Managing temporary COVID VAT rate cuts

Global finance ministries are introducing temporary COVID-19 Value Added Tax rate cuts – including Goods and Services and U.S. sales taxes - to boost consumer confidence as countries move from the emergency to recovery phase of the pandemic.  The immediacy of delivering price cuts for shoppers and state-aid for businesses leaving lockdown makes VAT the most popular stimulus measure.

However, at a time when most businesses face a collapse in sales, this brings a hidden administrative cost, resource distractions and major tax risks. How should businesses prepare for the inevitable brace of temporary VAT rates changes in terms of accounting, IT, tax and customer and supplier planning

Temporary VAT cuts create a huge business process drain. This could not come at a worse time for companies facing the existential coronavirus crisis. Offices remain fully or partially closed, and staff face difficulties with remote access and communications. Many are also juggling childcare responsibilities. This means day-to-day workflows are hugely disrupted without the burden of two temporary VAT rate implementations: a cut; and then a reversing rise.

The burden of temporary VAT cuts splits into two: VAT recalculations and reinvoicing; accounting system changes.

The extra workload created by a temporary VAT rate change is generated by the suspension of the normal ‘time of supply’ rules. These set the date that VAT is due, and therefore which VAT rate to use during a rate change. Generally, it is the earlier of the invoice, payment or supply of the goods or services. This doesn’t work because businesses may accidentally or intentionally manipulate any of these to change the tax due by customers or to the government.

Businesses therefore have to scrutinise the treatment of supplies through the rate change period to ensure VAT calculations is reporting accurate. The common issues businesses will have to look out for include:

• Staff, customer and supplier awareness. It is important that all stakeholders are briefed on the implications and plans for managing the transition phased of a cut, and subsequent reversal of temporary rate decreases.
• Cashflow implications. Businesses may be taking less VAT, which is in effect a short-term cash line from governments. Finance must understand any implications of lowered funding.
• Anti-forestalling measures introduced by tax authorities to prevent deliberately delayed payments or VAT invoices to benefit from the new, lower rates. The delivery or performance date will now be closely scrutinised by authorities, and so finance and tax teams must be aware of any controls introduced.
• Invoicing in the notice period prior the VAT rise; which VAT rate should be applied and how to report
• Partially completed supplies over the implementation dates must have split VAT rates allocated
• Continuous service contracts, and the allocation of the VAT change must be reviewed and agreed with customers or suppliers
• Advance or instalment payments made over the implementation date by need to be reinvoiced with the correct VAT rate to match the actual time of supply
• VAT on simplified invoices which have different tax calculations will have to be adjusted
• Processing deductions on input VAT paid before the implementation date but under the new rate may be incorrect
• Import VAT charges and credits need to be checked to ensure no over-payment or claims of VAT
• Outstanding vouchers redeemed during the VAT cut may carry excess tax
• Processing refunds of VAT, including dispute management will require extra manual input
• Changes of the VAT return, which may be altered by the tax authorities to gauge the effects of the measure
• Subsequent additional bills after the implementation period for services concluded prior to the date will have to be confirmed and invoiced for
• Refund of deposit amounts accepted prior to the implementation but then refunded after the implementation date will need new VAT calculation and reporting. It is important that businesses taking deposits are fully briefed across all teams on the switch in rates
• Exchange of goods, which includes a cancellation of the previous delivery and the invoicing of a new delivery
• VAT rate treatment for specific industries with specialised VAT regimes, including travel and second-hand goods, will need extra consideration

For small businesses, with basic accounting packages, an overnight VAT rate change may be sufficient. It will undoubtably incorrectly report transactions stretching over the implementation period (see above). However, it is questionable whether tax authorities will give any discrepancies a close investigation given the magnitude of the COVID-19 crisis.

Mid and large enterprises will not be permitted the same grace. They cannot ignore the details of the changes, either for their own VAT declarations or matching the treatment of with their B2B counterparties.

Key system tasks will include:

• Liaising with businesses’ accounting and ERP providers to understand their interpretation of the implementation rules and if they are fully updating their software. For on-premise installed accounting systems, businesses will have to ensure they get updates as early as possible to ensure they are getting the VAT right.
• Sales ordering systems, if not integrated into the updated accounting system, will have to be addressed. Manual intervention may be required on some transactions with irregular delivery terms over the implementation period. Particular attention is required of open orders at the time of implementation of the rate change.
• Tax codes, which set the correct tax rates on a transaction-by-transaction basis in accounting systems, will have to be re-set, implemented in customised tables and thoroughly tested. This often requires the creation of new tax codes, which need to be agreed by all stakeholders across the business. It is important not to overwrite existing codes so that future checks and audit remain possible.
• Invoices templates, whether through dedicated AR invoicing or accounting/ERP system, will have to be re-stated with the correct VAT rates and references to implementing legislation, where required.
• Any travel expense reporting processes must be revised.
• Accounts Payable system must be reassessed where there are validations of vendor invoices.
• Point-of-sale systems such as cash registers, particularly where they report directly to the tax authorities must be checked to ensure the VAT is reset as appropriate.
• Certain affected balance sheet accounts will need to be reviewed to re-set any limits on VAT.
• To support the above, tax and accounting teams must liaise closely with their IT or engineering colleagues to plan a roadmap and implementation plan for the recoding required.
• When submitting filings, setting on XML, API and similar must be updated data must be updated.