The post-pandemic world will see much returned to normal, but there will also be change. For businesses that faced shutdowns, these changes will include higher taxes to pay for the costs of mitigating the economic impact, and the loss of tax revenue. In addition to imposing higher tax rates, some governments will strive to raise revenue by accelerating their adoption of digital technologies to enhance compliance. Taxes are the largest single expenditure for most corporations, both taxes on their income, and indirect forms of taxes such as value-added taxes (VAT) and sales and use taxes. Minimizing tax expense within the limits of the law must be a priority for CFOs.
Managing taxes will be a challenge for CFOs. Over the past decade, tax department workloads have increased as statutory accounting and tax authority reporting requirements have become more demanding. Spreadsheets may have been the only practical alternative in the past, but now, using dedicated tax applications enables tax and accounting departments to operate more efficiently, allowing them to spend time on tax analysis and plans to minimize tax expense. Yet, our Office of Finance benchmark research reveals that only one-third of companies use analytics to actively manage their tax strategy. Software also provides executives with deeper forward visibility into future expense, and gives greater control to ensure consistent application of tax policies and minimize compliance risk. Using the right software can cut the cost and uncertainty involved in handling a tax audit defense.
There are three categories of software that enable companies to manage three key tax processes more efficiently and minimize the impact of higher tax rates and more assiduous enforcement:
- Tax provision
- Transfer pricing and intercompany transactions
- Indirect tax management
The provision for income taxes is the most challenging of the above three processes facing larger companies, and even some midsize ones. Tax provision is the estimated amount that a business expects to pay in income taxes for its current fiscal year, which is not the same as the taxes it accrues under generally accepted accounting principles (GAAP). The provision is arrived at by adjusting the net income as defined by GAAP to reflect the permanent and temporary differences created by the tax code. For example, a temporary tax difference is created when a company uses accelerated depreciation allowed by the tax code but straight-line depreciation for financial reporting. A permanent difference occurs, for instance, when certain expenses such as fines or some entertainment costs cannot be deducted for tax purposes. As is the case with accounting, there’s a lot of minutiae involved in the process. Since income taxes are levied on each legal entity—not just the corporation—under rules established by the tax authority in whose jurisdiction the entity exists, corporations that operate in multiple countries with a significant number of legal entities or complicated legal entity structures struggle with this complexity.
Dedicated tax provision software is useful for companies with even a moderately complex legal structure. As is the case with all accounting operations, the quality of data management determines the qualities of the tax provision process. For example, most companies find that they can achieve a consistently high degree of accuracy, auditability and visibility by having their tax provision application share the same data used by their financial consolidation and reporting system. Using the same data ensures that the tax provision process is always reliable and up to date. Our Office of Finance finds that 62% of companies using a dedicated tax provision application control tax risks effectively versus 33% of those using spreadsheets. Moreover, these tax professionals spend far less time checking the accuracy of the data and calculations, which speeds up the tax provision process, thereby shortening the accounting close.
Tax provision software must provide bidirectional integration with a company’s ERP system, financial data stores and tax compliance software (the application that creates the tax filings) to maintain the fidelity of data at every step of tax-related processes. It gives administrators the ability to define and monitor tax department tasks to ensure all steps are performed and that they are alerted to delays. Data and formulas are stored in a central database to ensure quality and consistency. All of this promotes accuracy, reduces the risk of errors in calculations and presentations, and can substantially cut the amount of time tax departments need to spend doing the provision for taxes as opposed to those that must check and reconcile a mass of spreadsheets.
Corporations made up of more than a handful of legal entities and that operate in multiple direct-tax jurisdictions can achieve significant time savings by adopting dedicated tax software to manage the tax provision process. Companies with these characteristics face challenges that quickly overwhelm spreadsheets. Direct taxes are extremely complicated because national tax codes are complex and ever-changing. Not only do specifics such as depreciation schedules or inventory expensing rules vary from one country to the next, but even basic tax concepts can differ. For instance, whether a cake is a cookie. A company’s tax position can be fluid, so it is important to be able to work across multiple tax periods. Adjustments to individual entity tax expenses and positions occur frequently because of corporate restructurings, divestitures and acquisitions, so accurate adjustments and true-ups across tax periods must be easy to calculate, record and retrieve. Along with this are the myriad journal entries necessary to effect changes, and the need to assemble and present a consistent set of account reconciliations to manage the details.
