Cash is King and VAT is cash
08 September 2015
Posted by: Author: Folkert Gaarlandt
Author: Folkert Gaarlandt (EY)
VAT is a key driver for business performance. Folkert Gaarland discusses VAT in the broader business and international context.
In recent years the value of cash has become a key driver for business performance. Even though the interest rates in mature markets are low, the continuous search for free cash flow has been at the top of the agenda for many multinationals. In Africa this is even more prominent, interest rates are close to double digits and governments are looking for cash in the same way as many multinationals.
If one would take a simple supply chain of say, a procurement entity, a manufacturing company and a sales company within a group, the amount of VAT flowing through that group is close to its consolidated turnover. A simplified calculation, let’s assume 20 per cent VAT, prices at 50 (import), 60 (intercompany), 90 (intercompany) and 100 (ultimate sale) – the VAT in the supply chain is 10+10+12+12+18+18+20=100 on a turnover of 100. VAT to the amount of the turnover is flowing through the books. Is the company managing these amounts, or do you simply trust the ERP system and AP/AR staff to ensure everything is captured as efficiently and effectively as possible?
In South Africa tax payers are dealing with one of the most sophisticated and well organised tax offices in the world, yet I have often found the attention to VAT to be reactive, looking at opportunities but not at the risk side. In my view this is a mistake, for most businesses VAT is a wash and thus does not hit any profit and loss account, however with the important exception being financial services which is an industry that often does focus on VAT. VAT should be an integral part of any tax control framework, not only focussing on non-deductibility of French benefits but looking at the entire supply chain, zero rating, warranties, bad debts, pre-payment, vouchers, finance lease and whatever else is part of the activities.
In most companies one can no longer rely on manual controls to manage these amounts of VAT. Too many invoices flow every day, the accounts receivable are typically automated and after order entry, the system is a black box that produces an invoice and triggers the transactions to be concluded. To even complicate matters further companies may be part of a global organisation and adhering to global standards, occasional transfer price adjustments, recharges and cost sharing amounts are added to the regular types of transactions in the system. Each of these have VAT consequences but are not triggered in the normal processes. Let’s take a transfer price adjustment for example.
Transfer price adjustments usually come after the year end and after the books are closed. Closing the books is a requirement to actually know if the envisaged targeted margin is achieved and complex or less complex calculations ensure that a certain amount needs to be shifted from abroad to South Africa or vice versa. Needless to say that these adjustments have the full attention of the authorities, BEPS is high on the agenda and transfer pricing is a key element in that discussion.
So now back to VAT (and a bit of customs). Why would this be relevant? If we only look at the name it actually means that one is changing historic ‘transfer prices’, so prices of previous transactions. Since VAT is levied on transaction prices, when those prices change, there is a VAT consequence. So let’s adjust every single invoice and VAT return filed in the year, possibly also all import declarations, effectively doubling up on all paperwork. The good news is that this is only intercompany. The bad news is the enormous workload that is added, not only for the taxpayer, but SARS may also find this a cumbersome process.
There are, of course, alternatives, which will be covered in further detail during my discussion at the Indaba. Some of the questions that I also hope to address include: does a transfer price adjustment solely relate to a single product or to all transactions equally? Can it be seen as anything else than an adjustment of historic prices? What are the differences between upward and downward adjustments? Is there an impact on the customs value and possibly also on duties I over or underpaid?
To end with the beginning, "Cash is king and VAT is cash” - statistics show a tremendous growth of indirect tax revenue globally, the shift from direct tax to indirect tax is coming or is already in place in many countries. VAT rates globally are on the rise and every year new countries implement new VAT systems (for example India and Egypt this year, Malaysia last year, and China on a step by step basis). If for all these jurisdictions VAT means cash, we challenge you on the above questions, are you managing these amounts efficiently and effectively?
This article first appeared on the July/August 2015 edition on Tax Talk.