American companies doing business overseas already know the global marketplace is expanding—but many are unaware that it's coming at a cost, as overseas nations strapped for cash turn to indirect taxes. Those taxes are in place or in process everywhere now—and there's no chance at this point that the trend will reverse itself.
A new report by EY, Indirect Tax in 2016, points to three trends shaping the global landscape. First, indirect taxes are providing critical new revenues for foreign jurisdictions; second, the digital revolution is pushing countries to closely examine how to tax e-commerce; and third, that same digital revolution is helping countries to electronically audit a business's financial records and systems.
Businesses can pass the cost of indirect taxes on to another person or group but are ultimately responsible for collecting them and remitting them to the government. These taxes include the value-added tax (VAT) and the goods-and-services tax (GST). Generally speaking, a VAT or GST is an indirect consumption tax that applies as value is added to the goods and services being produced at every stage of the supply chain, but that usually grants credits for previously paid tax. Although it is imposed on every step of production, the tax is ultimately borne by the consumer.
"The research has shown that if you have only a final-stage consumption tax [i.e., a traditional sales tax], you can't raise rates much higher because it can make fraudulent activity more likely," said Gijsbert Bulk in an interview. Bulk is EY's global director of Indirect Tax and lead author of the report, which surveyed more than 100 jurisdictions.
By contrast, taxes such as the VAT and GST "create a built-in audit trail," Bulk said. "There's an incentive for businesses to stay in because it's levied at each and every level of the supply chain. It's a stable source of revenue for a government."
The increasing dependence on indirect taxes is revealed in statistics collected by Avalara, a cloud-based transactional tax and compliance systems company in Seattle. Between 2007 and 2014, tax revenue as a percentage of GDP changed markedly in 34 nations in the Organisation for Economic Co-operation and Development (OECD). While corporate income tax contributions fell from 3.6% to 2.8%, VAT income rose from 6.5% to 6.8%, Avalara figures show.
About 160 nations have some form of indirect taxes, but the list of countries continues to grow by the quarter. The EY report features a global map that reflects a dizzying number of VAT and GST tax changes—those over the last several years and those on the horizon. Brazil, Costa Rica, Italy, and Namibia are among those jurisdictions that have just amended their indirect tax systems or are introducing new ones.
On May 1, China completed an expansion of the scope of its VAT to several additional sectors, completing the replacement of its gross revenue business tax with the reformed VAT. China's VAT now applies to goods sold in all major service sectors, including construction and finance.
And in India—an increasingly important U.S. trading partner—a new GST tax system, originally slated for April, may go into effect in 2017. It will mark the nation's greatest tax reform since 1947 and will replace all indirect taxes levied on goods and services by the central and state governments in India.
Even oil-rich nations find themselves getting into the act. With energy prices in sharp decline, Persian Gulf states such as Saudi Arabia, which earns three-quarters of its tax revenue from oil and gas production, have accelerated talks to introduce VAT systems as early as 2018, the EY report shows. According to Reuters, once the Persian Gulf states that are members of the Gulf Cooperation Council (GCC) agree on an implementation date for the new VAT, member countries can introduce it at any time, and there has been a suggestion that Saudi Arabia would. (The GCC comprises Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates.)
And as any global observer might expect, indirect taxes have been a boon for countries more known for facing dire straits. "Governments can immediately raise revenues with an overnight VAT rise," said Richard Asquith, vice president of Global Indirect Tax at Avalara, in an interview. "For example, all the countries in the eye of the financial crisis storm—Greece, Portugal, Spain, Italy, Brazil, and Japan—raised VATs to shore up their budget targets so they could reassure panicked debt markets that they could meet their commitments."
Italy's VAT is currently 22% but is scheduled to increase to 24% in January 2017, and 25% in January 2018. The rate increases will not occur if Italy's economy improves. In fact, a scheduled increase in 2016 was canceled when the deficit was forecast to be below European Union requirements.
Since Greece has been dealing with its debt crisis, it has adjusted its VAT numerous times. A rate increase to 24% was effective June 1, 2016.
And so, American companies face new commitments as well, as they must keep tabs on VAT taxes as they come into effect in the nations where they do business.
"Over time, I think if a company goes abroad, it should examine indirect taxes in the destination broadly," said Philippe Stephanny, manager in the State and Local Tax practice and of Indirect Tax for KPMG LLP in Washington. He pointed out that companies could easily misinterpret the word "indirect," believing it carries the connotation that such taxes are of tangential concern compared to other priorities.
"Often they think, 'How much in duties do I have to pay?,' but they almost never think about other potentially applicable indirect taxes," he said. And especially susceptible are those American companies in the world of e-commerce.
"More and more nations are requiring that businesses selling digital content, software, or entertainment—whatever it is—register for a VAT," Bulk said. "So U.S. companies should prepare for a situation where they are required to remit a VAT on top of the sales prices. In a digital world, that could be anywhere. Those companies should therefore equip themselves for a time when VAT compliance may become a reality."
Lou Carlozo is a freelance writer based in Chicago. To comment on this story, email Chris Baysden, senior manager of newsletters at the AICPA.