Continuous Transaction Controls—Changing the VAT Landscape

In 2019, EU countries suffered an immense loss of 134 billion euros ($148.5 billion) in value-added tax revenues due to tax fraud and insufficient tax collection systems. Based on these trends, the EU has predicted that closing its VAT gap will take at least 13 years.

The U.K. VAT gap from 2020 to 2021 was estimated at 9.8 billion pounds ($12.9 billion). The U.K. will face the same challenge on a similar scale.

In light of these alarming statistics, it comes as no surprise that countries around the world are rethinking their tax collection systems and turning their attention to digitalization. One key approach they are considering is the adoption of continuous transaction controls (CTCs), which will give governments greater visibility into companies’ transactions and tax liabilities.

So, how exactly are CTCs going to change the future of the tax landscape? Let’s look at how CTCs work, which European countries are embracing them, and how U.K. businesses can prepare for this rise in digitalized VAT collection.

An Overview of CTCs

The CTC process requires businesses to submit their detailed transactional data electronically to a tax administration platform approved by each country’s tax authority. This submission takes place in real or near real-time when sellers and buyers have exchanged data, affecting obligations of e-invoicing and e-reporting.

The clearance model is a popular one among the economies that have adopted CTCs and requires an invoice to be presented to and subsequently approved by a tax authority or government servers before the trading parties can continue with their processing. As a result, tax authorities are able to gain an unprecedented level of operational control and visibility into transactions. Providing tax enforcement support is not the only purpose of CTCs; they also generate vast amounts of economic data that can be useful for guiding fiscal and economic policy.

Which Countries Are Ahead of the Curve?

Whilst CTCs are on the rise worldwide, tax authority requirements will vary and often include a diverse range of regulatory frameworks and specifications that evolve on a constant basis. Back in the 2000s, Latin America became one of the first regions to adopt CTCs. Countries including Brazil, Argentina, Peru, Mexico, and Chile were able to put entirely new systems in place and, as a result, they now have a vastly improved mandatory control infrastructure helping to combat fraud and corruption.

Meanwhile, Europe has been slower in transposing the legacy paper based processes and compliance concept to the digital environment. Initially, from 2001, the EU simply permitted electronic invoices for VAT compliance purposes but did not require them and did not take steps to capture transaction flows on a more dynamic basis. During this time, the periodic summary VAT return remained the principal source of information for control and audit of VAT.

Italy was among the first few economies in the EU to adopt CTCs. In January 2019, it became the first country in Europe to implement the clearance e-invoicing method for all business-to-business (B2B) tax transactions to combat the country’s sizeable VAT gap. Under current Italian law, all domestic transactions between Italian residents or businesses fall under this reporting method. However, that is expected to change from mid-2022. Through the same mechanism, the new regulations will see Italian companies being required to share cross-border transactional data with the country’s tax authority.

From the beginning of this year, Poland joined Italy in the adoption of e-invoicing, implementing a single, centralized national billing system, on a voluntary basis. However, the voluntary basis will only last until 2023. From that date onward, all invoices must be issued and received using this system. With a VAT gap of roughly 25% around a decade ago, Poland’s progressive steps towards CTCs in the past years have reduced this to an impressive 10% in 2020, ranking them as one of the most successful EU performers in attempting to close their VAT gap. There is no doubt that the country’s plans to adopt a CTC approach will only accelerate this trend further.

The centralized, state-controlled Italian and Polish models, however, may come at the expense of less flexible B2B data integration along the broader set of supply chain messages in addition to invoices, such as orders and advance shipping notices. The impact on continued innovation in supply chain automation—using technology advances such as blockchain or artificial intelligence—in the longer term also remains an area of speculation.

