34 !

into IT

Auditing e-taxationThe rise of e-commerce

poses new questions for
taxation policy and adminis-
tration. E-commerce makes it
easier for business to be
conducted without creating
the "permanent establish-
ment" that would otherwise
subject a seller to tax on
income. It blurs the distinc-
tions between the sale of
goods, the provision of
services and the licensing of
intangible assets, each of
which is subject to some
form of taxation.

Rapid developments in
information technology have
not only had an impact on
assessing tax liability and
collecting revenue, but on the
State's ability to identify the
growing number of taxable
transactions that take place in
cyberspace.

Mukesh Arya considers these

problems and suggests some
general requirement for
auditing e-Taxation.

Issues and Challenges
Introduction
Information technology (IT) now
pervades our lives. Everyone, including
the tax authorities is trying to cope, and
the tax auditor cannot be excluded.
Globalisation has enabled large multi-
national corporations to grow faster
than some nations in terms of gross
domestic product. By using their large
information bases international media
conglomerates are able to shape world
opinion on most subjects. With
workforces that can exceed some
nations' populations, international
business is able to impose a significant
influence on international trade and
commerce, mostly to enhance profits.
Consequently their powers to employ
innovative tax saving devices cause the
State to lose revenue. IT has
exacerbated this by placing international
business in a better position to
manipulate their accounts worldwide,
and to wield greater negotiating power
with the State on the taxability of their
transactions. But a state's rights to
impose taxation must be protected if it
is to survive.
Understanding e-taxation
E-governance essentially means the
electronic delivery of government
services. In the context of taxation this
translates into:
! on-line filing and assessment of tax
returns;
! electronic funds transfer to enable
taxes to be paid and refunds to be
issued across the Internet;
! different government departments
sharing information on tax
assessments to support compre-
hensive policy decision making;
Web-based information portals for
!
use in educating taxpayers and
researchers on taxation issues, and
publishing information.
The overall aim e-taxation is to replace
cumbersome manual, bureaucratic
service systems with collaborative,
efficient, process-driven and secure on-
line delivery.
The tax auditors' traditional skills in
conducting Value for Money and
systems based auditing will need to be
reoriented as e-taxation is introduced.
The pre-requisites for effective tax audit
are appropriate audit methods, software
and training. Other major issues to
overcome are access to computerised
databases, digital documents and
evidence, and the auditor's ability to
understand e-taxation systems.
Measures induced by the
need to interface with the
global impact of it (non-
controllable)
Traditionally nations tax the economic
activities carried on within their jurisdic-
tions. These can be broadly categorised
as taxes on production, trade,
consumption, income and import-
export. Even though laws, rules and
regulations have been built around each
nation's unique needs, levying and
collecting taxes follows more or less
identical procedures. Elaborate national
and international tax law has also
emerged from judgements. These laws
remain relevant to tangible goods, since
they can be used in conjunction with
their location of manufacture, trans-
portation, customs entry and exit, and
physical delivery.
into IT ! 35
But these distinct tax identities break
down in the case of digital products such
as software, books, music and medical
transcription services because they can
be produced anonymously, offered for
sale simultaneously anywhere within the
world, and delivered and paid for elec-
tronically. In the case of e-commerce
the concepts of permanent residence
(to determine location of manufacture),
point of sale (for the application of
relevant tax rates), income classification
(based on source of income), product
classification (for preferred tax rates),
etc. become difficult to apply. Within
borderless cyberspace, web-enabled
commerce effectively obliterates any
footprints leading to the buyers' and
sellers' locations. Governments are
distinct tax identities
break down in the case
of digital products such
as software, books,
music and medical tran-
scription services
because they can be
produced anonymously,
offered for sale simulta-
neously anywhere
within the world, and
