of systemic tax risks. Indeed, manual overwriting has always been a well-known source of uncaught mistakes.
Data analytics solutions can help identify exceptions and inconsistencies (e.g. the application of incorrect tax treatments) using significant sets of varied information. For business enterprises, the benefits can be tremendous and are mainly twofold:
Quality
First, they improve the quality of the compliance reporting by helping identify issues and then taking corrective actions. Irregularities can be spotted and remedies found. As a consequence, tax audits are often reduced (in scope and frequency) and their consequences limited, meaning less disruption to the taxpayer's activities and lower audit costs both in management and in reducing regularisations and fines. "Pre-controls" using data and analytics also offers the possibility to increase (or establish) confidence in the data submitted to the authorities (FAIA or more generally SAF-T files). Additionally, reporting processes and control procedures can be formalised and maintained despite staff turnover.
Safeguarding
Second, data analytics solutions make it possible to detect inconsistencies, which can reduce the costs linked to incorrect reporting in terms of over-payment of tax. Indeed, even though a taxpayer who has incorrectly charged VAT should be entitled to a refund of such tax invoiced in error,1 it is still necessary for him or her to identify such over-payments quickly enough to initiate the recovery process before the end of any applicable statutory period, as well as to take corrective actions to avoid similar transactions down the line.
Unlocking potential
Identifying these opportunities is often challenging or time-consuming for tax payers. They may be hidden below a thick layer of operational and accounting complexity, or simply not directly visible because the information is not captured. A taxpayer wishing to identify VAT refund amounts in employee expenses without using data analytics would need to go through piles of receipts and invoices to manually identify the amounts at stake, which would require spending time and resources on a result which can prove disappointing (not to mention the knowledge required to assess if, for example, VAT incurred on accommodation costs in France or Belgium is recoverable).
Using the example of travel expenses, a data-based approach would take into consideration the differences in rules applied by the European Member States to allow a quick identification of the amounts at stake before a single box of receipts has to be opened. If it is worthwhile enough for the taxpayer, the data could also be used to go for quick/material wins, for example claiming VAT recovery on invoices of a certain value and/or in certain countries.
Takeaway
Big data and the dexterity developed to harness it have constituted one of the greatest developments of the recent years across industry sectors. The possibilities in the area of indirect taxes seems to have been underestimated by some taxpayers, but cannot be ignored any longer.
Considering their use by the tax authorities as well as their potential benefits for companies, data analysis solutions are becoming a must. Data analytics do not only enable companies to meet their indirect tax compliance requirements but pave the way to improved processes of managing indirect taxes. Ignoring the power of data analytics could lead to compliance issues, fines, and missed opportunities.
For businesses still living in the indirect tax management Stone Age, in a realm of manual adjustments and spreadsheets-based reconciliations, the time has come to enter the brave new world of data analytics.
Footnote
1. Court of Justice of the European Union – case C-138/12 “Rusedespred OOD”
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