The French government has recently introduced a gradual, staged approach to the implementation of mandatory B2B e-invoicing clearance and e-reporting obligations for businesses. With this change in regulation comes the requirement for larger enterprises to issue e-invoices and e-reports. Additionally, companies based or founded in France will be obliged to accept e-invoices through the country’s CTC system from July 2024. Following this, the next stage will occur at the beginning of 2025, which will see e-invoicing and reporting become mandatory for 8,000 mid-size companies. Finally, in 2026 the same obligations will apply to the remaining four million small and medium-sized enterprises (SMEs) in France.

France is taking steps to find a balance between a fully centralized CTC model—which is anticipated particularly to benefit the country’s large base of SMEs—and the free exchange and evolution of supply chain automation where larger businesses are involved that want to use more complex or integrated data exchange methods than those offered by the state controlled transmission system.

Not far behind France, the German government recently announced a plan to adopt CTCs in an effort to combat their fraud gap. Similarly, several Eastern European countries such as Romania, Slovenia, Slovakia, Serbia and Bulgaria have announced the same intention or have already started the implementation process.

It is therefore clear that a growing number of countries across Europe and beyond are on the cusp of embracing some form of CTC approach in the years to come. It is only a matter of time before every European country adapts.

How Does This Affect Businesses in the U.K?

By 2030, it is highly probable that CTCs will have been put into effect to some extent by almost every country that has a VAT, goods and services tax, or other indirect tax. While the U.K. is likely to be one of the last European countries to adapt, the government did introduce a Making Tax Digital initiative on April 1, 2019, which suggests progress is being made. With this initiative, VAT-registered businesses that reach a taxable turnover above 85,000 pounds are required to keep digital records of invoices and use software to submit their VAT returns. The same obligations will apply to VAT registered businesses with a taxable turnover below 85,000 pounds from April 2022.

A first step that U.K. companies should take to prepare for the digitalization of tax is to simplify how they handle transactional data. Many businesses today rely too heavily on manual processes and multiple data sources. When the submission of real-time data becomes a requirement in countries where they trade, it will be critical to ensure that all internal business operations are prepared to transfer live data for real time transactions to tax authorities as consistently as possible.

Further, it is imperative for U.K. businesses operating in Europe to maintain a strong understanding of EU legislation since it is likely to be subject to further changes.

Issues for Multinationals

Ensuring total compliance where CTCs are implemented can be challenging for many international companies, who have historically viewed VAT as something to be addressed by local subsidiaries’ accountants. They then continue this view of VAT as primarily a local concern by adopting local solutions that combine business and compliance functionality for each region when CTCs come into force. This approach can create considerable challenges for a business to continue with its broader digital and finance transformation.

CTC methods usually begin with simple invoicing rules. As they evolve, they tend to cover a comprehensive range of physical and financial supply chains and customer data. Multinational companies can get themselves into a bind of unachievable global digitalization when they let the need for compliance drive their procurement of business systems in each country.

In addition, the adoption of multiple standalone systems to connect to government platforms means allowing local software companies access to important business processes and data. Such companies are often not equipped for the needs of larger multinational businesses.

Therefore, enterprises are increasingly adopting a modern integration strategy of decoupling compliance from business functionality. This enables the business to freely adopt the business application it needs to remain competitive while safely sharing data with governments through a loosely coupled single data tax compliance solution. An advantage of this is a significant reduction in the total costs and employee time to meet VAT compliance.

Furthermore, because it is capable of accessing data from all regions at a granular and aggregate level, a centralized compliance system allows business leaders to make more effective strategic decisions.

Finally, given the increasing complexity of VAT legislation, and the speed at which it changes, sticking to a single solution allows businesses to grow, adapt and scale as and when needed.

Looking Ahead

Whether it takes a year or a decade, the digitalization of VAT in your markets is inevitable. Rather than viewing reforms as obstacles, IT leaders should view them as chances to enhance and streamline their financial systems. Corporations across the globe should allocate sufficient time and resources to strategic planning. To ensure an effective business approach for the years ahead, preparation is vital.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Christiaan van der Valk is VP Strategy and Regulatory at Sovos.

The author may be contacted at: christiaan.vandervalk@sovos.com