delivered and paid for
electronically
36 ! into IT
Governments are already
losing millions in tax
revenue through the
penetration of e-commerce
within their jurisdictions,
and their tax authorities
are finding it increasingly
difficult to stem this
haemorrhage
already losing millions in tax revenue
through the penetration of e-commerce
within their jurisdictions, and their tax
authorities are finding it increasingly
difficult to stem this haemorrhage.
Supreme Audit Institutions (SAIs) are at
a loss to understand the evolving
situation and find it extremely difficult to
quantify this revenue loss or make
effective recommendations.
Cross Border Transactions
The international community of traders
and manufacturers has grown significant-
ly in the Information Age. Double
taxation avoidance agreements between
countries often create tax havens that
erode their national taxation base. In the
case of e-commerce these loopholes are
difficult to plug quickly, and may become
impossible to control without verifiable
evidence, which in cyberspace is difficult
to obtain. E-taxation therefore needs to
address the electronic content of cross
border finance, e-services and the sale
of products, and the State may need to
find new sources of Information Age
revenue. The canons of sound taxation
that recognise simplicity, equity and
efficiency are more relevant to the
digital environment because a
complicated taxation system can lead to
complex technological problems in tax
collection.
International corporations could indulge To enable a meaningful analysis to be
in harmful tax evasion schemes whereby made, a reliable structured information
financial transactions might be shown to base covering all enterprises subject to
originate in other jurisdictions. Such
organisations are well represented in the
tax becomes a necessity for both the tax
authority and the tax auditor, and efforts
corridors of powers where they attempt
to extract tax concessions from the
may need to be directed within the
revenue department at creating it. E-
State or have loopholes incorporated in
tax legislation. SAIs are often confronted
governance presupposes the possession
of a reliable information base on
with these knotty issues when auditing taxpayers, the major constituents of the
various executive notifications that tradi- economy and the effects of tax policies.
tionally have the force of law. The absence of a strategic information
In cyberspace the situation is further
base that is capable of analysis signifi-
cantly weakens tax administration.
complicated by the very deep under-
standing required of the links between In auditing taxation SAIs are confronted
information and tax law. For instance, with non-computerized systems,
where multi-national organisations inadequate computerised databases or
operate in international markets, the an unreliable information base. There
auditor is professionally challenged first are no universal standards for evaluating
to determine the transactions that have public domain databases that could be
validly arisen in his national jurisdiction, accepted as audit evidence, and using
conduct a risk analysis, determine the such databases for drawing conclusions
audit sample of data to be collected on or for making audit recommendations is
cross-border transactions, and then fraught with risk.
devote due attention to its analysis. SAIs
may experience practical difficulties in
undertaking these types of audits unless
e-taxation projects address the auditor's
requirements.
Intra-border transactions The traditional brick and
In addition to cross-border transactions mortar structures that
impacting on the State's ability to levy
and collect taxes, there are larger issues
were necessary for
for nations with strong federal and
provincial political structures where the
dealers to register under
powers to levy and collect taxes are sales tax laws are
distributed. The advent of e-commerce
has already weakened this delicate gradually disappearing into
balance of power, with tax evasion
becoming a rule rather than exception. cyberspace and it is
Indian provinces, for example, depend
largely on taxing sales and inter-state
becoming more difficult for
transactions. The traditional brick and
mortar structures that were necessary
the tax authorities to
for dealers to register under sales tax identify the legal 'person'
laws are gradually disappearing into
cyberspace and it is becoming more for tax compliance
difficult for the tax authorities to identify
the legal 'person' for tax compliance purposes
purposes, particularly as traders and
consumers can assume multiple virtual
identities.

