This blog was last updated on October 6, 2021

Corporations in a wide variety of sectors are rapidly transforming their supply chains.

The core goals of supply chain globalisation and automation are operational and to achieve financial benefits. However, many companies overlook the impact of indirect taxes – like value added taxes (VAT) – that are assessed by the countries in which they operate.

Companies must consider the impact of VAT compliance as part of their supply chain strategy from the start, with a proactive global approach, to minimise risks and disruption to their business.

Cash flow is where companies feel the most immediate impact of VAT, since they have to collect and remit VAT receipts to tax authorities in each country in which they operate.

Paying VAT obligations up front

Companies are required to pay VAT obligations up front, whether or not they have collected the payment from the sale or receipts against the invoice amount. In some cases, governments are even moving to real-time payments, or split payments, where money owed to the tax authority goes straight into a government account while the rest goes to the supplier.

While VAT will ultimately be recovered, this process can put some companies in a bind, requiring them to redirect operating capital to make VAT payments or leverage another source of funding to cover the outgoing cash flow in the near term. This is especially true in countries like Italy which have extensive VAT regulations and tax authorities may take up to two years to refund companies, holding up cash flow during that period.

What is the impact of VAT compliance on cash flow?

To avoid issues, companies must retain accurate, audit-proof records to support their VAT deductions, or risk what’s supposed to be a neutral net result becoming a hard cost. They should also consider specific bank accounts to track transactions with tax authorities so that tax owed to the government isn’t used in other transactions, and for greater visibility into cash flow to and from the government.

Consequences of noncompliance

For businesses operating in Europe, the cost of noncompliance or errors with VAT can take a significant toll on supply chains. Consequences can include:

• Depending on the issue, businesses could have their VAT refunds delayed, tying up significant sums of money that could instead be put toward paying suppliers or investing in innovations.
• Errors can also result in penalties or fines of up to 200% of VAT owed, directly impacting the bottom line and transforming VAT from a neutral to a hard cost.
• Goods may be withheld in customs if VAT hasn’t been applied correctly, disrupting supply chains, operations and speed to market.
• In certain countries and in extreme cases, or after multiple violations, businesses could even experience complete government-mandated shutdowns.

All these risks put supplier relationships and supply chain stability on the line, which is why VAT must be a critical factor in supply chain planning.

The definitive VAT system

The EU is planning to move toward a destination principle such that intra EU deliveries will no longer be two transactions (dispatch and acquisition) but one – an intra Union delivery on which VAT is due in the Member State of arrival and reported on a single VAT return covering all Member States.

This should remove the need to prove an exemption and will simplify reporting. Details of this plan including entry into force are not yet available. There will, undoubtedly, be conditions to fulfil.