Why a Tax Engine May Be the Right Solution for Your Business
The right tax engine can provide a relatively simple way to streamline indirect tax calculation and drive more accurate tax compliance globally without worrying about never-ending maintenance and long implementation times.
- Applying complex and constantly changing indirect tax rules in multiple jurisdictions – and in real-time – requires automation.
- Many companies use their ERP system to automate VAT. However, this has limitations and puts much of the burden on internal teams to configure the VAT automation, monitor changes in the law and promptly modify the automation settings to take these changes into account. Something that is often hard to achieve in practice.
- A dedicated tax engine can be a great alternative to add flexibility, efficiency and get to a more robust end-to-end tax process
Why automate indirect tax determination?
Businesses operating globally are faced with complex indirect tax rules that are subject to constant change, making indirect tax management difficult. Applying the correct tax calculation and determining the correct tax rate depends on ever-changing variables, including customer location, whether the customer is a business and/or a final consumer, the type of product/service sold, and whether the seller has surpassed local revenue thresholds that make it liable to charge local indirect tax. These rules need to be applied in real-time, making automation essential.
But how should you automate? There is no one answer for all businesses. However, the increasingly complex tax landscape, including new obligations on non-resident e-commerce businesses, have made dedicated tax engines an attractive option.
What is a tax engine?
A tax engine is a software tool that collects and processes transactional data to assign a tax treatment to a given transaction and determine tax liability. This tax software is commonly relied upon to calculate transactional taxes such as Value Added Tax (VAT), Goods and Services Tax (GST), sales and use tax, as well as other tax types. Today, tax engines are typically cloud-based solutions that maintain local tax rules and tax rates applicable in a particular jurisdiction and provide output that is used for tax compliance software to file tax returns.
Until recently, most of these software solutions focused on servicing use cases in the United States, since the complexity of determining the correct sales tax rates in the US Sales tax system is vast. However, the rapid internationalisation of (digital and SaaS) businesses expanded the need for tax engines globally much beyond sales tax automation and US exemption certificate management.
The transactional data required to make a tax calculation includes elements like taxpayer VAT/GST registration status and location, as well as taxability drivers (e.g. type of goods or services, ship from and ship to, net amount, etc.). The source of information varies and depends company to company. In some cases, the user’s ERP or billing system is the core source. Other times, it is a homegrown transactional system or a variety of different systems together, all containing pieces of the puzzle. The tax engine itself acts as the received of transactional information, but often does not store it or houses data.
The tax treatment is the output of the tax engine and normally includes the tax rate, tax amount, and the country in which the tax applies. The tax treatment can then be sent back to the user, where it gets posted on the line-item data of that specific transaction in the system of record.
Tax determination software should always be up to date with the most recent changes in tax legislation (tax rules and tax rates) in order to produce the correct result. This is why transparency on its content (rules, rates, logic) and flexibility to adjust content fast are crucial, but unfortunately not always a given. This is something to be aware of and investigate before choosing any third-party solution.
Why don’t I just use my ERP?
Many ERPs come with limited tax automation capabilities that must be configured by tax professionals together with technical professionals from scratch. While these capabilities can often be expanded using ERP add-on tools, there are still many limitations. Automating using these solutions therefore comes with significant downsides. These downsides rarely make ERP automation a good option for most businesses, especially those that are expanding or that have complex operations. There is no shame in this, nor does it have anything to do with the quality or value add of the ERP system. It is just that by their nature ERP systems are not made for these tax task specifically, but rather focus on other core processes of the business operations.
Here are some downsides of using your ERP for tax automation:
- The initial set-up of tax automation can be highly complex and resource-intensive. All transaction types must be mapped, the drivers must be determined, the VAT/GST treatment must be analyzed, and an extensive process by ERP experts must be completed to build the automation. This process must be repeated when new countries or business activities are added. This makes it quite static, and not very agile to adjust to changes, let alone fast.
- The setup-up is only the first step - tax determination through tax logic and rules needs to be maintained, normally by internal teams. Tracking changes to tax laws internally requires significant tax resources and often additional high consulting fees. This is increasingly the case given the wave of new tax obligations on non-resident businesses in many jurisdictions.
