One of the most important functions at which companies must excel is selling goods and services with as little transactional friction as possible—particularly in today’s world of digital commerce. Companies invest significant effort in the sales environment, but an equally necessary value-add for tax is the ability to purchase goods and services and pay the proper amount of tax.
For far too long, a struggle has existed between procurement and tax to rate purchases properly. Procurement systems vary widely—from sophisticated enterprise resource planning systems (ERPs) to other home-grown or industry-specific systems. Because these systems are generally built for procurement needs—speed and inventory control—existing tax calculations (which includes built-in and custom functionality that may not be updated) are often treated as “good enough” and may not identify incorrect tax or flag invoices for reissue by the seller.
Historically, when tax is improperly calculated on purchases, the tax department has often borne the responsibility in terms of cost and personnel by researching the correct tax or dealing with use-tax audits. If the invoice is found to be improperly rated at the time of payment, the vendor faces “short paying” or even not paying the invoice. In a VAT or GST transaction a company cannot deduct incorrectly charged taxes.
The best approach to overcoming these challenges is to implement a third-party tax engine. Adding a tax engine to a procurement system enables the tax department to control the tax calculation within the P2P process, taking the onus off procurement and the accounts payable department. Any discrepancies requiring correction will be flagged immediately and managed in the procurement, accounts payable, and vendor workflow. The engine has built-in transactional and fee data content that can then be mapped onto the purchases that procurement makes. The mapping ensures proper rating of the transaction and can produce exception reports when transactions are improperly rated.
Such a tax engine allows the organization to fulfill its business requirements through automated purchases and to benefit from reduced costs and a lower risk of audits. Procurement can continue to focus on its own strategic efforts, and IT does not have to load manual tax updates to the ERP or procurement system; rather, the updates become part of the monthly tax engine update cycle. Furthermore, the tax engine supports additional applications across the supply chain, including the order-to-cash cycle, ERP, e-commerce, and point-of-sale.
This change also enables procurement to rethink some of its own important activities, such as allocating personnel, vendor reviews, and upskilling its employees for more strategic initiatives.
Let’s look at some specific issues.
Product mapping is the process of correctly assigning a tax category to a product or service based on the laws of the sale destination jurisdiction and the product’s attributes. Incorrect or manual mapping in the ERP or procurement system leads to underpayment and overpayment of taxes. These errors put a company out of compliance with its corporate governance model and will often lead to posting a reserve for financial statement purposes. Trying to recover overpayments after the fact is time-consuming, and tax underpayments lead to interest and penalties. Tax engines are designed to map products in a very granular fashion due to the extensive tax research behind them—thus ensuring proper tax mapping and correct tax determination across multiple jurisdictions.
Improved Master Data Control
Proper mapping can be achieved by having a digital catalog that correctly describes the attributes of each item. Digital catalogs are essential on the sales side. For procurement, companies can benefit from having a digital purchase catalog. That catalog could contain the most frequently purchased items (it is understood the digital catalog may not be appropriate for all purchases) with the proper attributes assigned to each purchased item. Tax engines perform best when a company has central and consistent control over its catalog. The procurement group should take a disciplined approach in working with its key vendors to ensure that all purchases have been correctly entered in the catalog. Often a company purchases thousands of items; however, procurement can work with its vendors to ensure that the most-purchased and material items have been described properly and placed in the catalog, thus leading to a properly mapped item to ensure optimal performance of the tax engine rating process. Some products are miscoded—yet material and substantial compliance will be achieved when the master data is current and correct.
Eliminate In-House Transactional Tax Research
Maintaining transactional tax research in-house can be a significant burden for any tax department. In the United States and in VAT/GST (value-added tax/goods-and-services tax) countries, ERP and e-commerce systems don’t provide deep enough content to manage the complexity and keep up with changing regulatory rules. Legislative changes in the indirect tax system in every country where a company does business bring new risk to that company’s transactional tax determination.
Adding a tax engine to procurement, ERP, and e-commerce systems shifts that research responsibility to the tax engine provider, since content is managed in the tax engine and not in the ERP/procurement system. This shift eliminates the need for in-house research and costly external advice, freeing up procurement, tax, accounts payable, and IT department resources for more valuable work.
Since the transactional tax content is maintained in a single centralized tax engine and updated continually by the tax engine provider, the result is that every transactional finance system connected to the tax engine is leveraging the latest rules for destination, VAT/GST place-of-supply, rates, and deductibility requirements. Tax engines ensure compliance over the multitude of state and local jurisdictions. Globally, they ensure that companies can adapt easily to otherwise costly developments such as Brexit, implementation of VATs in Gulf Cooperation Council countries, European Union VAT reform, and additional “verticals” of taxation.
Ensure a Reliable, Repeatable Accounts Payable Process
Adding a tax engine to your procurement, ERP, and e-commerce systems automates processes to ensure a more reliable and repeatable accounts payable (AP) process. It replaces “user trust” with “system certainty.” Here are some specific benefits.
At the point of requisition, a tax engine provides a real-time calculation of the applicable transaction taxes and the deductibility of these taxes (VAT/GST). Therefore, purchasers can understand the projected cost of their purchases.
At the invoice posting stage, a tax engine eliminates any guesswork on the part of AP.
The tax engine replaces human decisions with reliable rules-based automation for improved accuracy and reduced risk. Automating these decisions also significantly reduces the time that the tax department will spend answering tax questions from AP.
Exemption Certificate Management
Up to now, this article has focused on tax engines in the procurement buying process. In the United States, purchases are often not subject to a transactional tax due to how the items will be used or to whom they are sold. Tax jurisdictions often require exemption documents to be produced at the time of sale and stored for audit purposes by the vendor to substantiate the exemption.
Exemptions will always be audited. Tax departments work intensely every day to purchase goods and services with the aim to minimize transaction taxes legally. Tax engines can often work seamlessly with a certificate management system (CMS). Most often it’s best to have either a CMS that is digital and has a core functionality to store paper documents produced by the purchaser or a “decision tree” CMS that walks the purchaser through a series of questions to ultimately produce a digital certificate that is then stored with the seller until the certificate expires. Too often purchasers claim an exemption upon purchase with no supporting or incorrectly produced exemption documents. Current certificates are especially important if your procurement and tax groups use a direct-pay method to purchase taxable goods and services. In doing so, only use tax will be accrued and paid by the company once the item goes into use.
A tax engine can also scale to and move with your company’s business, for these reasons.
As procurement systems are updated or new ones implemented, these systems can often be connected to the existing tax engine and be up and running with minimal customizing as long as the engine supports the same geographies and purchase lines of the previous system. New purchase lines may be added as necessary.
Whenever the company installs a new procurement or ERP system, there will be no need to start coding from scratch or to risk copying old settings to the new environment. The engine will remember these.
When centralizing or off-shoring AP or IT functions, tax knowledge is no longer a blocker, since the required knowledge is outsourced to the software provider and embedded in the tax engine.
The tax department has a unique opportunity to provide great value to the procurement process. Tax and procurement can start small, often by selecting an initial area where procurement has stable vendor relationships and a minimum number of SKUs or geographies. Your company will experience both quantitative improvements (accuracy, fewer audit assessments, fewer hours devoted to manual reviews) and qualitative ones (increased tax governance and automation). Good luck.
Editor’s note: For more on VAT/GST, please see this article by Donal Colbert and Peter Boerhof, “7 Reasons to Add a Tax Engine for VAT/GST Determination,” at www.vertexinc.com/resources/resource-library/7-reasons-add-tax-engine-vat-determination.
Michael Bernard is chief tax officer—transaction tax at Vertex Inc.