Getting tough on tax: the increasing importance of VAT compliance

Unless you’ve been running your business from under a rock, you’ll know that VAT has been steadily rising across Europe over the past few years. Thanks to well-documented financial pressures, governments have been making VAT adjustments, with Hungary, Italy and Spain all increasing their rates at the drop of a hat last year. Rather confusingly, the UK reduced its rate from 17.5% to 15%, before returning to 17.5% and finally increasing to 20% in January 2011. Because of this, VAT now typically represents one-fifth to one quarter of a company’s turnover, which is no small sum.

In tandem, tax authorities are becoming more aggressive about ensuring they claim this money; with HM Revenue & Customs (HMRC) in the UK explicitly stating it will be “supporting those who seek to comply but coming down hard on those who seek an unfair advantage through non-compliance”. Fundamentally, they want to see whatever it takes to confirm the figures on your VAT returns are correct, including: VAT accounts, general ledger, purchase and sales ledgers, invoices (in sequential numbering), import and export documents and bank statements. They may also ask to see annual accounts, management accounts, data files and correspondence between you and your tax advisors.

The complexity associated with calculating tax correctly in the first instance, preparing VAT returns and subsequently being able to provide all the supporting data on request should not be underestimated. Even for businesses that have relatively straightforward tax processes and internal systems it will be time-consuming at best; but, inevitably, as business models become more complex, so does the path to compliance. No matter how challenging, businesses need to ensure that accounting records and systems are accurate, complete and available on request (for up to seven years). The authorities will expect them to show they follow well defined and strictly enforced systems and processes. HMRC is forgiving of those who make the odd genuine mistake, but any organisation failing to take reasonable care, deliberately understating VAT and/or concealing this information faces a hefty fine, interest and perhaps worse.

The easiest way to make sure that you don’t get caught out is to give compliance the attention it deserves, making it part of your standard business process and operations from the very outset and implementing internal reviews and alerts to proactively identify exceptions. As such, general good practice should include:  identifying areas of potential risk, developing documented processes for managing tax, reviewing and updating an ongoing tax strategy, building and maintaining a relationship with your tax authority and submitting full disclosures to them at the earliest opportunity.

According to Grant Thornton, ensuring your ERP system adequately supports your evolving business and the ongoing revisions to legislation is essential. As Grant Thornton indirect tax manager Alex Baulf explains: “A company’s IT infrastructure may not provide the level of detail necessary, or the level of detail may reside in part of the system not easily accessible. Legacy systems and the limitations of native VAT functionality can also result in errors.”