Part 1 Transcript
MS. SCHWABENBAUER: Hi. I’m Kristin Schwabenbauer. Welcome to Tax Today, a Vertex podcast series. On today’s episode, we’ll be exploring the indirect tax and procurement landscape. This is part 1 of our discussion with Donal Colbert, about opportunities and challenges with global VAT.
MS. SCHWABENBAUER: Hi, Donal. Thanks so much for joining us.
MR. COLBERT: Hi, Kristin.
MS. SCHWABENBAUER: I’m so happy to have you on to talk to us about your experience. So, before you came to Vertex,can you talk to us about how you’ve seen accounts payable and procurement functions evolve during that time?
MR. COLBERT: Yeah, happy to, Kristin.
Speaking specifically to procurement from a procurement perspective, I’ve definitely seen a lot of evolution in the AP space over the last maybe fifteen years in industry, seen a lot of process evolution and transformation. In my first involvement when I would have come to it about the early 2000’s, procurement and accounts payable was a very labor-intensive process. It posed some significant business challenges, right. First thing issue that we would have had from a VAT perspective is that VAT invoicing regulations were formulated in a pretty restrictive manner. Effectively businesses were required to obtain original paper invoices from their suppliers for every business expense that they were posting, or else the whatever 20 percent plus VAT that was on each invoice would have to be recorded as a business cost.
MS. SCHWABENBAUER: Donal, do you have any examples of the business challenges?
MR. COLBERT: At my first involvement, in or around about the early 2000’s procurement accounts payable would have been a very labor-intensive process. And it posed some significant business challenges. I think the first thing that I would mention is that E-invoice regulations were formulated in a very restrictive manner in VAT countries. It effectively required businesses to obtain original paper copies of every receipt from their suppliers or else the 20 percent plus VAT that was on each invoice would have to be posted as a business expense.
So, when a vendor-issued an invoice to a customer, it might take four days to arrive in the mail, and then maybe spend three or four days in somebody’s in tray before it could actually be successfully recorded by accounts payable. Receiving original paper invoices generally meant uncertainty in invoice transmission processes. A lot of invoices might have been lost in transit, for example, and then they would need to be cancelled and reissued rather than just re-emailed. That always presented a delay factor and opened up an increased propensity for duplicate invoices being posted in error. Recording invoices that were transmitted by the postal services meant that accounts payable was largely a data entry, a manual data entry process. Manual data entry clearly requires significant human effort and significant human effort clearly leadings towards a strong opportunity for a human error. Many businesses came to regard accounts payable as a data entry process, a volume and scale operation.
I think quality checks within a system were very often aimed towards ensuring accounting rather than tax accuracy. For example, a three-way match would have been one of the main ways of actually validating an invoice when it arrives. And really, what does it do only take a look -- ensure that there’s a match between a purchase order, between a receipt of goods and an invoice. That really validates that it’s a valid business cost, that it’s posted to the appropriate profit and loss account, but it really validates from a tax perspective it really just validates the taxable base. It doesn’t actually validate the VAT in question. Was always a challenge.
VAT accuracy, therefore, it would have always have presented a challenge to us in the accounts payable process. Invoice posting as a manual process that means that the VAT outcomes relied really on user trust. We have to trust the person who is actually posting the invoice into the system.
MS. SCHWABENBAUER: OK great, fantastic. From a VAT perspective, do you have any particular concerns about manual AP processes?
MR. COLBERT: I think when you’ve got a situation where you’re relying on user trust, you’re going to have a couple of aggravating factors that make it hard to ensure accuracy and VAT determination. As somebody -- it was my role really to be responsible for the VAT outcomes and the accounts payable processes.
The following factors really bothered me. So, the first thing is entry-level staff generally arrives with data processing or accounting skills but little or no background in VAT determination. The VAT training needed to be provided by us, the tax function within the company. And a multi-international accounts payable operation that staff generally need to adhere to different VAT requirements in a variety of VAT, GST jurisdictions with different languages and laws.
