A look at the OECD’s recent publication on digital tax administration and the steps organizations can take to prepare themselves
In recent years, we have observed that tax authorities are all going through journeys of digitalization, each with their own approach. In Hong Kong, the Inland Revenue Department (IRD) is also focused on e-filing, with the IRD strengthening its infrastructure, including plans to build tax portals by 2025 including a Tax Representative Portal. These portals will enable the submission of financial statements and tax computations. Like other tax authorities, the goal is to improve the efficiency and the volume of digital information collected, streamlining tax administration and compliance through the use of automation and data analytics.
Globally, the Organization for Economic Cooperation and Development (OECD) has shared its vision on the future tax administration in its recent publication Tax Administration 3.0: The Digital Transformation of Tax Administration (TA 3.0) focused on bringing digital tax administration to the next stage. In parallel, the OECD continues to promote cooperative compliance programme initiatives, which promote trust and mutual transparency between tax authorities and taxpayers and hence achieving compliance by design.
What does tax administration of the future look like?
In TA 3.0, the OECD highlights a few key trends. Tax authorities are moving away from both electronic and paper forms. Tax administration is relying more on data, especially transactional data, for tax compliance and administration.
Furthermore, tax authorities of the future will look to build interoperable ecosystems with key players (e.g. banks, welfare agencies, international agencies, retail, citizen data, etc.). It enables data exchanges across multiple parties and hence reduces the compliance costs from both taxpayers and tax authorities and enhance data accuracy. An example of which is the Inland Revenue Authority of Singapore. They have introduced the “No-filing services.” That is, taxpayers falling under certain criteria are exempted from filing an income tax return. This is a government joint effort. The tax authority will leverage the data they have access to (e.g. tax-deductible donations, central provident fund, etc.) prepare the assessment to the taxpayers directly.
One of the major themes in the OECD’s model for the tax administration of the future is that “adapting taxation processes to fit in the taxpayers’ natural systems will facilitate compliance by design and ‘tax just happening.’” By doing so, tax authorities will be able to collect real-time transactional data from taxpayers’ business systems, which enable tax to happen closer to when the transaction is made. Coupled with advanced data analytics, tax authorities will be able to validate the data and collect tax when business happens. This can potentially reduce tax administration costs on both sides.
The Australian Taxation Office (ATO) has pioneered in this space with its Single Touch Payroll (STP). With STP, organizations can report employees' payroll information including salaries and wages paid, taxes withheld and pension contributions to the ATO when they pay the employees through STP-enabled software. This can reduce the administrative burden in preparing annual reporting e.g. summary report or employee payment summaries.
Continuing development of the cooperative compliance programme initiatives
Although tax authorities are collecting more digital data and running data analytics to detect anomalies, tax authorities are also relying on a tax control framework to assure the reliability of the internal governance process, rather than checking every individual transaction. In recent years, we have noticed that tax authorities are requiring or recommending tax technology and data governance to be part of an organization’s tax control framework especially with a focus on data accuracy and completeness. For example, whether an organization establishes information technology control policy is considered by Germany, Italy, Netherlands, Poland, and others. Moreover, tax authorities are beginning to consider controls over tax calculation accuracy and how to ensure transactions are properly accounted for in the business systems.
Some tax authorities are even looking for access to data as part of the cooperative compliance programme. In Russia, the tax authority has launched its cooperative compliance framework since 2016. The key building block of this cooperative compliance framework is granting the tax authority with remote access to the taxpayers’ accounting and tax reporting systems as part of ongoing due diligence and monitoring.
Developments in Hong Kong
Although Hong Kong does not currently have extensive digital reporting requirements, the IRD is expected to catch up and be able to play its role to support global transparency. With the increasing demand for global transparency, tax authorities are under the pressure to collect digital data for fulfilling their obligation as international players especially for exchange of information. With Base Erosion and Profit Shifting (BEPS) 2.0 initiatives, it is expected that the IRD will also take this opportunity to impose additional digital reporting requirements.
How should organizations get ready for future tax administration and global transparency?
