Handling Errors, Adjustments, and Voluntary Disclosures

The central theme of this series of articles is to help key stakeholders build an indirect tax control framework that ensures consistent, accurate, and compliant handling of all indirect tax matters across business operations. This is achieved through risk management, effective governance, and integration of technology. However, even the most robust control framework cannot eliminate errors. 

As businesses expand their operations into new jurisdictions, the risk of error increases. Once discovered, errors must not only be corrected but also should serve as triggers for broader control enhancements. With that perspective, the way a business handles errors, assesses their impact, makes adjustments, and, where applicable, interacts with Tax Authorities through voluntary disclosures becomes a core component of a mature indirect tax control framework.

Identifying and Classifying Errors

The building block of any effective error management is the ability to identify where errors can occur and categorise them in a way that supports meaningful decision-making. In the indirect tax workflow, errors can occur at several points, from initial data entry to final reporting. 

Some of the most notable points where errors occur are during transaction recording, due to incorrect master data such as wrong tax codes, misclassified suppliers, or inaccurate location information. Also, issues may arise in how data is mapped or processed in accounting systems, such as ERP systems or specialized tax software. In the final stage, mistakes occur during reporting or filing, when the tax information is submitted to the authorities.

For example, an incorrect VAT rate is applied to the transaction. Erroneous data is communicated from the moment the transaction is completed until the VAT return is submitted to the Tax Authority. Other examples include omitted transactions or misclassification of input tax. 

Nevertheless, even when the error arises from a failure in records rather than from tax return preparation, the business must amend its internal records and account for the correct position in the submission. As the UK's HMRC stated in its guidelines, errors must be corrected as soon as they are detected.

However, detecting or identifying errors is only part of the error management process. The second, equally important part, is the classification of errors. One way to classify them is based on their significance. Therefore, errors may be classified as immaterial or material errors. Immaterial errors are minor, rare, and have little impact. In contrast, material errors are serious and may point to underlying issues. 

Additionally, errors may be classified as those that can be corrected within the regular reporting cycle versus those that require a stand-alone adjustment or disclosure. Depending on the classification, key stakeholders may make better decisions about how to allocate resources and respond to errors. 

Assessing Impact and Deciding on Adjustments

After the error has been identified and classified, the next step is to assess the impact and decide on the most appropriate course of action. The assessment should be done with several factors in mind, including the scale and nature of the error, its cause, and external factors.

The scale of the error should provide data on the value, percentage of turnover, and number of periods affected by the error. The nature of the error provides insights into whether the error concerns input or output tax, whether the transaction is domestic or cross-border, the applicable VAT rate, and similar. Regarding the cause of the error, it may be an isolated human error or a systematic fault. External factors typically provide data on whether Tax Authorities have visibility into the error, whether the return period is still open for amendment, and potential penalty exposure.

The impact assessment is crucial as it helps businesses understand the required actions once the error is detected. Depending on the national rules, some errors above a defined threshold, or those representing a certain percentage of turnover, must be reported separately rather than simply corrected in the next return. Conversely, for other errors, they can be corrected internally through an adjustment within the next reporting cycle.

Notably, the path for making decisions on errors should be codified in the indirect tax control framework. It should include limits on action, specifying when issues need to be escalated, requiring documentation and approval from the responsible business owner, consulting a tax advisor when necessary, and reporting essential matters to senior management or the board.

Managing Voluntary Disclosures and Communication with Tax Authorities

While in some cases businesses can make minor adjustments to their reports, or in more extreme cases need to report more serious errors separately, there are instances where corrections alone are insufficient. In such cases, businesses should consider a Voluntary Disclosure Agreement (VDA). 

The VDA is regarded as proactive communication by the taxable persons that there was an error or omission in previously submitted returns or tax periods, which is reported to the Tax Authority in advance of an audit or discovery. There are several key benefits of coming forward and admitting mistakes, including reduced penalties, limited look-back periods, more favourable payment terms for disclosed VAT non-compliance, demonstrating cooperative behaviour, and mitigating reputational risk.

Several key components of the VDA should be integrated in any indirect tax control framework, including establishing an internal protocol for deciding when a disclosure is necessary, also known as the escalation criteria, preparing the VDA submission, which must include all relevant and required data, assessing interest and penalty exposure, obtaining appropriate internal sign-off, and communication with external advisors, if necessary, and, ultimately, Tax Authority. 

Regarding the communication with the Tax Authority, it should not be treated as simply transactional. When the VDA protocol is initiated, communication with the Tax Authority should be direct and transparent, as it enhances the credibility of taxable persons and may result in reduced penalties. In fact, the Irish Tax and Customs published the Code of Practice for Revenue Compliance Interventions, which underlines that early discovery of errors, combined with full cooperation, is the best protection against higher penalties.

Learning from Mistakes: Feedback into the Framework

Even though errors sound like bad things, they are not just something to be fixed and can have a more profound impact when building an efficient indirect tax control framework. Data on error occurrences and the results of adjustments or disclosures, when used and interpreted correctly and embedded in the feedback loop, may strengthen the tax control system.

The best way to see errors is as symptoms of deeper control or process weaknesses. Thus, the responsible approach is not just to report and fix them but also to investigate root causes, quantify the impact, and implement corrective measures to prevent recurrence. 

Data that should be put in the feedback loop is the number of errors identified, the number of adjustments made, the number of VDAs submitted, the value of tax adjustments, the amount of penalties or interest paid, the time to detect and resolve errors, and trends over time. This data, or metrics, informs key stakeholders of the effectiveness of the indirect tax control framework and contributes to further improving and updating the system.

Conclusion

Errors, adjustments, and VDAs are central to the integrity and credibility of the indirect tax control framework. Accepting errors as a regular part of business is perfectly fine. Even the Irish Tax and Customs stated that “even the most compliant taxpayers can make errors in filing tax returns and paying the correct amount due”. However, neglecting them, not having an action plan, and not using errors as feedback on the effectiveness of the indirect tax control framework is a whole other thing. 

Therefore, businesses should deliberately embed procedures for identifying and classifying errors, assessing their impact, deciding on adjustments or disclosures, appropriately engaging with Tax Authorities, and feeding the lessons learned back into the framework to ensure compliance and continuous improvement.

Source: UK Government, VATabout - The Role of Voluntary Disclosure Agreement (VDA) in VAT Compliance, VATabout - Backdated VAT Registration: Causes, Consequences, and Compliance Tips, Isle of Man Government, Irish Tax and Customs