Governments around the globe are looking for ways to increase their tax revenues by curbing fraud and eliminating tax reporting errors. Increasingly, they are turning toward compliance measures that give them more visibility into corporate transactions. Naturally, payroll is a key source of that information. In the coming years, global payroll teams can anticipate fundamental changes in how they collect, store, and report key information.
Let us examine what’s happening in Brazil and discuss how new government compliance measures are setting the stage for emerging global payroll trends.
New Business-to-Government Requirements
The context surrounding Brazil’s business-to-government compliance environment is important.
In 2008, the country launched a massive crackdown on tax fraud. E-invoicing was mandated, inserting the government into every business-to-business transaction within its borders. Though e-invoicing is also required for public sector transactions in certain parts of Europe and is coming soon to the United States, Brazil’s requirements are much more complex and comprehensive.
It wasn’t long before the country expanded its requirements to affect shipping and logistics, inventory procedures, and fiscal reporting. Brazil’s visibility into corporate transactions is unprecedented, and its efforts are paying off. Brazil was able to increase its annual tax revenue in 2012 by $58 billion. This significant increase explains why other countries are emulating Brazil’s requirements, and why the country is examining additional ways to continue its momentum.
For enterprises, the complexities and risks associated with Brazil’s compliance requirements are immense. Errors and discrepancies in reporting trigger audits, fines, and even operational shutdowns. Some of the largest businesses in the world have realized the high costs of ineffective compliance. The Eastman Kodak Company was fined US $233 million, including interest and penalties, for infractions in Brazil. As a result, Kodak is now required to carry an escrow fund of US $16 million, an immediate hit to the company’s cash flow and profitability.
Government Visibility Extends to Payroll
Brazil’s business-to-government mandates are rapidly expanding and becoming part of a number of business processes, including sales, procurement, supply chain management, human resources, and cash flow. The latest in Brazil’s series of compliance initiatives is eSocial, which specifically targets human resource functions, most notably payroll. The mandate is designed to eliminate two primary sources of tax and social services fraud:
- Avoidance of payroll taxes through cash payments to the country’s proliferation of contract workers.
- Individuals claiming unemployment or disability benefits when they are actually working.
According to The World Bank, up to 210 million people in Latin America do not use a bank, making regulations at the enterprise level the only way to track individual cash flow.
Brazil isn’t the first country to go on the offensive when it comes to payroll. Mexico, for example, requires that all paychecks be registered with the government. Companies cannot deduct taxes until payroll has been submitted electronically to the government for approval, and all payroll deductions must then be included and validated in journal entry accounting reports. However, Brazil’s requirements go much further and are more complex than anything we’ve seen across the globe.
eSocial Launch Presents
Unprecedented Payroll Challenges
eSocial goes into full effect in Brazil for companies with revenue greater than US $20 million first, and then for all other companies. A partnership among the department of labor, social security administration, workplace safety institute, and tax authority, eSocial requires companies to electronically submit all labor and payroll events related to each individual employee or contractor. The result is up to 41 data points per employee, per month, including:
- Hiring date
- Contract details
- Contract changes
- Wages
- Benefits
- Hours
- Social security contributions
- Union dues
- Leaves
- Warnings
- Suspensions
- Accidents and injuries
- Exposure to harmful substances
- Termination
- Severance pay
Labor events—such as hiring and termination—must be submitted in near real-time and are fed into a work history database that the government maintains on each employee. Payroll events must be submitted monthly and will be validated against any labor events that occurred. By comparing the two data types—labor events and payroll—the government can easily pinpoint someone who is collecting both a paycheck and unemployment benefits. By creating work histories, it can easily identify someone who is claiming disability more frequently than the average person.
While in theory this mandate is simply centralizing information organizations already should be collecting, it presents several practical challenges for global payroll teams. According to a February 2016 PricewaterhouseCoopers report, companies are behind in addressing those challenges, with only 4% being fully prepared and 19% having conducted no initial compliance steps. Because these challenges incur both technical and process change requirements, compliance is no easy measure. For these reasons, Brazil soon will release an updated implementation schedule, which will be done gradually, according to the Brazilian Federal Accounting Council-CFC, which incorporates the Confederate Group of e-Social (GTC), along with representatives of other professional associations, ministries, and government agencies.
Three Challenges
The first challenge the mandate creates is the consolidation of information from various operational units into a centralized database. What was previously only documented in paper files housed in individual departments must now be transmitted in a single electronic file.
A second challenge is transmitting that information in the government-mandated format at the correct time. This involves customizations to centralized systems of records, making IT a central component of compliance.
The third, and most daunting, challenge is a fundamental shift in global payroll processes. Automation is a key compliance tactic to avoid the errors inherent in manual data entry. This means payroll teams need to eliminate manual processes to the highest degree possible and adopt automated transmission of data, from pay stubs to the government to accounting records.
Additionally, an expanding partnership between payroll and accounting needs to become a part of operational processes. Many companies typically report payroll at the line-of-business level in their accounting ledgers. However, as governments increasingly tie individual payroll to tax deductions, they will be validating links from accounting entries to those individual payroll files, requiring more granular reporting than ever before.
Global Processes Key to
Managing Compliance Proactively
Key steps to maintaining compliance and avoiding the fines and penalties are process automation and data centralization. These efforts ultimately reduce error risk and ensure companies have validated, accurate records in the event of an audit. And that’s not just true in Brazil.
Companies need to see business-to-government compliance from a global perspective and start implementing such initiatives on a wider scale. That way, enterprises can adopt a proactive approach instead of being forced to react as the tidal wave of business-to-government compliance measures continues.
In an increasingly volatile global economy, enterprises aren’t the only organizations seeking new ways to keep up their profits. Governments are doing the same and are showing a growing propensity toward legislation that gives them increased visibility into corporate transactions, ultimately maximizing tax revenues. Look no further than the rapid adoption of e-invoicing, for example. In just 10 years, 16 countries have implemented e-invoicing as standard practice, with more and more following suit. If Brazil sees success in its eSocial initiative—and based on its success with previous legislation, there is no reason to think that it won’t—we can expect payroll to be increasingly affected by such compliance initiatives on a global scale.