Quantifying VAT Compliance Costs
“Tax compliance activities can be considered a necessary evil,” according to the European Parliament's Policy Department for Economic, Scientific and Quality of Life Policies. “But, at the same time, they burden private enterprises with costs that may eventually cause them additional tax-induced burden.”
Tax leaders whose resources are stretched thin by the ongoing challenges of managing VAT returns might greet that observation with a resigned, “Tell me about it.” Fortunately, the new report, Overview on the tax compliance costs faced by European enterprises – with a focus on SMEs, does more than that by quantifying the cost of VAT compliance burdens for companies based in the EU and UK.
The report calculates tax compliance costs by analyzing available empirical literature and data; it also compares different European tax systems and enterprises of different sizes, including companies that engage in cross-border trade. The study’s stated purpose is to “provide sound evidence about the drivers of tax compliance costs, the association with specific taxes, and the possible existence of best-practice tax systems to draw inspiration for the design of EU-wide policies.”
Here are some notable findings that tax leaders should be aware of:
- Compliance is a 2% ‘tax on tax:’ Taxpayer compliance expenses are not directly related to how much in taxes are paid, but rather to the steps that taxpayers must perform to fulfill their tax obligations. These activities include financial and accounting planning, the recording of financial transactions, the gathering and storing of data, the filing of statements, and – in some cases – the management of audits and legal proceedings. The term "tax compliance" encompasses any and all of these types of actions. Tax compliance costs for companies based in the EU and UK generally range from 1% to 2% of annual turnover (“revenue” for U.S. audiences). However, these averages obscure the fact that some countries impose far greater VAT compliance burdens – up to three times as high compared to countries with lower VAT compliance costs.
- VAT compliance costs are not proportional: The report emphasizes that “smaller companies are burdened with relatively larger compliance costs.” Additionally, VAT has both the highest tax audit costs and frequency of tax audits compared to all of the other kinds of taxes that are evaluated in the study.
- Cross-border compliance doesn’t cost more: The research finds that the additional compliance burden “if any, is very small” for companies engaged in cross-border trade. Conversely, businesses that operate exclusively within domestic borders may take on additional tax liabilities, primarily because they are unable to take advantage of transfer pricing (as multinational competitors do), which can put them at a competitive disadvantage, particularly on credit markets.
- Complexity adds cost: Not surprisingly, the study finds that tax compliance complexity and uncertainty increase VAT compliance costs. In light of this, the report suggests that EU policy should put emphasis on the introduction of common rules that limit the ability of local jurisdictions to deviate from these common guidelines.
The report also emphasizes that the harmonization of national tax bases and rules along with the simplification of national tax systems would help lower compliance costs.
While those developments would be welcome, tax leaders can and should take action today on reducing the VAT compliance burden via automation, process improvements and other mechanisms within their control. They should also continue to monitor the EU’s VAT in the Digital Age (ViDA) proposals so that they can get in place the tax technology and processes needed to address evolving VAT compliance requirements.
Please remember that the Tax Matters provides information for educational purposes, not specific tax or legal advice. Always consult a qualified tax or legal advisor before taking any action based on this information. The views and opinions expressed in Tax Matters are those of the authors and do not necessarily reflect the official policy, position, or opinion of Vertex Inc.
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