The need for effective management of indirect taxes in rapid growth markets (RGMs) to avoid unnecessary costs and risks and maximize opportunities is the primary concern for many multinationals, according to a new Ernst & Young report, "Managing Indirect Tax in Rapid Growth Markets."
As the first wave of emerging economies such as Brazil, Russia, India and China mature, new RGMs are emerging such as Colombia, Indonesia, Peru, Turkey and Vietnam – resulting in a change in pattern to trade and investment. This has lead to a marked increase in global transactions with RGMs which, while boosting the economy, creates significant tax implications.
“For many multinationals, the task of keeping up with obligations for VAT/GST, customs duties, export controls and grants and incentives in every country where they operate can represent a heavy burden which is exacerbated by the lack of harmonisation between countries’ requirements, a lack of qualified resources in some regions and the use of multiple accounting systems," says Philip Robinson, Global Indirect Tax Leader at Ernst & Young.
“As a result, many companies are beginning to look more critically at how they manage indirect taxes in RGMs, adopting and adapting management structures and processes from other region.”
Local compliance in a global world
Multinationals are finding that indirect tax costs, formal rules, restrictive regulations and bureaucracy can be a barrier to international trade but opportunities exist to improve business outcomes, speed up deliveries and reduce costs. Effective controls, robust processes, standardiSed procedures and the use of appropriate technology can all help to improve accuracy and reduce risks.
In addition, collaborating across functions and geographies, and building relationships with trusted third parties and tax administrations makes the most effective use of scare resources – and helps to avoid costly and protracted disputes.
RGMs are refining their indirect tax systems to become more efficient
Most RGMs are overhauling their consumption tax systems and in some cases, introducing major new taxes. At the same time RGMs are improving and modernising their tax administrative process, using advanced technology to help them.
China and Brazil enforce the use of electronic data transmission and filing for submission of VAT/ GST reports, as well as capturing information in real time about companies’ transactions. Increased use of technology to supply services cross-border is challenging indirect tax legislation, leading to the risk of double taxation in some RGMs and non-taxation in others.
RGMs are not immune to the increased focus on enforcement
As the more mature countries face greater scrutiny on tax practices, RGMs are not immune to this increased focus on enforcement.
While RGMs are not as advanced in using technology for enforcement, the report shows that this will become the norm over the next few years. RGMs are still lagging behind when compared to mature markets on exchange of information. Just 2 out of the 17 RGMs reviewed for this report exchange information about tax payers’ VAT affairs with other countries.
The two RGMs, Poland and Czech Republic, are both EU Member States and are thus required to do so according to legislation. RGMs are also applying stricter penalty regimes in the case of non-compliance and mistakes, thus following the mature market trend.
RGMs use grants and incentives to encourage investment
Most RGMs offer a variety of tax and business incentives to attract investment in specific regions and areas of industry by offsetting the cost of taxes and other investment activities, or by providing financing at favorable rates.
As RGM economies develop, they also transform the activities that they undertake, with many moving up the value chain away from low-cost manufacturing to focus on innovation.
Compliance is also an important consideration when multinationals enter RGMs and utilise incentives. The cost of complying with the terms of an incentive may, however, outweigh the benefits or the terms may be hard to comply with in the medium to long term.
New indirect tax challenges
Companies that invest in RGMs encounter unfamiliar indirect tax laws and obligations, which they are not always prepared to meet – a lack of experienced indirect tax staff and opaque regulations can further complicate their efforts.
In addition, local indirect tax rules may require companies to adapt business models, processes and practices. VAT/GST rates may be relatively low, but the system itself may be highly complex or undergoing reform, so that there are high levels of uncertainty, leading to errors and risk.
Excise duties on the rise
Globally, we have seen excise duty rates on alcohol, tobacco and mineral oils increase and this trend is prevalent in RGMs. These rises are partly driven by governments’ need for revenue and also due to a trend toward using these taxes to influence consumer behavior.
Another area of focus for RGMs is environmental taxes with a number of countries currently looking at implementing carbon tax legislation.
Increase in protectionist challenges
A number of free trade agreements (FTAs) are expected to be implemented over the next 12 months and RGMs are particularly active in this area, with countries such as South Korea and Peru widening their FTA networks considerably. However, the increase in trade comes with complexity and this may create additional tax administrative burden for RGMs.
Despite RGMs being so heavily dependent on exports, it could be assumed that protectionist measures would apply exclusively in developed economies; however we have seen RGMs start to introduce measures both to protect local industries from foreign imports and raise revenues.
“Indirect tax treatment of transactions, compliance obligations and the customs regimes and incentives can lead to business delays, increased costs and poor cash flow if they are not managed proactively," says Robinson. "Effective forward planning can help to enhance a company’s return on investment, for example, by recovering VAT/GST on set up costs or by entering a free zone that provides exemption from customs duties.”