So, for example, you know, somebody needs -- somebody in the accounts payable department who speaks Italian may need to become frequented with the rules for posting Italian VAT on an Italian VAT invoice. Or, you know, somebody in Swiss VAT needed to maybe have German language skills in order to understand the laws that pertain there.
The tax functions, therefore, was generally required to provide a per country cheat sheet to the AP staff that shows, for example, the rates of VAT and all of these applicable countries as well as whether your entitled to the 50 percent, 100 percent or 0 percent VAT on, for example, maybe Carhart as an expense category. So, there was a lot of maintenance involved in actually kind of keeping all of that data up to date usable for the AP staff.
In a volume and scale operation, it can be very hard for accounts payable staff to spend proper time when they’re actually undertaking the posting. So, if they have, for example, two minutes or three minutes to post an invoice and undertake the accounting, the data entry, how long are they going to pause and actually think properly about the VAT outcomes that they are going to record when they actually post the invoice? Will they have time to stop and consult the cheat sheet that the tax function actually prepared for them? And even when we know that the accounts payable team has been given adequate training materials and un-training, that they understand the myriad details tax requirements that pertain to maybe three or four countries that each of them responsible for. Can we really be sure that they are actually going to stop and pay the level of attention that they need in order to ensure the tax outcome was recorded properly?
So, those would be the general concerns that I would have from a VAT perspective in the accounts payable processes, particularly in a manual accounts payable process.
MS. SCHWABENBAUER: Thank you. Are there any trends you think will have a major impact on the procurement space going forward?
MR. COLBERT: If I look a little bit over the last ten years, fifteen years and say, you know, what movements, what trends have I seen in procurement, I think the first thing would -- as I’ve mentioned a few minutes ago maybe be the outsourcing of work to low-cost locations. I think they have come very, very far away from the vendor location. Very often it’s undertaken overseas.
Another technology that we’ve seen coming into this space not really minimize maybe the data entry aspect of accounts payable would be optical character recognition. So, a much easier way to get data into a system.
In terms of the invoicing, Europe made great steps forward in 2013 liberalizing the E-invoice regimen, if allowed for basically a wholesale movement from postal invoice transmission, right, all the way to digital transmission. And instead of waiting a week to get your invoice posted, you could be certain with an email that the invoice had actually gone to your customer. Before that, you know, there had been some nominal allowance in the European Union for E-invoices, but really it was too restrictive to operate successfully.
MS. SCHWABENBAUER: And Donal, now we’re seeing the growth of the procurement systems, right?
MR. COLBERT: Another one that we’ve obviously seen particularly in the last five years is a very strong movement towards procurement systems. Such as, for example, Ariba or Coupa, where the business procurement functions incorporate their full procurement process which might mean, for example, vendor onboarding, the legal conditions that agree -- that exist within the contract, purchase ordering, goods receipting and invoice would all be placed within a dedicated procurement workflow platform with advanced functionality that specifically addresses purchase business functionalities.
So, in these data platforms, in the Aribas and the Coupas, we very often, again, see the data entry aspects are usually made their responsibility of the vendor. So the vendor uploads their invoice into this procurement platform, clicks submit basically and the invoice transmits through to the recipient. The invoice generally, obviously, it has to be validated on procurement systems have a means to validate invoice. That means that they generally rely upon is the so-called three-way match which I might talk about in a couple more minutes.
So, businesses are generally heralding the efficiencies in automation the procurement systems are bringing. Procurement systems are also behind what’s -- one of the most current movements in accounts payable procurement at the moment, which is what’s referred to as touchless accounts payable. So, touchless AP process.
MS. SCHWABENBAUER: Right. Now, that all makes so much sense. I appreciate your insight and your experience. I think we see a lot of the same on the U.S. side, but there might have been some more, I guess, movement or the ability to kind of automate things a little bit more quickly. But that’s what we’re seeing too is this, the Aribas, the Coupas and everything else have really tried to bring everything full circle. So, that’s fabulous.
