GST: What’s your ratio?

September 2016

by Tim Simpson

At this week’s Malaysian Institute of Accountants GST Conference the Royal Malaysian Customs Department’s (“RMCD”) Director General – Dato’ Sri Khazali Ahmad announced that the RMCD intends to audit 50,000 companies for GST compliance between 1 September and the end of this year as phase one of the Customs Blue Ocean Strategy Operation (Ops CBOS).

While the first 50,000 companies for Ops CBOS will be randomly selected, we would expect that, moving forwards the RMCD would begin to take a more intelligence based approach to GST audits. Rather than selecting companies at random, audits will be targeted on those companies that show evidence of being non-compliant. In the absence of overt evidence such as reports of fraud or corruption, the RMCD would start with their only regular form of interaction with the taxpayer. The GST return.

What would the RMCD look for in a GST Return?

In GST Pulse Issue 7 we looked at how trends in your GST returns could lead to red flags with the RMCD. However trends will be apparent in more than just the data submitted to the RMCD. The relative values of one data field when compared with another could also how up potential errors or areas of non-compliance. Simple ratio analysis of your GST return would greatly assist the RMCD in determining whether or not your business would be worth visiting for an audit.

A basic example would be a trading business. It buys and it sells. It would be expected that the ratio of its acquisitions to sales would be relatively consistent. Therefore, it would be expected that the ratio of its input tax claimed to output tax declared would also be within a specified range.

Consider the table below showing the output tax and input tax declared by ABC Trading Sdn Bhd:

ABC Trading has an average input / output tax ratio of 0.47. That is, for every RM1 in output tax it declares, it claims 47 sen in input tax credit. When analysing the GST return history of ABC Trading, the first thing a RMCD officer should do would be to ask, is this reasonable? Assuming the company is a fully taxable supplier and acquires all of its inputs from GST registered suppliers, it would be expected that this ratio would be a close approximation of cost of goods sold / sales turnover. Is it?  A quick check of the ABC Trading annual accounts would tell.

Having established whether the annual ratio for a company is reasonable, the next step would be to look at the monthly variance from the annual figure and establish a tolerance level. In the example above the variance has been configured with a tolerance level of ±10%. This is, any month with a ratio within 10% of the annual figure would be acceptable.

Exceptions are noted in the months of May and June when the variance in the ratio falls outside the tolerance level. In May the input tax is significantly higher in comparison to the output tax declared. Does this mean there is an error? Or can it be explained? Perhaps ABC Trading acquired a capital asset in May which resulted in an increase in the input tax credit claimed for that month. This could be verified by checking if any capital asset acquisitions have been declared on the GST return for the month. If so, removing the input tax credit in respect of the capital asset should bring the ratio back within tolerance.

However in this example, the significantly high ratio of 0.55 in May is followed by a significant low of 0.40 in June. So perhaps ABC Trading acquired a significant amount of trading stock in May, which was not sold until June. This could also explain why the acquisitions for June are lower.

While the example of ABC Trading Sdn Bhd is a simple model, the principles can be expanded across any business. Certain businesses may require additional data manipulation, for example a mixed supplier would need to consider fluctuations in his residual input tax recovery formula in computing the above ratio.

This is also by no means the only ratio that can be computed based on the return. The more fields a company fills up, the more data a RMCD audit officer has to review. For example if ABC Trading was also involved in export, there could be an expectation that the ratio of exports declared against total supplies made would be relatively consistent. For a mixed supplier (providing taxable and exempt supplies), there should be a correlation between the ratio of exempt supplies to taxable supplies and the amount of input tax credit claimed.

In the trending article we considered how the RMCD could compare the trends of a specific business to a set of ‘industry standards’ gathered from all of the returns submitted. This is equally true for GST ratios. The RMCD will be collating the key ratios for all businesses and coming up with a set of standard benchmarks and variances it will accept depending on the industry and the relative size of the business. If your ratios fall outside the expected industry range, it is likely that you will receive a visit from the RMCD.

So what can businesses do?

Like trending, ratio analysis is a powerful tool for businesses in preventing the unwanted attention of the RMCD audit team. You should know your key ratios and review them on a monthly basis as part of your GST return strategy. Variances could lead you to detect errors, such as under or over declarations in the return. If there is a significant variance and you can explain it, you should note it in your GST return file for the month. Then if the RMCD do come to audit, you will be prepared to answer their queries.

Want to learn more about ratios or the GST Audit process? Please call us for a chat.

Tim Simpson is a Managing Consultant, Indirect Tax Advisory Group at PwC Malaysia.