8 minute read
VAT Processes
The transition to real time reporting
Christiaan Van der Valk, VP of Strategy and Regulatory, Sovos considers global government mandated digitisation for VAT reporting, including continuous transaction controls.
The first decade of the new millennium saw governments globally test the waters of new e-invoicing models. During the last decade, continuous transaction controls (CTCs) and e-accounting initially swept across Latin America to improve tax collection. Digitisation of tax administration and private sector VAT processes had long lagged behind general business and government practice – because of the strict nature of VAT regulation and nervousness about the auditability of electronic data. Today, many governments are evaluating and implementing innovative VAT and general fiscal law enforcement models based on mandatory data transmission by businesses source systems.
Continuous transaction controls
CTCs encompass a variety of requirements for e-invoices and similar transaction documents to be sent to – and often pre-approved by – the tax administration in real time or near-real time as part of the communication process between suppliers and buyers. Jurisdictions that already have CTCs in place have shown not only improvements in VAT collection, but also greater digital resilience. The global health crisis armed governments with established CTC programmes with all the evidence needed to argue that rapid digitisation was essential to a modern economy where tax is paid as due and policies can be varied flexibly based on advanced data analytics.
Digitising tax reporting processes has allowed early innovators to reduce VAT gaps and eased the burden of traditional reporting methods on administrative staff. While CTC introduction has not always been easy on businesses, many of which had to migrate to new systems and processes to comply, all this points towards the rapid development of real-time economies over the next decade. Tax will become a continuous activity powered by automation, as global legislators work towards reducing any obstacles that prohibit the secure collection and legitimate use of data across businesses, markets and governments.
Although it carries global benefits, tax digitisation happens at a local level, bringing a range of compliance challenges for businesses operating across multiple markets. In the coming years, developing the knowledge and technological capabilities to adapt to these regulatory changes as they happen will be critical for any business.
So, how can businesses implement the right strategy to remain agile in the face of coming tax transformations?
Understanding the VAT challenge and the digital solution
While VAT concerns all parties involved in the supply chain, only businesses can deduct their input tax – the VAT incurred during the supply of goods and services. Therefore, VAT requirements concerning invoicing typically only apply to businesses. Invoices are a key source for governments to determine the indirect taxes owed to them, with private companies playing the role of tax collector through their own self-assessment.
VAT contributes over 30% of all public revenue for nearly all the world’s trading nations, so while businesses are required to self-report their tax obligations, it’s necessary for authorities to audit and control business transactions. Despite this, fraud and mismanagement often mean that governments collect less VAT than is owed. This is commonly referred to as the VAT gap.
The ongoing health crisis has hurt economies and governments across the globe are therefore now placing greater focus than ever on reducing their VAT gap. In Europe, the annual VAT gap is approximately €140 billion, increasing to €164 billion in 2020 due to Covid-19. So, many governments are realising that more effective measures through structural changes are needed to improve how VAT is regulated and enforced.
Existing VAT reporting in many EU member states is becoming more granular and more frequent. Many are quickly evolving towards real-time controls with or without electronic invoice mandates.
In January 2019, Italy became the first EU country to introduce mandatory e-invoicing through a data exchange platform previously used for public procurement messaging. Spain was an early adopter of the CTC reporting method. Since 2017, all companies have been required to report inbound and outbound invoices within four days. However, new plans are now in discussion to make B2B invoicing mandatory.
Meanwhile, in Hungary, suppliers have had to report their sales invoices above a minimum threshold in real time since 2018 and they can now, together with their customers, decide to exchange their invoices using the tax administration real-time reporting platform.
Across Europe and other regions, the past two years have highlighted the need for more accurate and real-time e-invoicing systems to help reduce the VAT gap – enabling governments to recoup tax owed and drive economic recovery. Next, let’s look at four major trends in VAT digitisation.