MS. SCHWABENBAUER: Tune into our next episode for part 2 with Donal Colbert.
Part 2 Transcript
MS. SCHWABENBAUER: Welcome to Tax Today, a Vertex podcast series. On today’s episode, we’ll be exploring indirect tax and procurement landscape.Today’s episode is part 2 of our conversation with Donal Colbert, talking about opportunities and challenges with global VAT.
MS. SCHWABENBAUER: So, talk to us now, too, like why is touchless AP such a difficulty for VAT process? Is it really possible to have touchless AP, or is that just a made-up dream that someone just threw together?
MR. COLBERT: It’s a great question. I think touchless, the notion of touchless AP, I think it’s a really good idea and a real noble ambition, maybe within the procurement domain, but I think it can’t exist unfortunately for me and people in my area without giving VAT people in particular a bit of heartburn. Right?
MS. SCHWABENBAUER: That’s interesting, now talk to me, What do we call a touchless AP process?
MR. COLBERT: I mean, like it’s pretty much almost anathema to what you require from a VAT perspective. I mean, to call a process touchless means generally that we can trust it to be automated from the beginning to the end, from end to end. But there’s no need in this process for human resources to become in any way deeply involved in the process, right.
With procurement systems, we can have a high degree of confidence that most parts of the procurement process can be automated, but not necessarily the VAT.
MS. SCHWABENBAUER: So, what can we automate?,
MR. COLBERT: Well, the first thing that we can automate really is the data entry element. So, when we look at the data entry element, we might presume that we can have validation rules in the form. We can have PO flip functionality, etc. We can make great progress to ensuring data accuracy, our vendor is actually uploading accurate invoices in the portal to us. So, that’s the first thing that we really can validate. We can maybe aim for an accuracy rating of 99 percent or whatever of the data flows through accurately, and maybe 1 percent of the data that’s transmitted by the vendor needs to actually be manually or user corrected, right. No heavy data entry requirement.
Second thing that we can do is validate the business costs, right. Can we ensure that what we are actually paying for in the business, what we are procuring, the invoices we receive, I mean in order to ensure that these are valid business expenses, generally we should be able to tie them back to the purchase order, the requisition, the purchase order, the fact that the materials were actually received by the invoices.
So, for example, if I get an invoice for a table, what did I order? Well, the purchase order says I ordered a table. How many tables did I receive in the receiving process? One table and I’m invoiced for one table. Well that clearly is a three-way match and we can basically post the invoice, put it through to accounting as approved. So, that’s something we can automate.
What we might see then, for example, in this touchless AP process is we might get 500 invoices into our Ariba or our Coupa system and we might find that there are only 30 invoices that actually need to be intervened. So, maybe 27 invoices didn’t have a three-way match. Three invoices were uploaded incorrectly. So, instead of posting or instead of undertaking work on three -- 500 invoices, we actually only need to intervene with 30 which is a real good labor saving device and we might call that something like touchless AP.
MS. SCHWABENBAUER: Are there any VAT related concerns when it comes to touchless AP?
MR. COLBERT: I think the real problem for VAT, however, starts with the three-way match validation. It actually doesn’t really take any account whatsoever of VAT accuracy in the transaction. It’s the principle accounting check-in these procurement systems, and it cannot pay any -- it can’t really tell us anything about the VAT accuracy of the invoice.
What does the three-way match do? Well, really what it does is it validates the cost element only of the vendor invoice. Were the materials invoiced in a compliant manner? Were they receipted by the business? Yes. And were they ordered by the business? Yes. Are those values -- the value we ordered, the value we received are they accurately reflected in the taxable base of the invoice? If tax cannot be validated by procurement systems in an automated manner, then basically the tax will need to be reviewed by users.
