Strategic indirect tax

planning to reduce
liabilities
Daniel Broekhuizen
Ruth Felsing
Hafiz Choudhury

Need for corporate strategic view of

indirect tax

Complete tax burden can be 20-25% of cashflow

Effective tax management is key driver of
shareholder value
Low visibility and budgets for tax management
functions
Limited role in corporate MIS
Need to integrate tax impact of corporate decisions .

Importance of indirect
taxation
World Bank/IFC global project, Doing Business, on investment

climate includes Paying Taxes as an integral factor in investment

decisions by business.
The 2011 study shows that on average a global company pays
nearly half of its commercial profit in taxes, spends seven weeks
dealing with its tax affairs and makes a tax payment every 12 days.
Corporate income tax is only part of the burden the average
company pays more than nine different taxes.
Consumption taxes (mainly VAT) are the most time-consuming of
the taxes,
Time needed for VAT also varies considerably and is dependent on
the administrative practices implemented in each economy
Huge importance of customs duties in many developing countries
despite developments in WTO and FTAs.

Examples from Toyota

Examples from American

Express

Information needed for strategic view

on indirect taxes

What is the total annual global throughput of Indirect

taxes for the corporate group?
How much of your working capital requirement (WCR) is
created by indirect tax?
What impact has indirect tax had on Free Cash Flow
(FCF)?
What impact has indirect tax had on EBITDA Margin?
What is the true cost of indirect tax compliance?
What impact can indirect taxes have on EPS?
What are the best practices for indirect tax?
How can better tax compliance reduce direct costs

Why consider indirect taxes

Example Group numbers (From actual accounts):
Total sales = GBP 120,341,000 (P&L)
EU sales = GBP 98,673,000 (Note 2), 81.99%
Average Daily Sales = GBP 270,337
Total trade AR = GBP 19,849,000 (Note 21)
AR (EU) = GBP 16,275,000 *
VAT within AR (EU) = GBP 2,712,515**
Days Sales Outstanding (DSO)= 60.2 days***
Average VAT rate 20%
*Pro-rated GBP 19,849,000 @ 81.99%.
**AR (EU) X 20%/120%
***AR (EU)/Average Daily Sales

Possible VAT Gap for

example group
Supply made
Supply made
X
X

100 units
100 units
+20 VAT
+20 VAT
120 units
120 units

Payment of VAT
Payment of VAT
Measure of speed = BEP
Measure of speed = BEP
X
X

20
20

Collection of Debt
Collection of Debt
Measure of speed = DSO
Measure of speed = DSO

Critical Point
Critical Point
High DSO is where DSO >
High DSO is where DSO >
BEP i.e. on the average
BEP i.e. on the average
sale, VAT is paid before
sale, VAT is paid before
the debt is collected
the debt is collected

X
X

Time
Time

120
120

Mean Gap 26 days

Mean Gap 26 days
To VAT Authorities
To VAT Authorities
EU Mean circa 34,
EU Mean circa 34,
Range 25 (Germany) to 75 (UK)
Range 25 (Germany) to 75 (UK)

From Customers
From Customers
DSO (Europe) Y/e Feb 2003
DSO (Europe) Y/e Feb 2003
Estimated @ 60
Estimated @ 60

Key :Key : Cash In-flows or Out-flows

Cash In-flows or Out-flows
DSO = Days Sales Outstanding
DSO = Days Sales Outstanding
BEP = Break-even Point
BEP = Break-even Point

Direct cost of VAT Gap: 26/365 x (cost of funds) x GBP2,712,515

VAT breakeven point (BEP), UK rules

Due
DueDate
Date(+30)
(+30)
VAT
VATReturn
ReturnPeriod
Period(90)
(90)
BEP
BEP(75)
(75)

Month
Month11
30
30days
days

XX
Month
Month22
30
30days
days

Month
Month33
30
30days
days

Period
Periodof
ofgrace
grace
30
days
30 days

Assuming
AssumingFlat
Flatdistribution
distributionof
ofsales
salesan
anAverage
Averagesale
saletakes
takesplace
place
on
45th
day,
leaving
45
days
to
the
end
of
VAT
period.
Add
period
on 45th day, leaving 45 days to the end of VAT period. Add period
of
ofgrace
graceto
tothis
thislatter
latterperiod
periodto
toestablish
establishBEP.
BEP.AAskew
skewin
insales
sales
towards
the
period
end
or
payments
on
account
will
lower
towards the period end or payments on account will lowerBEP.
BEP.