Measures initiated by tax
executives with the desire
to leverage information
technology (controllable)
Most nations have sought to intensify
their exploitation of IT, and with the
launch of their e-governance initiatives
the concept of public accountability has
also assumed a digital identity. Because
taxation is the most visible area of
governance for the citizen, it is no
wonder that tax executives find
leveraging IT through e-taxation projects
irresistible! It is imperative that SAIs
assess these changes and provide
Parliament with assurance that e-
taxation provides good value for money
(including sound information security).
However, such projects present signifi-
cantly different platforms for evaluation,
so the crucial issue is whether an SAI is
capable of undertaking an effective audit
in the context of the major e-taxation
components enumerated below.
IT investments
IT investment decisions relate to the
procurement of hardware, software and
communications networks, and are
normally synchronized to present a fairly
robust e-governance project. As with
any other procurement, IT investment
involves assessing and auditing
acquisition risks. Despite these
rudimentary requirements, studies of e-
taxation projects have shown technolo-
gies to be mismatched or badly sized,
and have revealed a lack of awareness of
IT procurement standards.
The problem seems accentuated in
countries with federal and provincial
governments each having its own e-
taxation project. It has been observed
that while federal government taxes
share a common administration
technology, provinces experiment with
their own IT solutions, a situation that
leaves public auditors confronted with
multiple information systems
implemented on different platforms.
A uniform IT audit approach to this
problem requires standard audit
software, and the gathering and analysis
of information on client systems for
input to a systematic audit planning
process. Training auditors on different
platforms requires 'technology set-up',
which may include an e-laboratory for
experimentation and the preparation of
suitable audit programmes, but most
SAIs lack the resources to undertake
development work of this scale. Public
auditors also lack sufficient time to audit
IT investments. Whereas, client staff gain
knowledge from specific IT implementa-
tions, the public auditor arrives much
later, and then for only a limited time.
Issues of public accountability for IT
investment are challenges that SAIs must
face in the e-governance age.
Information bases
Most developing countries aim to use IT
to make their tax administration more
efficient. Like India, they generally
operate with a small tax base, which
means large scale evasion by those
outside the tax net. The basic problem
in widening the tax base lies in an
inability to link to and analyse different
sets of information; a particular obstacle
is the inherent limitation in cross-linking
to relevant information in manual record
keeping systems. E-governance projects
typically address this issue through the
on-line filing of tax returns, bills of entry,
registrations, licences, etc., thus creating
a growing information base that signifi-
cantly enhances the tax administrator's
ability to widen the tax base.
Major issues for the tax auditor are to
analyse these new information
databases, link the results to other
information bases, and then draw
conclusions on which to make effective
recommendations. It is also important to
audit both the information base design
parameters and the operational
controls.
into IT ! 37
Websites
For the tax authority, a web-presence
that provides information and other
services is an important interface with
the citizen, and many tax authorities
operate such websites. The emergence
of private websites that provide
taxpayers with personalised services,
thereby plugging deficiencies in official
websites, is an interesting trend in many
developing countries. These sites
provide on-line tax forms, jurisdictional
information, tips on tax avoidance, the
services of lawyers or accountants, an e-
forum for tax policy debates, etc. They
might be regarded as an embodiment of
the failures of official websites to
provide a quality service.
For the tax authority, a
web-presence that provides
information and other
services is an important
interface with the citizen.
In their quest to analyse website design,
content and use, tax auditors are partic-
ularly intrigued by benchmarking
standards for websites and what could
be termed 'proven indicators'. While
audit observations on website
performance may need to be tempered
by acknowledged shortcomings in acces-
sibility, computer literacy and the
telecommunication infrastructure, there
remains the need for auditors to evolve
suitable assessment criteria for rating
websites.
Security issues
Citizen confidence in e-taxation is a pre-
requisite to its success. Taxpayers are
highly concerned with their tax liabilities
and will only participate in the electronic
transfer of tax remittances if they are
confident about their security. E-taxation
must therefore address the security of
online payments, web-based notification
systems and the online filing of tax
38 ! into IT
returns. Business process reengineering
by tax authorities to address security
concerns vis--vis technical and process
changes will need to be evaluated.
Tax auditors are now called upon to
assess the adequacy of security in e-
taxation projects and 'business continuity
and disaster recovery planning', 'logical
access controls', 'network auditing' and
'database management' are among their
latest responsibilities. These are
complex issues requiring in-depth
knowledge of IT. IT auditing standards
for the government sector are still to be
prepared, leaving the audit of security in
e-taxation projects to be resolved.
There is an urgent need for global
initiative to lay down standards,
structured training modules and audit
programmes.
A framework for the audit
response
Training
It is imperative that auditing skills are
sharpened to keep pace with the needs
of a constantly changing business
environment. E-taxation initiatives
demand different techniques and audit
tools that are necessarily technology-
centric. A holistic training approach
based on a skills gap analysis is therefore
an essential perquisite to equipping an
SAI to audit e-taxation and render
strategic advice to clients on managing
their IT investments.
Business process re-engineering
Introducing e-taxation obliges a tax
authority to reengineer its business
processes. SAIs also need to redesign
their audit framework in readiness for
leveraging technology to optimise the
value of their audit, but there is always a
dilemma as to whether BPR is required.
This could be determined through a
structured approach that recognises
specific environment in which the SAI is
operating.
Plan & establich the
audit capability
Plan
Implement and operate Maintain and improve
the audit plan Do the audit plan
Act
Check
Monitor and review the
audit plan
Development, maintenance and improvement cycle
Plan: establish relevant policies, objectives, targets, processes and procedures
to deliver results in accordance with statutory and other obligations.
Do: implement and operate the audit policy, processes and procedures.
Check: evaluate process performance against policies, objectives and operational
experience and report to management for review.
Act: take corrective and preventive actions based on management review
results to achieve continual process improvement.
A quality assurance framework Standard tools and techniques
International standards require the E-taxation applications implemented on
adoption of a process driven approach multi-platform IT systems are becoming
to developing, implementing and common, requiring audit attention that
improving a quality management system. often coincides with the development of
Some tax authorities have obtained ISO an audit capability. Extracting relevant
or equivalent quality management data from client servers, warehouses,
systems certification by adopting a "Plan- data-marts and complex online applica-
Do-Check-Act" (PDCA) methodology tions is essential in any e-taxation
for their business processes, principles project, involving the use of different
that apply equally to implementing e- audit tools for different platforms and of
taxation systems. a level of sophistication that is commen-
surate with the complexity of the
IT audit processes should also be
underlying database. This involves the
consistent with the international
innovative use of data-mining tools and
standards of quality for auditing. To be
CAATs, such as ACL and IDEA, which
able to evaluate the suitability, adequacy,
should be tested and benchmarked to
effectiveness and efficiency of a quality
achieve standardization and cost
management system within an e-
effective use across the audit office. The
taxation project it is necessary to build
adoption of audit frameworks such as
an IT audit capability on comparable
SEI-CMM and CoBIT may also enhance
PDCA quality lines.
capability.
 into IT ! 39

