Tax Compliance Management System

Your expert for questions

Sounia Kombert
Partner, Indirect Tax Leader at PwC Germany
Tel.: +49 221 2084-384
Email

Better with a System

Tax authorities and law enforcement agencies are getting more efficient at investigating violations, especially in the sensitive area of VAT tax. Legislators are also taking action. With the announced Association Sanctions Act, a robust and flexible Tax Compliance Management System (TCMS) is in high demand from companies and other responsible parties. The existence and quality of a TCMS will - if the law is passed - have a direct impact on the level of sanctions or even the imposition of sanctions. This is one reason why tax compliance management systems (TCMS) are increasingly on the agendas of management, and of internal auditing.

Relief through the right system

Keep Control 

The starting point is the VAT return. Errors here or in the advance return and their subsequent corrections regularly lead to two questions: How is a “simple” correction notice (§ 153 of the German Fiscal Code, AO) to be distinguished from an exempting self-disclosure, and when is there a reproachable fault on the part of the organization? If organizational culpability is established, the accusation of tax evasion or “reckless tax evasion” can arise, and with it the potential personal liability of management also increases. 

Exemption from liability is only possible if a company maintains a TCMS or internal control system (ICS) for taxes that considers the company’s material VAT risks. No one is obligated to have a TCMS, nor can it eliminate every tax error. But it does provide evidence, or at least an indication, that errors in complying with tax related duties were neither intentional nor reckless.

The tax authorities have expressly agreed with this view and have stated the following: “The establishment of an internal control system can be an indication that intent or recklessness is ruled out.” A TCMS can therefore reduce the risk of impending fines or criminal proceedings and protect the function holders from liability.

Practice Note (“Praxishinweis”) and Tax Guidelines 

The Institute of Public Auditors in Germany (IDW) has described the nature of a TCMS in a Practice Note (PS). It is to be based on the requirements of IDW PS 980. As currently the best available indicator for companies in Germany, this Practice Note should serve as a benchmark for the establishment of such systems. 

The culture, objectives and organization of compliance can be well regulated with a tax guideline. It documents the commitment to a compliance culture, as well as the commitment to its goals. The organizational structure is outlined and responsibilities for compliance are defined.

Focus on VAT 

At the heart of a TCMS is VAT. This is not just because of the high monetary risks involved. In the often IT-based VAT findings, the smallest inaccuracies or incorrect settings can lead to significant VAT risks. The greatest risks are in errors made during the preparation of a VAT return, but in other areas of the company and its functions. This makes the design of a VAT CMS, the identification and assessment of risks, the defining of appropriate measures to ensure compliance, and its monitoring and improvement, a highly complex task. 

For example, the check when an invoice is received - usually a core task of accounts payable - is a source of potential risk. On the one hand, it must be ensured that the tax findings are correct, and on the other hand that the formal requirements are met. Here, suitable measures and controls must be defined and implemented to shield against risk. 

Optimization of Processes 

Other relevant corporate areas include purchasing, master data management, sales, and customer relationship management.  Decisions made by the company, and the data that’s entered into the resource planning system (ERP) will have an impact on the VAT posted and then later reported in tax returns. The sheer number of transactions makes it almost impossible to check all entries when preparing the tax return.

In the best case, errors are identified “at the source” and prevented or corrected. However, the world doesn’t always operate in best case conditions. The introduction of a CMS for VAT affects almost all company areas and processes. Consequently, one of the main tasks within a TCMS is first to identify the processes and where relevant decisions are made and actions are taken. Then it is a matter of figuring out which controls are carried out and how they are documented. The tax department itself usually has little knowledge of these processes. In this respect, a TCMS is often initially used to identify, organize and, if necessary, restructure processes.

Visibility Through Documentation 

Another challenge is the documentation of processes and controls. The operational processes of most companies are suitable for effectively countering VAT risks. At the same time, however, they are often insufficiently or inconsistently documented and communicated. Implementing a TCMS makes the existing processes visible through documentation and thus makes controls and measures more accessible.

Analysis of Business Processes 

A TCMS should not be limited to individual company or functional areas. Fundamental issues in the company should also be examined, such as the settings in the ERP system or the staffing of the VAT function. In the case of the latter, it often becomes apparent that regulations for substitution are lacking or inadequate staffing makes it impossible. If processes are outsourced to shared services centers, it is necessary to ensure that the personnel working there receive preliminary and further training in tax matters and to check whether the outsourced tasks can be mapped there in a meaningful way at all.

Taking a closer look at existing business processes, analyzing weaknesses, improving processes and introducing controls are highly demanding matters. The complexity of many processes should not be underestimated, because some things have simply fallen into place over time or there is a lack of comparisons with competitors. But the effort is worth it, because the result is almost always leaner processes, more efficient workflows, time and cost savings, risk minimization, and VAT compliance. The added value resulting from a TCMS project in the area of VAT is immense.