Sampling involves selecting a portion of the total population of available data, particularly when evaluating the entire population would be too costly or time-consuming. To ensure effective sampling, it is crucial that the selected sample is representative of the larger population and collected randomly. A random sample guarantees that each individual element has an equal chance of being included.
While direct tax rates are decreasing globally, rates for indirect tax continue to rise. For the average multinational company, this means managing over five billion euros in indirect tax transactions. A seemingly small error of just one percent can dramatically impact profitability, posing a significant risk during due diligence investigations in the event of an acquisition.
The Big Four audit firms report in their indirect tax surveys that the risks of additional tax assessments, substantial penalties, and reputational damage are increasing, particularly as the amounts of indirect tax keep rising and KPIs and controls for indirect tax remain inadequate. Significant sums of money are at stake without appropriate oversight.
Moreover, the internal indirect tax function within companies, if it exists, is often understaffed and frequently lacks the budget necessary to effectively manage the global indirect tax position.
A due diligence investigation aims to identify material risks and emphasizes the importance of quantifying those risks.
A traditional due diligence investigation typically involves the completion of standardized questionnaires and the collection of standard information provided by the vendor through a specially designed data room. When discrepancies in VAT determination are identified, a rough estimation of the associated VAT risks is made based on turnover and sales figures.
This approach is not ideal for either the vendor or the purchaser, as it relies heavily on guesswork and generally provides an inadequate foundation for price negotiations.
The key question is whether there is a more efficient and effective method for accurately determining potential additional tax assessments.
It is essential to begin with the identification and recognition of material indirect tax risks. Each industry presents its own unique set of risks, and further differentiation is required due to the complexity of the business models in place and the specific indirect tax risks that may arise from them.
Broadly speaking, the largest VAT risks can be categorized into the following areas:
- Cross-Border Transactions: Ensuring the legitimate application of the 0% VAT rate.
- Intercompany Transactions: Correctly determining VAT application within the transaction chain.
- Input VAT: Validating justified input VAT deductions.
By addressing these specific areas, the due diligence process can provide a more accurate understanding of VAT risk exposure, facilitating better-informed negotiations and decision-making.
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Sampling |
Sampling is the process of taking only a proportion of the total population of available data, when measuring the entire population would either be too expensive or take too much time. |
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To ensure that sampling is done correctly, the sample must be representative of the larger population and be taken randomly. |
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A random sample ensures that any one sample has an equal likelihood of being taken. |
To quickly assess the level of tax risks—including the potential amount of tax assessment—statistical sampling can be employed. By selecting a representative sample of data (in monetary terms), one can reliably determine the composition of tax items. Through the identification of errors within the sample, it becomes possible to calculate the exact amount of additional tax assessments.
The strength of this approach lies in its alignment with the tax audit methods used by the Dutch Tax Authorities. The calculations are based on the specific parameters that the Tax Authorities apply during their audits, and this method has been explicitly endorsed by the highest Dutch court.
Implementing statistical sampling necessitates a different approach and process for information retrieval compared to traditional methods. Practically, this involves the following steps:
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Roadmap sampling |
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Defining the scope (see aforementioned main VAT risks); |
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Defining the required data from the systems; |
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Defining the sample size based on parameters of the Tax Authorities; |
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Obtaining the data file provided by the vendor because of instructions; |
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Drawing the sample; |
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Obtaining the selected (physical) invoices, claims, documentary evidence or other documents provided by the vendor because of instructions; |
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Fiscal assessment of the tax items; |
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Calculating the amount of potential additional tax assessment based on detected errors. |
Defining the scope and designing an appropriate sample requires a multidisciplinary approach that combines expertise in both indirect tax and statistical sampling techniques.
Sampling is not only pertinent for the due diligence of the purchaser; the selling party can also benefit from it during the preparatory phase for a potential takeover. When a statistical sample is drawn and yields satisfactory results, these conclusions can be proactively included in a data room, serving as robust evidence of the implementation and maintenance of an effective control framework.
Furthermore, in the Netherlands, there is an opportunity to align findings with the Tax Authorities, which can provide greater certainty regarding the adopted tax position. This alignment can positively influence sales negotiations, particularly in terms of the guarantees and/or discounts that may need to be offered.
A strong start can significantly reduce future costs and enhance the overall transaction process.