The four megatrends in VAT digitisation
The swift adoption of new tax legislation places new demands on businesses and their IT systems to send sales and supply chain data in real time. And with unrestricted access to company transaction data and financial ledgers, tax authorities and other government entities now have extraordinary insight into companies’ operations across the entire economy.
In many ways pioneered by Latin America, the rest of the world is now also digitising VAT in the following four areas.
Trend 1: Adoption of CTC models is accelerating
After introducing CTCs in the early 2000s, many countries in Latin America now have a stable system in place, requiring a significant amount of data from invoices, transport documents and other key transaction data. Europe and other regions took a different path, starting with legal acceptance of electronic invoices with voluntary adoption in the early 2000s to now swiftly moving to approaches more closely resembling the Latin American CTC systems.
However, the problem for many global businesses is that all these countries are adopting different variations on the CTC theme – making it increasingly difficult for companies to know the rules and compliance requirements for each tax regime and arm themselves with the legal monitoring and technical tools needed to stay compliant.
Trend 2: The rise of destination taxability for cross-border transactions
Cross-border online sales of low-value goods or digital services to consumers in other countries for a long time escaped VAT collection altogether. Governments for years simply considered the volume of such transactions to be too low to invest in fiscal enforcement measures.
Meanwhile, however, the volume of cross border e-commerce has increased significantly. Therefore, tax administrations are looking to implement measures to apply indirect tax to the trade of goods and services in the country of consumption.
Many OECD and G20 countries have recently adopted rules for the VAT treatment of B2C supplies from abroad. While a big focus has been on cross-border digital services, others have also introduced elaborate programmes for low-value consignments. Europe, for example, in 2021 introduced its One-Stop-Shop (OSS) platform which aims to facilitate reporting for taxable persons and their representatives or intermediaries.
Trend 3: Tax authority dependency on the availability and performance of online services
With the introduction of CTCs, many tax administrations have created a major dependency on the availability and performance of digital government platforms to receive and sometimes approve massive amounts of economic transactions. The failure of these CTC systems would have a significant negative effect on the economy and citizens’ well-being. What’s more, having placed VAT reporting and remittance obligations on nonestablished vendors of goods and services to local consumers, governments are facing new administrative and systems challenges.
Digital transformation is a massive undertaking, so to ease the burden over the past decade governments have found ways of distributing responsibilities to third parties – often companies that already process transactions for large amounts of taxpayers.
An example of this is the EU’s e-commerce package, which contains far-reaching assumptions that e-commerce marketplaces, rather than individual vendors, in certain cases are responsible for VAT. This way, the tax authorities can focus on one easily identifiable party rather than a large number of taxable persons with varying degrees of administrative capability.
However, tax administrations piggybacking on natural aggregators to support digitisation is not limited to B2C transactions. Over a decade ago, Mexico pioneered the PAC model for CTCs. This concept of accrediting or obligating B2B technology vendors that already manage business transactions has since become popular in many countries.
Trend 4: E-accounting and e-assessment
The move towards CTCs has revolutionised the decades-old routine of VAT compliance. However, tax administrations aren’t just interested in transactional data from businesses. They also want to have detailed insight into taxpayers’ accounting data.
Until recently, this need to consult a company’s core data was met through the instrument of onsite audits. But tax administrations have now developed sophisticated software tools to e-audit businesses’ ERP and accounting systems. To make this even more powerful, standardisation of business data can play a major role. A growing number of tax administrations are therefore relying on the OECD’s Standard Audit File for Tax (SAF-T) specifications and guidelines.
With these four trends in mind, we can be sure that the pace of global VAT digitisation will continue to accelerate. For more detailed analysis of global tax developments, Sovos’ annual “Trends report” aims to condense recent regulatory, business and technological developments in this area into an accessible format (see bit.ly/349aB6P). ●
Author bio
Christiaan Van der Valk is VP of Strategy and Regulatory at Sovos, where he leads research into trends in the market and tax legislation.
