INSIGHT: The Evolution of Digital Tax—to Continual Transaction Controls and Beyond

The last 20 years have seen a global shift in tax reporting. As tax authorities seek to tap directly into the transaction process rather than wait for the taxpayer to report afterwards, there has been an explosion of country-specific variations of digital, continuous transaction controls (CTCs) such as mandatory e-invoicing and real-time reporting.

As a result of countries on different continents pursuing their own digital tax transformations without much coordination, international companies have been presented with an increasingly complex set of rules and regulations with which they must comply.

To address this compliancy challenge, business leaders must take pragmatic steps to ensure they understand and adhere to these various regional requirements, both to manage the risks and maximize the opportunities they represent.

Regaining Control

Businesses have long capitalized on advances in digital technology to reduce their administrative burden. It has been almost two decades since the introduction of PDFs and EDI (electronic data interchange) as replacements for manual, paper-based invoicing and reporting processes. At that time, however, most tax authorities were ill-equipped to audit these new digital invoice flows.

However, the momentum behind e-invoicing was unstoppable. Concerned they might lose control over revenue collection, tax authorities quickly began accelerating their own digital transformation, and implementing their own forms of tax digitization based around the CTC model.

The governments of Latin American countries were among the first to adopt ambitious programs aimed at maximizing the full benefits of e-invoicing. Rather than transposing traditional paper-based processes and compliance concepts to the electronic environment, Latin American countries simply put in place entirely new real-time control infrastructures made mandatory by regulation.

European countries initially took a more timid approach, allowing the use of e-invoicing but requiring no more than integrity and authenticity assurances. Referred to as “post-audit” e-invoicing, this initial European approach meant the tax authority had no operational role in the invoicing process and instead relied heavily on periodic reports transmitted by the taxpayer.

This approach to e-invoicing without any major re-engineering of the value-added tax (VAT) control system failed, in the sense that it did not drive a massive migration to e-invoicing, nor substantially improve VAT control by governments. With VAT proceeds still missing 100–200 billion euros ($131–262 billion) every year and a sovereign debt crisis that is far from resolved, EU countries have been looking to Latin America for new approaches to collect more tax and lower enforcement costs.

Where it Began

Clearance e-invoicing, the oldest and most prevalent form of CTC in the world today, was built around the concept of the clearance of invoices directly with the tax authority, or its appointed agents. Since its introduction, regulation has made—or is making—the use of electronic invoicing mandatory within many countries across the region.

Over the last 10 years, the countries that pioneered electronic invoicing systems have been able to bring most taxpayers into their controlled tax enforcement networks. These countries now have stable CTC systems in which a significant amount of the data required for VAT enforcement is based on invoices, with other key data harvested and pre-approved directly at the time of transaction.

The staggering improvements in revenue collection and economic transparency delivered by the implementation of CTC across Latin America were viewed with great admiration by other tax authorities around the world. It wasn’t long before countries across Europe, Asia and Africa began adopting similar schemes. This adoption was far from linear, though; the introduction of new tax regimes has so far been based on a multiplicity of different models.

Continuous Reporting

In 2001, its interest piqued by the success of electronic invoicing in Latin America, the European Commission set about removing a number of legislative obstacles that had arisen as a result of varying transpositions of changes to the VAT Directive, which at that time required EU member states to accept e-invoices as evidence of supplies.

However, disagreements arose between different member states over the direction of change, and legal constraints around the Directive itself meant that individual member states were unable to use invoicing rules to increase controls based on modern technologies. As a result, it became especially challenging for EU member states to mandate e-invoicing, which would have required a change to the VAT Directive or an EU derogation.

Instead, many countries in the EU introduced VAT reporting requirements that, rather than periodic aggregate data, required digital files containing more granular transactional data to be submitted more frequently than traditional VAT returns.

However, while this form of continuous VAT reporting can often look similar to other e-invoicing methods, its rules often don’t require the invoice as exchanged between supplier and buyer to be electronic. Even in cases where an invoice report must be sent to the tax authority in real- or near real-time, the taxable person is not required to wait for the CTC platform to return an explicit approval of an invoice before taking the next step in the process.

Whether or not the systems of all EU member states will eventually coalesce is hard to say. For the foreseeable future, though, it is likely that different forms of continuous VAT controls will coexist within Europe, forming a colorful patchwork of audit packages that allow tax authorities to match transactional data from different periodic, real-time and near real-time sources.

Inter-operable Public Procurement E-Invoicing

Latin American e-invoicing models are not the only influence on the EU approach to CTC, however. In recent years, the EU has given considerable attention to the use of e-invoicing within public procurement—and some of the concepts that have arisen in this context are in turn becoming part of the policy mix for VAT.

The EU Commission recently introduced a comprehensive package of measures under which all EU members states’ public administrations must be able to receive electronic invoices for public procurement transactions. Several EU member states are also pushing ahead for mandatory invoicing for all business-to-government transactions. Indeed, countries including Spain, Italy and Slovenia have required suppliers to invoice electronically to the public sector for some years now.

The increasing uptake of PEPPOL among member states is expected to further accelerate the evolution of interoperable electronic public procurement across the EU. Initiated in 2008, the PEPPOL project comprises a set of specifications designed to enable the diverse national e-procurements systems of EU member states to interconnect, thereby allowing the public sector to select and easily conduct business with any EU-based vendor, regardless of location.

PEPPOL is being embraced outside the EU, also. The Singapore government recently introduced a nationwide e-invoicing framework with the aim of raising productivity and efficiency within the country’s business ecosystem. Enabling companies to send and receive e-invoices based on the PEPPOL standards means that not only is Singapore able to adopt e-invoicing on a large scale, but its businesses are able to carry out relatively friction-free international transactions with businesses from other countries that use PEPPOL standards.

A Special Set of Challenges

Elsewhere in the world, other CTC trends continue to grow in popularity.

In some parts of Asia, for example, tax authorities are taking the clearance model a step further by seeking to control or even own the entire technological stack for the transference of transactional data. By “owning the network” in this way, the public administration runs the entire communication flow, including the approval process. With the government network effectively becoming the invoice exchange platform, this model introduces some of the highest levels of control on invoices and tax ever seen.

Such a stringent process could have an impact on global supply chains, though. Should a manufacturing company with a footprint in a country using this model fail to get its invoices processed within acceptable time limits, it could impact the just-in-time delivery of critical components. It’s arguable, then, that a lighter touch in government influence on the exchange of invoices between trading parties, such as that used in Singapore, may strike more of a balance between control and ease of use.

Planning Points

Just from the examples outlined above, it is clear how this haphazard transition to CTCs by tax authorities around the world represents a special set of challenges for any company operating in multiple countries—particularly when compliance is non-negotiable for doing business in every country.

In order to avoid the risks, and turn the global CTC trend to their advantage, businesses therefore require a strategy built upon two fundamental pillars. Excellent insight is needed onto all applicable and upcoming CTC mandates, alongside which it is important to have a shared understanding across the company of which systems and process are—or soon will be—affected by new and changing indirect tax imperatives.

In today’s era of CTCs, there is no time between the recording of a transaction and its reporting to the tax authorities. As authorities seek to insert themselves further into business transactions, and close the VAT gap, any errors and inaccuracies will be immediately apparent.

Digital transformation has forever changed the VAT compliance landscape, and this revolution will continue to drive fundamental change in business and government processes. It is vital that business remain on top of those changes—or risk the consequences.

Christiaan van der Valk is VP of Strategy, Sovos

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

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.