In this new world of transparency and digital tax administration, organizations need to get their data on hand and ready for compliance and tax authorities’ scrutiny. The ongoing BEPS 2.0 project, for example, aims to provide new taxing rights to jurisdictions over organizations with market but no physical presence, and ensure organizations are subject to a global minimum tax rate. Organizations that wish to evaluate and substantiate if they are subject to any tax adjustment under BEPS 2.0 are likely to face challenges to collect extensive data for analysis. The starting point is usually to group generally accepted accounting principles financial data, related party transaction details, tax losses, tax credits, tax payable, etc. Most of these data are already available within organizations’ enterprise systems, the main one being enterprise resource planning (ERP).
Leveraging natural systems and enterprise systems is key to ensure data readiness and accuracy at source systems. With the use of enterprise performance management (EPM) systems, data from different legacy systems can be consolidated into a single tax data source globally. The tax data can then be used for various purposes including tax reporting, tax compliance, country-by-country reporting, BEPS 2.0 compliance, and monitoring. Leveraging “a single source of truth” for various reporting could ensure data accuracy and consistency. Upon a tax audit, data could easily be collated and provided to the tax authority.
From the organizations’ point of view, the approach of leveraging enterprise systems makes good commercial sense – with no need for additional tax software, minimized reconciliations, user familiarity and above all, a great foundation for value-added management reporting and analysis.
How to implement and operationalize the cooperative compliance framework initiatives
Other than leveraging enterprise systems for accurate data, enterprise systems can connect the key components of a cooperative compliance framework, including process, workflow, people, data and document in one single location.
In general, tax authorities are taking a holistic view on a cooperative compliance framework which covers tax control strategy, internal control policy, risk appetites of management and technology. For instance, tax authorities may request the group tax strategies covering all tax types, board involvement, group legal structure, internal control reports summarizing the process for tracking and reviewing tax risks and the risk matrix, etc. A recommended approach to a cooperative compliance framework is a top-down approach with a clearly defined risk control and monitoring matrix and documentation underpinned by enterprise systems.
Many organizations already have workflow and document management technologies in place which could be used to enable control frameworks. Workflow or process management functionality is embedded in core financial systems which enable financial processes such as ERP or in other enterprise tools like Microsoft SharePoint, ServiceNow, Pega, etc.
The Federal Tax Service of Russia is a good example of operationalization. They use a maturity assessment model to evaluate an internal control system under tax monitoring comprising five key components including control environment, identification and assessment of risks, control procedures, information system, and monitoring and evaluation of effectiveness. During an audit, documentation is required to be provided to substantiate the control effectiveness (e.g. register of risk identified for tax monitoring, register of taxpayer's control procedures performed for tax monitoring, analysis report on the control procedures performed, etc.). Furthermore, a key highlight of tax monitoring is granting of the remote access to the accounting and tax reporting systems through application programming interfaces to the tax authority. We expect to see this more and more, so organizations need to get their governance and data ready as part of good tax governance and tax risk management.
In conclusion, modern technology has significantly enhanced our ability to manage and process very large data sets. So, it may soon be possible to automate the accuracy of accounting records and production of regulatory compliance. Tax administrations are collecting more digital data than ever. Hence, it is expected that future tax administrations will lean more towards data that is backed by a governance framework. Then tax administration and taxpayers can focus on the principled areas of the application of complex law to complex facts to arrive at the correct tax treatment.
Here in Hong Kong, the IRD is also embarking on the journey towards digital tax administration. Organizations should start to assess their data readiness and accuracy for digital reporting obligations, and on the other hand, ensure their tax controls are in place and effective for monitoring tax risks and future scrutiny by tax authorities. This journey can start with leveraging the enterprise systems as a tax data warehouse and building up a single source of truth for tax reporting, overlaid with a tax governance and monitoring platform on top for risk management. Start with a current state and gap analysis that will naturally identify a transformation road map and business case for building an intelligent tax function.
This article was contributed by Albert Lee, Asia Pacific Tax Technology and Transformation Leader, and Agnes Fok CPA, Director, Tax Technology and Transformation at EY Hong Kong.