- In addition, hard-to-find IT or engineering resources are required for both the initial setup and any future modifications, putting the company at the mercy of the engineering/IT roadmap. The reality is, often times these teams have overly full roadmaps with to do’s for actual business related activities already and getting these resources is a struggle for the tax function.
- 93% of large companies use multiple ERP systems for tax requirements. This situation is also common in medium-size businesses. The VAT/GST automation setup and maintenance would need to be done for each ERP system. This does not only has as cost and pricing impact, it is inefficient and leads to tax and finance teams continuously struggle to track and trace the relevant tax date.
Benefits of a tax engine
Relying on a third-party tax engine has numerous benefits:
- Effortlessly access data across all ERPs: Although still a rarity, some dedicated tax engines use a simple API connection to easily use data from all relevant sources and systems. Native ERP tax automation requires implementation and maintenance of tax rules in each system, multiplying the workload on internal teams on implementation and maintenance.
- Faster and simpler integration: Tax engines, specifically those that use an API connection, don’t need to integrate into the ERP. The tax engine needs to be provided with the information needed for tax determination, and that’s it. The API connection often takes as little as a few weeks to set up. Compared to 12 months or more standards for ERP system tax configurations.
- Lighter maintenance: Tax engine providers often have in-house research teams tracking changes in all jurisdictions covered (e.g. tax rates, place of taxation rules, exemptions, etc.), and work to update the tax engine to ensure accurate tax calculation. Alternatively, the transparency and flexibility offered by the tax engine provides functionality to change content simply. As tax law changes, making sure that your tax treatment remains compliant is crucial. Maintenance for an ERP-based automation falls completely on internal teams and specialised service providers. Unlike with dedicated tax software, specific tax or logic changes in the ERP based systems are often implemented after the fact and too late, because of the complexity that comes with changing these types of setups.
- Simple scaling: New countries and business lines can be added without any additional tax or even IT resources, as the tax engine provider would have already performed the necessary research and built the logic in the engine, or better yet provides the ability to change logic according to your needs in a simple way.
- Understanding indirect tax treatment: A tax engine automatically provides an output that explains why a particular tax calculation was determined, whereas finding this information in an ERP-based automation solution can be quite complex.
- Easier indirect tax compliance: The transactional reports produced by ERP systems are often fragmented or incomplete. It requires significant manual adjustments before they can be used for tax reporting, making getting it right the first time and achieving tax compliance more complicated. For example, transactions are often not configured to the right tax codes, and tax codes often do not correspond with the relevant jurisdiction’s tax return. A good tax engine can produce an easy to understand reports than can be easily used for indirect tax compliance purposes.
I’ve decided to go with a tax engine. Which one should I choose?
There are multiple factors that go into selecting the right indirect tax engine for your business. The best engines have the following qualities:
- Flexibility: Tax engines have historically been less flexible than ERP-based solutions. However, a tax engine doesn’t have to mean no flexibility at all. A good engine will have the means to make considerable adjustments tailored to your business needs and your interpretation of the tax rules.
- Ease of integration: One big plus of a tax engine is how easy it can be to integrate. How easy? A lot of that depends on your tax engine provider and the resources they are willing to expend to guide you through the process. But even an “easy” process can become difficult if you’re left alone to do it.
- Coverage: Your tax engine should be able to support you seamlessly as your business grows. That’s why picking an engine with coverage in only a few markets can be risky. Proper coverage can also include additional functionalities that enable global scaling, such as currency conversion (as in, allowing tax to be calculated in local currency). You want to be aware that many providers offer a tax engine under one brand, but in reality offer different software, modules, or APIs for different parts of the world. Getting a truly global solution is worthwhile.
How Fonoa can help
Fonoa offers an easy-to-use tax engine that covers VAT, GST, and sales taxes in over 130 countries via one API connection. Our top notch customer support means we have the fastest implementation time on the market, and our out-of-the-box indirect tax determination logic means you can start using our tax solution right away – wherever you do business.
Get in touch to automate all things indirect tax.