The shifting role of tax auditors in the digital age

Tax administrations across the globe are at various stages of digitally transforming their systems. However, while many welcome the opportunity to close troublesome tax gaps – not to mention the greater efficiency, accuracy and transparency that digitalisation offers – this disruption is not fully-embraced by everyone in the world of tax and finance. As countries move, one-by-one, from period-based VAT returns to live, or near-to-live, digital transaction reporting and invoicing, tax auditors are becoming concerned that they appear to be operating in an increasingly smaller field.

This perception needs to change – tax auditors are here to stay, and businesses should welcome that. Yes, technology will undoubtedly disrupt taxation, but even the most advanced technology can’t provide all the skills of an experienced auditor. Digitalisation is equivalent to strapping an outboard motor on to a rowing boat; it may be far more powerful, but you still need someone in charge to steer it in the right direction.

Moving to digital

The optional use of invoices in an electronic format by businesses was first introduced in the EU in 2001; an initiative followed in subsequent years by several countries including Japan, Canada and South Africa. Within years of these initial and largely cautious experiments, the practice of e-invoicing became mandatory in Latin American countries including Brazil, Chile and Mexico where the region’s tax processes underwent a significant overhaul.

In LATAM, businesses’ IT and finance functions were required to follow detailed government specifications in transforming long-held legacy practices. New, robust, end-to-end technical requirements were implemented, for example, with each invoice raised approved by the tax administration in real time, in a bid to improve efficiency and close the VAT gap quickly at reduced cost.

But, as paper increasingly began to disappear from many business processes, to be replaced by bits and bytes that couldn’t be as easily interpreted by human beings, the region’s tax authorities used the opportunity to adjust their audit approach and start using data analysing tools. European countries gradually introduced a modern audit framework, including audit tools to perform e-audits – initially within the context of onsite audits, but in recent years increasingly on the basis of transaction-level reports pushed to the tax administration. In September 2016, for example, having increased tax revenues by 34 percent with no need for a tax increase, the Mexican government introduced electronic auditing. With the documentation now available online, these “e-audits” granted the country’s tax administration total visibility into a business’ financial affairs, and gave it the ability to automatically levy penalties where necessary, without the need for intensive investigations.

Little to fear

The term e-audit is often used to refer to the use of electronic – rather than traditional manual and paper-based – tools to carry out a ‘post’, or retrospective, audit. It is more correct, however, to view e-audits as an evolutionary step from periodic to continuous tax auditing.

Several hybrid forms of e-audit and continuous controls are currently employed by tax administrations in Europe and elsewhere across the globe. Their use reduces the need for tax auditors to verify that, for example, invoice data is formally complete and computationally consistent. As more and more data gets collected closer and closer to the actual time of the transaction, tax administrations start to triangulate taxpayers’ data with that of their trading partners and other entities such as banks and logistics providers.

At first glance, this situation may suggest that the need for human tax auditors is on the decline. But for the foreseeable future, at least, highly trained tax auditors (the human factor) will actually become more important.

As it becomes easier to perform various controls on the formal aspects of invoices, it will become easier for intelligent machines to show anomalies that merit further investigation. These audits focus on what experts refer to as the material aspects of tax controls – the highly complex art of investigating whether invoices and accounts represent all genuine transactions. Indeed, by enhancing a tax administration’s ability to make risk-based decisions, the increased use of e-audit data will mean that auditors can spend less energy on the large number of bona fide companies within a country’s economy, and more on those companies and transactions whose tax reporting doesn’t add up. Some Latin American countries, as well as others including Turkey and India, have already taken significant steps to tie data from the physical and financial supply chains to such schemes.

Augmenting, not replacing

Ongoing developments and innovation mean that the number of controls in which technology plays a role – or even replaces human intervention – will certainly grow. Tax administrations, often with significant experience of data analytics tools, are already investing in AI-based tools whose decisions will allow them to carry out deeper, more granular, and more reliable audits.

But technology will never be 100% autonomous. It’s obvious that human experience, insight and expertise will always be necessary to fine-tune such solutions and – in many cases – interpret their output. Rather than replace human auditors, technology will instead augment their existing skills.

It’s unlikely – and perhaps misguided – that some countries will abolish some form of periodic tax audit, at least for the next two decades. What we will see is a development towards tax administrations turning the table on businesses by declaring the ledgers that they can build autonomously from authenticated real-time transaction data to be replace businesses’ ERP systems as the ‘source of truth’. In this new world, the role of specialists on each side will be reversed: companies will need to gather and maintain strong evidence of their transactions, including by using powerful reconciliation tools, and tax auditors will be needed to defend the government’s position.

One might argue that this logical conclusion of the trend towards varying types of continuous transaction controls puts businesses in a position where they must prove that the tax administration has made a mistake in its calculations or conclusions, rather than the other way around. This is true, but the reality of many businesses is so complex, with so many tangible angles that cannot easily be represented in transaction data, that neither side can do without trained expert auditors to build a case that is demonstrably anchored in reality in case the tax administration’s data are challenged in a court of law.

As disruptive as it appears, the rise in e-auditing won’t come as a surprise to anyone in the industry. Education programmes are in place, recruiters are using new auditor profiles, and organisations across the world are continually sharing their experiences and best practices.

The simple fact is that digital transformation is ubiquitous and unavoidable. Tax administrations across South America, the EU and beyond are increasingly moving toward continuous, real-time, digital reporting. E-audits are also being transformed, but will remain part of a new reality.

 

Christiaan van der Valk is VP of Strategy at Sovos