SAIs face increasing difficulty providing

IT presents a kaleidoscope
of scenarios with which one
is required to keep in
constant touch in order to
remain knowledgeable and
competitive.
A technology interface
IT presents a kaleidoscope of scenarios
with which one is required to keep in
constant touch in order to remain
knowledgeable and competitive. A
"technology watch group" may serve the
limited purpose of keeping pace with IT
developments in client organizations, but
in the longer term linking with interna-
tional organizations such as INTOSAI,
IEEE, ISO and the Software Engineering
Institute may prove fruitful.
As electronic funds transfer becomes
the typical means for remitting and
refunding tax, auditing EFT both within
and across jurisdictions will increase
audit risk. Common acceptable laws and
standards for national and international
cross-border transactions are still
evolving, and e-payments may need to
be extensively logged for audit analysis.
their legislatures with assurance that e-
taxation revenues have been properly
realised. Cross-border transactions,
trans-national corporations, double
taxation avoidance agreements, transfer
pricing, the shift to market oriented
economies, analysis of information
bases, the administrations' web-
presence and attendant security
concerns are some of the e-taxation
issues they need to address. The
solution lies in reputable standards for
assessing e-taxation initiatives and in the
appropriate training and equipping of tax
auditors to audit its roll-out and
operation.
About the author
Mukesh Arya B.Com
(Hons), LL.B., AICWA,
IAAS, CFE has served as
Principal Director
(Research, Training & IT
Audit) in the Office of the
Comptroller & Auditor
General of India. Between 1997 and
2001 Mukesh was assigned to audit
India's internal revenue department.
Since then he has been engaged in
preparing and implementing IT audit
strategies for the government sector,
including the audit of India's e-
governance projects.
Mukesh currently holds the position
of Director of the Audit & Inspection
Department of the United Nations
Relief & Works Agency (UNRWA).

Conclusion
IT is rapidly shrinking the world eco-
nomically, raising the prospects of
governments losing control of tax
collection, an ability that must be
protected if they are to survive. E-
taxation is the taxation authorities'
response to their inherent desire to
leverage technology to provide a better
standard of service delivery. Tax auditors
too are required to cope up with e-
taxation, and they must be properly
trained and equipped to audit this
emerging scenario effectively.