Operating touchless AP and proper VAT controls is impossible as both are absolutely incompatible. If you want to operate touchless AP, well then you have to accept significant VAT risk as the VAT GST cannot be manually reviewed. Right? Or else, if you decide you want to apply proper VAT controls, well, guess what? You’re going to need a user to actually look at the invoice and that is by definition not touchless AP. So, there’s only one real way to overcome this, right, and that is you need -- if you’re going to have proper VAT validation, and you’re going to have touchless AP, what you really need is to embed proper extensive tax conditioning within your procurement platform. And by this, I mean the procurement platform makes a calculation to estimate the vendor charge tax and then uses this to validate the vendor charge tax.
So, for example, you have some functionality within Coupa or within Ariba that says this vendor sold me a table. I expect 22 percent tax on the sale of a table within this country. Okay, how much tax did the vendor actually charge? 22 percent. And then you have a match -- then you have a VAT control. You can have both touchless AP and you can have VAT -- proper VAT validation in your system.
MS. SCHWABENBAUER: Wow. That makes a lot of sense to me. And hopefully it makes a lot of sense to our listeners, too. It does seem like touchless AP and with VAT it really is impossible and incompatible. So, that just resonates a lot, and I appreciate that -- your insight into that. So, talk to me now and to our listeners what are the VAT risks to the purchasing business? What’s out there that from a global perspective audits or law? Can you help us understand that?
MR. COLBERT: Yep. It’s a great question, right, and I think it’s a question I spent my life answering really in one form or another. So, the first thing I find that it’s always difficult, I guess, from a VAT perspective is the VAT law is framed, unfortunately, on the founding principle that the business is required to operate as the tax collector. So, in every single transaction that a business transacts it’s required to put itself in the place of a tax inspector and say should I charge tax if I’m receiving the invoice? Am I entitled to charge -- or to deduct tax if I received an invoice with 0 percent VAT? Maybe I’m required to actually self-tax on that invoice. Right?
Now the problem generally what we find is what happens when this goes wrong? What happens in the purchase and sale transaction that the wrong VAT treatment has been ascribed? Well, under the VAT law generally it’s the vendor’s responsibility, the responsibility to issue a compliant, correct tax treatment invoice generally falls on the shoulders of the vendor.
If the vendor charges VAT at the wrong VAT rates, the invoice is invalid, not VAT can be deducted, meaning your business costs just increased by anything like between 5 and 27 percent according to the -- what you’re purchasing and the country you’re purchasing it in.
MS. SCHWABENBAUER: Does this carry any potential consequences for the purchasing business?
MR. COLBERT: So, if you didn’t apply a control and you didn’t realize, you didn’t check the VAT amount that you’ve been charged, well then the purchase business will generally let that VAT or flow all the way through to its tax returns and it will actually deduct incorrect VAT. That happens maybe once, but very often it doesn’t happen once, right. It happens once every single month. If you don’t have the controls, remember from a VAT perspective that you don’t get a tax audit every month or every quarter. You generally get one maybe once every four or five years and then the tax inspector, if he sees an error of this nature, what he’s going to do is he’s going to widen his frame and he’s going to say, I want to see this transaction not just the month that went wrong, I want to see it in every sample of this transaction in every single month. And maybe he finds if the procurement system isn’t correctly configured, that actually this occur -- this error has occurred every month over 60 months. And what we might say then is it’s no longer a small problem. It can be quite a significant problem. When the inspector takes a look at an occurrence like this, what he’ll do is he'll say why did this occur. Has the business maybe been careless? Has the business maybe been negligent? Has the business been reckless, or has the business maybe willfully ignored its responsibilities to actually properly account for input VAT? Did it not equip itself properly in order to properly deduct VAT? Yeah.
And depending on his outcome of VAT if he finds that it’s kind of negligent or careless, he may apply fines and penalties against the business and the scope of the audit -- a two week audit might become maybe a two month audit or a six month audit, depending on the tax inspector’s level of dissatisfaction with the business.