Using a dedicated tax provision application saves the time of tax professionals who currently rely on spreadsheets to manage their process. Our Office of Finance Benchmark Research found that 59% use spreadsheets for their tax provision, even though the prevalence of data and formula errors in spreadsheets could be deemed to be a material weakness in tax provision and in the calculation of uncertain tax positions.
Tax departments that spend less time on the mechanics of the tax-provision process have more time to perform work that is of higher value. For example, only 26% of organizations are significant users of tax analytics that can be used for planning aimed at lowering tax outlays. Tax professionals also can use this time to do what-if scenario planning that simulates possible outcomes and helps guide strategic decision-making across the organization.
Transfer Pricing and Intercompany Transactions
Transfer pricing occurs when one legal entity of a corporation sells a good or service to another legal entity. When these entities operate in different taxing regimes, companies will set a transfer price that will maximize the profit in the jurisdiction with the lower tax rate. Transfer pricing is not a new issue but grew more pressing as intellectual property in the form of software, entertainment, trademarks and other virtual goods and services have accounted for a large and increasing share of trade. Moreover, some countries that offer lower taxes or special treatment of certain goods or services can be a magnet for transshipments from the originating country to the ultimate destination. To counter this trend that has reduced their revenues, tax authorities worldwide are requiring that multinational companies provide greater transfer pricing and intercompany-transaction transparency.
At the very least, multinational corporations must have sufficient control over pricing and billing to minimize taxes owed, avoid fines, streamline audit defense and mitigate reputational risk. Centralizing the means of setting and reviewing transfer prices, even if decisions are done in a decentralized fashion, can provide senior executives and the audit committee better oversight of pricing to ensure that pricing actions do not expose the company to undue risks. Managing the intercompany billing process more intelligently can reduce avoidable VAT leakage—payments that cannot be recovered—or needlessly expose the company to be deemed to have a permanent establishment in a country rather than a sporadic commercial presence.
Indirect Tax Management
Indirect taxes are levied on the sale and purchase of items. Depending on the location, these are known as VAT, sales and use tax, or goods and sales tax (GST). Indirect taxes are a particular issue in countries that have highly complex tax regimes, notably Brazil, India and the United States. The U.S. is complex because state and local governments have taxing powers, each with their own definition of which items are exempt or taxed, sometimes at different rates. In some cases, sales-tax rates are different depending on which side of the street the business entity is legally located.
In the United States, indirect taxes recently became a bigger issue for businesses because the Supreme Court’s Wayfair decision eliminated the requirement that a seller must have a physical presence in a tax jurisdiction to be liable for collecting sales tax. Two reasons behind the decision were the rise in interstate sales volumes driven by online shopping, and the availability of software to manage sales-tax calculations. For businesses, knowing which rate to apply to a specific buyer based on their exact location and then filing and paying taxes to the appropriate tax authorities is just the start of their workload. Goods that are acquired by a buyer for resale are exempt from sales tax, but the buyer must have valid tax-exempt certification in force from every tax authority involved in a transaction. Managing the certification—especially ensuring that the documentation is up to date—is time-consuming and error-prone unless the business uses software that handles this process.
An increasing number of countries are requiring companies to file taxes electronically, including China, India, Mexico and the United Kingdom. Business software providers have responded by providing applications that simplify the process of calculating taxes owed and creating the tax documents. The software may incorporate validation rules that can reduce filing errors. Electronic filing also can reduce compliance burdens because it eliminates the need for companies to produce past filings when authorities want to review them, and some countries enable companies to monitor the status of their filings, payments and refunds. To deal with the rising tide of electronic filing, corporations must have the software and systems in place to collect and process all the tax data required for electronic filing. While this can be straightforward for small and midsize businesses, larger corporations operating in multiple tax jurisdictions with high volumes of intercompany transactions may find their systems are not well suited to handling the complexities.
The heavy cost of coping with the global pandemic is leading to higher tax rates, more complex tax regulations and stricter tax enforcement. I recommend that CFOs, controllers, CEOs and audit committees of Boards of Directors be actively involved in corporate tax matters to legitimately minimize taxes and enhance tax oversight and control. Using software designed to manage direct and indirect taxes, as well as handling transfer pricing, is the key to reliably achieving both objectives.