COVID-19 and Beyond: The Challenges of Indirect Taxes Changes
In the midst of the global coronavirus pandemic, challenging economic conditions have necessitated many changes to keep economies afloat. Around the world, governments are facing the dual pressures of having to increase their spending at the same time that their tax revenues are on the decline. In this difficult environment, indirect taxes are likely to be impacted—and in many cases, already have. Understanding what’s in store in the near future can help global organizations ensure their systems are prepared to handle the inevitable indirect tax changes.
How Governments Are Reacting to COVID-19
With market demand sagging as a result of lockdowns and high unemployment, and businesses across countless industries affected, government economic policy is going through a series of cumulative phases, which are common worldwide:
- Maintain market liquidity and income to ensure markets keep functioning and basic needs are met. In many countries, this phase has focused on providing direct income support.
- Maintain solvency to prevent otherwise healthy businesses from going under, focusing on mid-term survival.
- Maintain rebound capacity to ensure businesses and consumers can engage in the post-crisis recovery. In this phase, the emphasis is on making sure businesses have sufficient staying power to participate in the pandemic recovery and consumers have the income to support those businesses through demand for their products and services.
- Repair government budgets in the aftermath of the pandemic, whether through spending cuts, revenue increases, or a combination of both.
In the initial phases, where market liquidity and solvency are the chief goals, many governments have reacted by providing financial support to businesses and consumers alike, aiming to shore up demand. In other cases, government entities have sought to make market supply cheaper by reducing consumption taxes, such as general sales tax (GST), value add tax (VAT) and equivalent taxes.
For instance, countries like Germany, Ireland, and Kenya have temporarily reduced their VAT rates to encourage consumer demand. Some VAT rate cuts are specific to certain economic activity, such as housing and real estate transactions (in Hungary), food (in Croatia), and tourism (in Costa Rica and Egypt). Other countries have delayed their planned indirect tax rate hikes (as in Singapore and Thailand).
Additionally, many countries are allowing businesses to file their indirect taxes late, delay payment or defer collection of those taxes, or incur lower penalties for late filings or late payments. Likewise, many countries that planned to introduce new tax-related compliance measures have postponed them to avoid increasing the compliance burden on businesses at a time when they’re struggling to maintain solvency and move toward recovery.
It’s not surprising that indirect taxes are playing such a prominent role in many government policies enacted during the early phases of pandemic relief. As these taxes have the most immediate impact on economic activity, and the compliance and collection tasks fall squarely on businesses (not government), it’s an easy target for government entities that are reluctant to make widespread changes to their own processes.
Few countries have progressed yet to phase 4, in which governments begin to repair their budgets to recover from the impacts of the first three phases. Saudi Arabia appears to be a lone exception, raising its general VAT rate from 5% to 15% as of July 1, 2020. Given that the country has been uniquely hit by the slump in global oil prices—driving down revenue since the beginning of the pandemic—it puts into context why Saudi Arabia has already made this move.
The Budget Impact
Given the scope and scale of the interventions that government entities have engaged in, it’s not surprising that their budgets have been hit hard by the pandemic. In the US, COVID-19 relief has pushed the deficit to a record $3.1 trillion (that’s 12 zeroes), or 15% of gross domestic product (GDP). Across Europe, the budget deficit is expected to increase more than tenfold—from 0.6% of GDP in 2019 to 8.5% in 2020. It’s a perfect storm of fast-shrinking tax revenue and significantly rising spending.
The only positive in this otherwise-gloomy forecast is the fact that interest rates are at historical lows, so the interest costs associated with expensive pandemic relief efforts won’t add materially to deficits. However, given that the funds are being spent on consumptive goals, government debt will have to be paid back at some point.
While the expected post-pandemic economic rebound will drive increases in tax revenues and collections, if the level of economic activity remains below pre-pandemic levels it would be unrealistic to expect to simply grow out of these rising deficits. Realistically, it would take economic activity consistently above pre-pandemic levels to provide enough capacity to reduce these mounting deficits simply through growth.
Instead, once governments are eventually in budget-repair mode, they will need to cut spending and/or raise taxes. However, if we’ve learned anything from the 2008 banking crisis it’s that spending cuts aren’t likely to be the main method of choice, leaving tax increases as the only alternative.
Businesses and consumers should expect more tax increases across the board in many countries, including changes in indirect taxes—whether future rate increases and/or increases in the base. Across the OECD (Organisation for Economic Co-operation and Development) countries, on average 27% of tax revenue (excluding social security contributions) comes from indirect taxes like VAT and GST, vs. 32% from individual income tax. As governments attempt to shelter their constituencies from these tax hikes to the degree possible, the pressure will likely be on foreign taxpayers. As a result, businesses should prepare for a renewed push for digital services taxes, already implemented in many countries—whether by increasing the indirect tax base through inclusion of foreign digital services providers, instituting a separate tax (such as DST in the UK), or both.
Automating the Inevitable Indirect Tax Changes
Staying up to date with indirect tax changes is vital to remaining compliant and benefitting from reduced rates and/or transitional tax regimes. The more indirect tax rates and the related collection and payment policies change, the more important it becomes to automate that change for several critical reasons: to improve accuracy, reduce the time spent managing these taxes, and avoid penalties associated with collecting and paying insufficient taxes.
In addition to any indirect tax changes already implemented, it is prudent to expect even more changes as global economies move into the post-pandemic recovery phase. Governments will face the daunting challenge of repairing their budgets after incurring sizable spending increases due to COVID-19 relief efforts, making indirect taxes a likely target for revenue generation.
For multi-national companies, the right automation solution can significantly reduce the time and other resources required to manage changes in indirect tax rates, deadlines, and other policies, which will vary significantly across countries. For instance, a solution that integrates the relevant tax rate databases can simplify management of any associated changes, reducing errors and streamlining invoice processing. This goes beyond simply applying the new rate(s); transitional rules and rate changes aimed at specific categories of transactions require more sophisticated automation.
If your business operates globally and engages in intercompany billing and invoicing, call on the specialists at FourQ to help streamline and simplify your processes, especially during this time of inevitable change. FourQ software is automatically updated with the latest tax changes, ensuring the most current tax rates and qualifications, and incorporates sophisticated logic that enables organizations to benefit from temporary tax rate reductions.