Death and taxes are the only two certainties in life, according to Benjamin Franklin. But as everyone in business knows, another certainty is that paying those taxes and ensuring compliance with the payment regulations adds further costs on top of the tax bill itself.
Red tape compliance costs the UK economy an estimated £17bn each year, according to a recent NatWest Small Business Research Trust survey. It also identified the worst offender. Value added tax is the largest of the red tape burdens businesses face, according to 71% of respondents.
The bulk of the burden of compliance falls on those in business and industry, so the associated cost has always been a popular argument against VAT. The administrative costs - the costs to the government of collection - represent only one third of the total costs of collection. Two thirds of the costs fall on the taxpayer.Revenue recognition
Tax guru Cedric Sandford found that across a sample of UK industry VAT compliance cost in broad terms some 4% of revenues raised - a large sum of money for companies to bear. Sandford splits the compliance costs into three main elements: fiscal, time and psychological.
In addition to the obvious administrative and management overheads created, he also factors in the burden of fear, ie, worrying about the responsibility of failure to comply. The onus is squarely on businesses to conduct their VAT affairs properly, with financial and even criminal sanctions for those who don't.Widespread suffering
Those hit heaviest tend to be those that can least afford it. In very small companies that sit just above the VAT threshold, compliance costs sometimes go well into double figures when expressed as a percentage of VAT paid. One National Audit Office study found that in the smallest companies the cost of compliance could be as high as 20% of the tax paid.
Larger companies don't automatically fare any better. Sandra McLean, a senior VAT consultant and national VAT manager at Mazars Neville Russell, lists other factors that also contribute to higher compliance costs:
- Movement of goods to a different state from that of the customer, and triangular sales in three or more countries.
- Transfer of own goods to another country. This may require registration in the other country for the acquisition and also the subsequent sale of the goods.
- Selling goods to the private sector internationally at a level of sales above the VAT registration thresholds of the foreign countries concerned. The VAT registration thresholds for 'distance selling' are different from general VAT registration thresholds.
- Requesting exemption from VAT in a number of countries. This can involve onerous documentation requirements, with time limits, to prove that the exemption thresholds and criteria for each country are being met.
- Supplies of services where the VAT treatment can depend on: the type of service; whether the customer is in the business or private sector; the location of supply of the service.
- Where goods and services are combined, such as in supply and install arrangements.
- Complications arising from the treatment of software suppliers.
- Differing treatments of the liabilityto VAT of goods and services in EU member states - let alone the rest of the world. In some circumstances this can still lead to double taxation or no taxation at all.
'It follows that the more product types, service types, markets and countries that are dealt with, the more problems that are likely to be encountered,' comments McLean. A recent study of Dutch companies (Europe's New Border Taxes, by E Verwaal and S Cnossen at Erasmus University, Rotterdam) confirmed that dealing in a number of different countries leads to higher VAT compliance costs.
Meeting the VAT regulations of trading with another EU partner typically costs 5% of the value of the trade.
The study also showed that in the case of the costs of intra-EU trading, bigger was not better. 'The artificial split-up of business information systems,' which frequently occurs in big European-wide companies, was found to result in significant 'diseconomies of scale'.
Clearly, complexity of business, particularly where there is an international dimension, quickly leads to high costs of VAT compliance. But it's important to recognise that the pattern of business is changing. With hi-tech businesses, in particular, complexity is often built into the business model from the very start, even when the company is small.Optimise or minimise?
So what can companies do to help themselves? As attempts to minimise compliance can increase the risk of non-compliance, the best that companies can hope for is optimisation.
Obviously in all but the smallest companies the major burden falls on inhouse human resources, those responsible for the day-to-day accounting operations, their management, and, possibly, those dealing with the business's accounting environment at a higher level. In addition, almost every company will also be running some sort of computerised accounting system - most companies could not operate their business without one.
To address their VAT requirements, companies can look to two further expert resources - external accountants, and VAT specific software packages. The tricky part is getting the right balance between inhouse effort, utilising external expertise and resources, and depending on software.Look outside
External accounting advice and resource are essential in guiding companies through the policy minefield, providing the essential local presence, and contributing knowledge of both local language and local practice.
In the case of international VAT operations, the costs of submitting returns to different national authorities vary enormously. Although the requirement for appointing fiscal representatives in EU member states no longer exists, most businesses need to engage some kind of local VAT representation, especially when doing business outside the EU. There are inevitably foreign exchange costs, and in some cases it is necessary to open bank accounts and leave a security deposit.
Ancillary costs may include translation costs and notarisation by local accountants.
Faced with this high level of complexity, using expert external resource is not only the sensible operational solution - it is also one way to reduce the 'fear factor'.
Another sensible use of external assistance is in reclaiming VAT costs incurred in other countries - it is common practice for these to be neglected.
If a business is registered abroad these may simply be recovered via the VAT return. If not registered it is necessary to claim via the defined EU systems, known as the Eighth or 13th Directive systems. These are complex, costly (often requiring translation services) and with tight deadlines and may not guarantee a reliable (in the sense of a steady cash flow) recovery of incurred input taxes.Software solutions
VAT specific software is now available that integrates with existing accounting software systems to handle complex VAT requirements. The type of systems supplied by organisations such as Taxware can provide access to a knowledge base of VAT rates, plus the policies that determine how these are applied to each of the products and markets of the company. Users can also exploit online links to accounting systems, so that the appropriate rate can be attached to each transaction automatically.
This type of system offers costsaving in terms of external and inhouse operational accounting. Because the software can be regularly updated it makes it much easier to keep account of policy and rate changes - a constant factor in the 25,000 plus VAT rates in operation around the world. It can also reduce some of the costs associated with accessing necessary expertise, by eliminating the need to maintain an inhouse knowledge base or pay externals for low-level factual information.
VAT specific systems can also reduce the potential for error and confusion. The clean and complete data of the computer reports eases the external accountant's task, and therefore reduces the costs of both audit and submission of VAT returns.
Statutory reports such as Intrastat can be produced automatically. The confidence engendered by sound computer reports is a time and cost saving in itself.
The issues surrounding compliance costs raise a great many questions. They all merit attention. But in the final analysis, McLean asserts: 'Perhaps the better question to ask is what is the cost of not complying?'