MS. SCHWABENBAUER: That makes a lot of sense Donal, thank you. Are there any other types of VAT errors that could occur in a situation like this?
MR. COLBERT: So, yeah, the example I just gave you, you know, I was talking about the wrong VAT rate. That’s just one kind of error that can occur in purchase VAT. Other kind of errors that we might see are, for example, if you invoice me 0 percent VAT, I need to have rigorous checks and understandings that perhaps I have a requirement to post reverse charged treatment which means that I have a requirement to self-tax. It doesn’t just end with the fact that you charged me 0 percent. I need to do something with that 0 percent.
It can also be the case that even when we’re -- you know, you charge 22 percent VAT. I’m deducting 22 percent VAT. That’s not right sometimes either. So, if you’re, for example, in the fleet management business or vehicle car hire, the VAT might only be 50 percent deductible.
So, again, who is telling the procurement system that actually this invoice is not 100 percent deductible. You only have an entitlement to deduct 50 percent of it. If we’re talking about, for example, a partially exempt business, an insurance company or maybe a bank or something like that, then considering whether the relevant purchase cost cannot be attributed to a taxable business activity and we can deduct all that VAT, or is it an overhead and therefore we need to apply recovery rate. I mean, it’s not normal for that type of logic, partial exemption logic, etc. to actually be found in the procurement system. So, these are some of the risks that we would see generally in purchase VAT domain, right.
MS. SCHWABENBAUER: Great. That makes perfect sense. And that’s really helpful. So, what are some of the advantages of having tax determination be included in the procurement platforms and your procurement process? Can you talk to us about that?
MR. COLBERT: So, yeah, Kristen, the main advantage that I would reiterate is again without proper tax determination, there’s either you can either have touchless AP or you can have VAT controls. You can’t really have both, right. To have both touchless AP and to have proper VAT controls, you simply need proper tax determination for your procurement platform. There’s no two ways around it, right.
The other advantages that I’d mention are in a proper tax determination system with a procurement platform, every invoice gets an automated VAT validation check. So, for example, if we’ve got our business that’s receiving 25,000 invoices a month, what we might see is that 24,000 of those invoices might flow through with a tax validation. The rate is properly predicted. We know how much is deductible. We know what tax code to record in the process. And 1,000 -- the 1,000 invoices maybe that mismatched are escalated to a VAT superuser and instead of having human review of 25,000 invoices we have human review of 1,000 invoices, which is a very considerable process step forward.
I think another one is were the vendor charges an unexpected tax amount. These invoices would be placed onto an on hold workflow so the super user can communicate with the vendor and within the application. And so, you know, in real time, basically, the VAT super user can communicate within the Ariba Coupa platform out to the vendor with a query in relation to the VAT treatment and maybe in real time five minutes later get a response back within the actual procurement process and move the transaction back into the green queue, right, for payment.
Enabling proper structures for VAT validation within a procurement platform really demonstrates to a tax inspector that a business is a very serious commitment that quality process and employs audit risk controls, adequate audit risk controls. And then, finally, from a partially VAT exempt business, Kristin, I would say embedding proper tax determination in your procurement platform can really give you the opportunity to save very significant tax support overhead. So, you’re probably actually -- you’re probably spending quite considerable amount of money having your partial exemption validated by third parties, and what a great chance with the machinery of a tax determination to actually automate an awful lot of that difficult lift and shift stuff.
MS. SCHWABENBAUER: That makes perfect sense. I completely agree. Use the technology that’s out there. And wow, I can’t thank you enough, Donal, for joining us today. That will do it for today’s show. I’d like to thank Donal Colbert for joining me and thanks so much to our listeners.
Please make sure you tune in for our next episode when we will have a conversation with Vertex Consulting’s Adam Runnal’s about his experience at a global motor manufacturer.
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