Tax Control Framework and Data Analysis – Why the combination is not always successful

Tax Control Framework and Data Analysis – Why the combination is not always successful

3 April 2013

By Ferry Geertman, Managing Director of the KEY Group

A Tax Control Framework for VAT focuses on managing material risk areas. An objective of the data analysis could include determination of the controls’ effectiveness and efficiency with regard to these risk areas.

In practice, I have noticed the following in reviewing data analysis regarding indirect tax:

The Tax Control Framework of the organization contains 10 controls that can be assessed by means of data analysis.

  • Of these controls, 3 were assessed using data analysis and 7 were not included in the assessment.
  • Out of the 12 tests that were executed, 7 contributed too little for drawing conclusions regarding either the effectiveness of Tax Control Framework or the quality of the VAT data.

The root cause lies in the fact that many data analysis applications are offered in standardized form in the market, which means that the data analysis is not fine-tuned for the organization respectively the industry.

In the above-described situation identical tests were executed for Accounts Payable and Accounts Receivable, even though the processes and risks differ significantly. Because identical tests were run for both AP and AR, this resulted in many false-positives. There was no tightening of the tests based on specific conditions of this organization whatsoever.

One of the control measures that was not included in the data analysis was determination of the reconciliation of the VAT return with the General Ledger and the Accounts Payable and Receivable reports.

This is remarkable since lack of reconciliation eliminates any proper ground for drawing conclusions. A commonly heard remark is “the current ERP systems always ensure reconciliation”. In practice, however, making the VAT return depends heavily on data extractions from the system and many operations in Excel – a manual and error-prone process.

In the normative framework of VAT processes and work instructions for composing the VAT reports and returns, it is indicated which data are to be used for the VAT return and whether additional actions are required. Data analysis enables determination as to whether this is actually carried out.

Process      
VAT Return VAT Risk Control Activity Test of Control

Compilation of VAT reports: reconciliation

VAT reports are inaccurate or incomplete

The VAT department has work instructions detailing the creation of the VAT reports. A checklist is available detailing all data required for completion of the VAT return. The VAT reports are reconciled to the General Ledger by the (VAT/Finance) department. Any differences are explained and followed-up.

Verify that work instructions for completion of VAT reports have been followed and signed off. Apply data analysis to assess reconciliation between VAT reports and GL

 

Execution of an effective data analysis requires objectives that are clearly defined in advance.

Examples of objectives are:

  • Contributions to the realization of fiscal objectives
    - Managing material risk areas concerning indirect tax
    - Realizing savings respectively optimizing the cash flow position
    - Compliance with laws and regulations (including financial statements)
  • Ascertaining that the organization has control over material VAT risk areas and that the TCF is working effectively.
  • Showing the tax authorities that the organization is in control, in order that a tax audit can be prevented.
  • Defining actions for improvement based on the observed inconsistencies.
    - ‘process’ and ‘root cause’ analysis
    - more efficient and effective controls (manual and automated)

When the objectives are defined, the right approach regarding data analysis is as follows:

  • starting point is reconciliation of the VAT returns with the GL and AP and AR reports
  • gaining insight into specific VAT risk areas of the organization respectively the industry, such as:
    - intercompany transactions
    - cross-border transactions
    - transactions within fiscal unity
    - foreign VAT (included in incorrect VAT return)
  • clearly defining the applications of the data analysis on the basis of these objectives.
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Take aways 

We combine technical knowledge with industry understanding and knowhow of technologically advanced tools and methodologies available in the market or developed by ourselves.

  • Focus on tax processes that could be improved
    • Manual process: same data requests are made by different stakeholders
  • As Is assessment
  • Anticipate future changes and the data needed
    • What are tax trends?
    • What is happening locally and what should be considered across jurisdictions where you operate?
    • Anticipate new stakeholders and their data needs or requests (internal and external)
  • Define scope and actions for short, mid and long term
  • Write business case for change
  • Realize sponsorship for implementation
  • What tax data is requested and by whom?
  • What tax process can be improved and what can be automated?
    • CIT, VAT, tax data warehouse
  • What is the Return on Investment?
    • Hard saving: process improvement
    • Meeting (new) tax requirement
  • What systems are in use: SAP, Oracle, etc
    • By which entities?
  • How many end-use computing tools (e.g. excel spreadsheet) do we have?
  • How do we avoid an ad-hoc solution?
    • Understand the bigger picture
    • Real problem and not the symptom

Technology-related tax risk: understand and address the potential harms and benefits of (new) technology.

Ascertaining proper IT support for ensuring efficient, timely and reliable reporting.

VAT should be considered in every aspect of the process, from concept through completion and beyond. Managing by design — looking at any process or transaction from end to end and factoring in all the requirements and controls essential to designing and optimizing a compliant VAT process.

We speak the language of the business and IT and no translation is needed.