Cash-flow benefits of better VAT planning

Assumed local VAT funded from cash
T Account extracts

Sales a/c
Sales a/c
100 (a)
100 (a)
VAT a/c
VAT a/c
20 (b)
20 (b)

20 (a)
20 (a)

Debtors a/c
Debtors a/c
120 (a)
120 (a)

(a) Sale made; and

(a) Sale made; and
(b) VAT return rendered and paid
(b) VAT return rendered and paid
Working Capital : Accounting Definition
Working Capital : Accounting Definition
Current Assets (CA) less Current Liabilities (CL)
Current Assets (CA) less Current Liabilities (CL)
120 (Debtors) less 20 (Cash) = 100
120 (Debtors) less 20 (Cash) = 100
Working Capital : Free Cash Flow
Working Capital : Free Cash Flow
CA (excl excess cash)* less CL (excl NIBCL)
CA (excl excess cash)* less CL (excl NIBCL)
120 (Debtors) = 120 c/fwd slide # 21, line 1.
120 (Debtors) = 120 c/fwd slide # 21, line 1.
* Confirmed by Black
* Confirmed by Black

Cash a/c
Cash a/c
20 (b)
20 (b)

Key
Key
NIBCL = Non-Interest Bearing Current
NIBCL = Non-Interest Bearing Current
Liabilities
Liabilities

VAT position after tax shift* employed

T Account extracts

Sales
Salesa/c
a/c
100
100(a)
(a)
VAT
VATa/c
a/c

Debtors
Debtorsa/c
a/c
100
100(a)
(a)

(a)
(a)Sale
Salemade;
made;and
and
(b)
Nil
VAT
return
(b) Nil VAT returnrendered.
rendered.

Working Capital : Accounting Definition

Working Capital : Accounting Definition
Current
CurrentAssets
Assets(CA)
(CA)less
lessCurrent
CurrentLiabilities
Liabilities(CL)
(CL)
100
100(Debtors)
(Debtors)==100
100
Working Capital : Free Cash Flow
Working Capital : Free Cash Flow
CA
CA(excl
(exclexcess
excesscash)
cash)less
lessCL
CL(excl
(exclNIBCL)
NIBCL)
100
(Debtors)
=
100
c/fwd
to
slide
100 (Debtors) = 100 c/fwd to slide#21,
#21,line
line22

Cash
Casha/c
a/c

*Tax-shift is the ability, through planning and improved

compliance , to make B2B customers self-assess the VAT.

Cash Released
Summary of Working Capital (1)
Summary of Working Capital (1)

Slide
Slide
Reference
Reference

Accounting
Accounting
Definition
Definition

Free Cash Flow

Free Cash Flow

#4 (status quo?)
#4 (status quo?)

100
100

120
120

#5 (future state)
#5 (future state)

100
100

100
100

Difference
Difference

0
0

20 Decrease in WC*
20 Decrease in WC*

Impact of adding to Free

Cash Flow

Operations
NOPLAT

WCR

Free Cash
Flow (FCF)

Assuming Capex is nil,

NOPLAT (Net operating
profit less adjusted taxes)
equals FCF
FCF is the major driver in
Shareholder value (SHV)
Only when the sponge
(WCR) is saturated will
the water (NOPLAT) end
up as FCF

FCF increase and impact on

WCR Tax shift reduces the WCR in Y1

Operations
NOPLAT

Tax point
deferral

Free Cash
Flow (FCF)

In other words,
NOPLAT (water) still goes to
the bucket
But water from the sponge is
also squeezed out
The additional cash contributes
to FCF and adds to SHV
After Y1, the business returns to
an improved steady state.
Thus the sponge continues to be
squeezed so WCR is managed
and does not grow at the same
rate as total revenue

Other metrics

Foregoing shows one area where better VAT management

improves SHV
Metrics to use and develop further:
Throughput estimates used only
% of WCR not known
Impact on EBITDA can only be measured from published data
Impact on FCF use of more accurate data will quantify savings
Compliance costs review costs for automation savings
Impact on EPS not complete
Best Practice benchmarking can be established

Trends in emerging countries

Policy concerns

Increased emphasis on tax revenue as trade liberalization reduces

customs duties and aid budgets reduce
Combating capital flight
Reducing the size of the informal economy
A share of the tax pie from global business
Continuing preference for source based taxes
Reliance on withholding and presumptive taxes
Lowering of top tax rates in income taxation

Organizational trends

Major reorganizations around the world

Improve capacity to monitor compliance and collect taxes.
Trend towards an unified tax administration
Executive Agency status in many countries
Investments in automation and web enabled tax filing

Tax policy and administration challenges in

emerging economies

Tax Legislation, Rules and Administration needs to catch

up with trade and investment reforms in general.
Especially true in more complex areas and introduction of
a new tax a Ferrari in the hands of a new driver.
Areas for Improvement

Clarity of laws / rules

Dialogue with taxpayers

Administration capacity and communicating interpretations

Clarity of definitions: Transfer pricing rules and Tax Treaty

Implementation

Tax discrimination / selective application/ transparency