Report Says VAT Costly For UK Taxpayers

Tax-News.com, London

22 April 2002

Under the heading: 'VAT compliance costs - heavier than you realise?' UK-based Ford-Peacock Consultancy Limited has produced a report which looks at the costs of VAT compliance, the factors that increase compliance costs and how to optimise the cost of compliance.

Says the report:

VAT is a popular tax with governments and economists. Taxing at the point of consumption, and levying revenue down the supply chain according to the value added by each entity involved in the production of the final product, has advantages supported by current economic thinking in government, academia, and professional bodies. Over the last 40 years successive governments around the world have introduced value added taxes, under various names. Once introduced these taxes have often played an increasing role in fiscal policy, as can be seen by the increases in rates in the UK and elsewhere. At present standard rates around Europe vary from 15 - 25%, with the UK at 17.5%, almost double the standard rate at the time of introduction in the 1970s.

One of the arguments against VAT has always been the cost of compliance - that is, the cost to companies of complying with the regulations. There are a number of issues that govern the cost of compliance, which are explored later. But the clearest fact is that most of the costs of the tax fall on industry. 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 business - the taxpayers.
Components of the cost of VAT compliance.

Tax guru Cedric Sandford, found that across a sample of UK industry VAT compliance cost in broad terms some 4% of revenues raised, which in macro-economic terms is 1.5% of GDP - a large sum of money for companies to bear. He also laid out three separate elements to the costs of compliance:

• Fiscal costs - the employee costs of running day to day VAT accounting, the cost of expertise to understand and keep up with changes in policies and rates, the cost of submitting VAT returns, and the cost of external accountants for operational and advisory services;
• Time costs - the cost of senior management time in overseeing the function - in theory these can be turned into money, but in reality this is a very scarce resource in a company;
• Psychological costs - the significant worry brought about the fact that the onus is squarely on the business to conduct their VAT affairs properly, with financial and even criminal sanctions for failing to do so. VAT regulations can be very complex, and many companies know they lack some of the knowledge required to be certain that they are using the correct policies and rates for all their transactions. This " fear factor" is often highlighted as a component of compliance costs, even though it is not easily quantified.

There is no doubt that it is the very small companies just above the VAT threshold who bear the heaviest burden, sometimes going well into double figures when expressed as a percentage of VAT paid. For example, a National Audit Office study in 1994 found that, in the smallest companies, the cost of compliance was some 20% of the tax paid. This is the basis of a constant lobby to governments to increase the VAT thresholds and/or reduce the payment frequencies.

Larger companies do not necessarily have it easier. Sandra McLean of Mazars Neville Russell Chartered Accountants listed the factors that are likely to cause a high cost of handling VAT compliance. These are:

• Movement of goods to a different State than that of the customer, triangular sales (sales in 3 or more countries) issues and simplification procedures vary around the EU;
• Transfer of own goods to another country which 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 (bearing in mind that the VAT registration thresholds for "distance selling" are different than general VAT registration thresholds);
• Alternatively, requesting exemption from VAT in a number of countries, which imposes the burdens of documentation requirements and 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 place of supply of the service
  • Where goods and services are combined, such as in supply and install arrangements
  • Complications arising from the treatment of the suppliers of software
  • Differing treatments of the liability to VAT of goods and services around the Member States let alone the rest of the world. In some circumstances this can still lead to double taxation or no taxation at all.

She summarises "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."

So it is no surprise that size is not the only parameter that counts - complexity of operations has an impact too, especially where there is an international dimension.

A recent study of Dutch companies supports the conclusion that dealing in a number of different countries leads to higher VAT compliance costs . The results showed that complying with the VAT regulations of trading with another EU partner (in what is meant to be a Single Market!) effectively cost 5% of the value of that trade.

Interesting further results from this study also showed that in the case of the costs of intra-EU trading, bigger was not better. The study states, "despite the objective of the Single Market program to enable firms to exploit economies of scale, the artificial split-up of business information systems of big European-wide companies involves diseconomies of scale".

However, for certain types of companies, large and small, the impact falls heavily:

• Small start-ups exploiting the internet to reach an international market for their goods need expert advice and support to ensure that they are fulfilling all statutory requirements in their international trading, especially if they take ownership of any international warehousing or similar overseas supply activities;
• Medium sized companies with an international complexity of supply chain or sales outlets. Triangular trade arrangements - sales involving three or more countries - can cause particular headaches
• For large companies that trade in a very large number of countries - there is a threshold cost, which some estimate starts at £10k, of meeting the minimum requirements of VAT compliance in any country of registration.

In summary - complexity of business, particularly where there is an international dimension, quickly leads to high costs of VAT compliance. In addition, it is important to recognise that the pattern of business is changing. With high-tech businesses, in particular, complexity is often built into the business model from the very start, even when the company is small.

So finally, let us look at how best to optimise the costs of compliance. We say optimise rather than minimise, because simple minimising can lead to the risk of non-compliance, and all its attendant problems, financial and otherwise. Obviously in all but the smallest companies the major burden falls on in-house human resources, those responsible for the day to day accounting operations, their management, and possibly, those maintaining some higher level knowledge relating to the accounting environment of the business. 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.

External accounting advice and resource is 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 the Member States no longer exists, most businesses need to appoint 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 some kind of security deposit. Ancillary costs may include translation costs and notarisation by local accountants.

Faced with that level of complexity, using expert external resource is not only the sensible operational solution - it is also one way to take the "fear factor" out of VAT compliance.

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 there will need to be a claim via the defined EU systems, known as the 8th 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.

VAT specific software is now available that integrates with existing accounting software systems to handle complex VAT requirements, providing both:

• a knowledge base of VAT rates and the policies that determine how each is applied to each of the products and markets of the company;
• an on-linelink to accounting systems so that the appropriate rate can be attached to each transaction automatically.

The specific benefits of such a system are

• in-house operational accounting costs are reduced;
• the software is regularly updated to keep account of both policy and rate changes - a constant factor in the 25,000 plus VAT rates in operation around the world - eliminating the need to maintain an in-house knowledge base or pay externals for low level factual information
• the clean and complete data of the computer reports eases the external accountants task, and therefore reduces the costs of both audit and submission of VAT returns. Statutory reports such as Intrastat reports can be produced automatically. The confidence engendered by sound computer reports is a time and cost saving in itself.

The last question on the costs of VAT compliance is best left to Sheila McLean: "Perhaps the better question to ask is what is the cost of not complying?"

The answer is - it doesn't bear thinking about. So get the balance right of in-house effort, external expertise and resource, and modern software and you'll not only keep the costs down, but you can say goodbye to the "fear factor" that figures so prominently for so many people as they seek to ensure VAT compliance.

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