Bloomberg Tax
June 10, 2020, 7:00 AM

INSIGHT: VAT Compliance Software as an Essential Tool for Business

Christiaan van der Valk
Christiaan van der Valk

Until the very beginning of January 2019, when Italy became the first European country to mandate business-to-business (B2B) electronic invoicing, the practice in Europe based on voluntary adoption was far from spectacular.

Prior to Italy’s forward-thinking plans taking shape, European governments were reluctant and legally unable to mandate e-invoicing. Instead of going all the way to impose the electronic exchange and mandatory tax “clearance” of digital invoices, many contented themselves with basic rules to keep the origin and integrity of invoices in digital format verifiable, and focused their modernization efforts on increasing the frequency and granularity of value-added tax (VAT) reporting.

This optional approach to e-invoicing subsequently led to service providers in the B2B transaction automation space (encompassing processes such as procurement, electronic data interchange, supply chain management, order-to-cash and electronic invoicing) having nearly 20 years of being able to choose whether VAT compliance was to be part of their proposition.

A Long and Winding Road for Europe

For those not versed in the regulations that swept across the world regarding digitizing invoicing for tax reasons, it seems odd that Europe had shown such reluctance to be more assertive in adopting harmonized rules to rapidly create critical mass and easy on-the-fly tax controls through standardized technologies. The opportunity to use technology to drive friction out of the clumsy paper-based system has been there for decades, and the right approach could have benefited both the taxman and the taxpayer.

Instead, bold innovation in this space came from a place few could have predicted at the turn of the millennium: the champions of tax innovation, hands-down, are found in Latin America (LATAM). Indeed, countries such as Brazil, Chile and Mexico have become synonymous with e-invoicing and digital VAT compliance for the past decade or longer. This is because their models of e-invoicing were imposed via a “clearance” model, whereby the tax administration receives (and often pre-approves) digital invoices in real time.

This made a huge impact on the “VAT gaps” of the countries implementing these by building compliance into the very fabric of the invoicing process. Other countries began to take note of these systems. In particular, with figures from the European Commission showing an estimated VAT gap of around 137 billion euros ($150 billion)—more than 11% of the total expected VAT revenue—it was unsurprising that countries throughout the EU began looking to LATAM for inspiration.

However, tax authorities in the EU were hamstrung in innovation attempts by legal constraints from the 2001 changes to the EU VAT Directive, meaning that no single system could be agreed upon by all the member states. Subsequently, different European countries introduced their own variations of continuous VAT controls, forming a colorful patchwork of periodic, real-time and near real-time reporting systems across the continent—a patchwork that represents a real compliance headache for those organizations with a presence in several different jurisdictions.

The Knock-on Effect on Transaction Automation Providers

The freedom to decide how to meet the EU VAT Directive’s key requirements for optional e-invoicing and e-archiving has subsequently translated to a broad variety of B2B automation service provider approaches. Much like the open-ended European approach that meant individual countries could approach it in different ways, service providers were also free to make the choice as to how they implemented VAT and tax compliance.

Looking at the market, these range from some service and software providers explicitly making compliance a customer problem, to the other end of the spectrum whereby they fully embrace it as integral to their value proposition. Vendors in the former category have often promoted the notion that compliance is first and foremost a function of the trading partners’ internal controls rather than something that can or should be achieved by a platform processing the invoice between the trading partners’ internal systems.

But vendors that embraced VAT-compliant e-invoicing from the start took the opposite view. They believe it is beneficial to trading partners if the invoice exchange platform handles the compliance aspects of the issuing, receiving and archiving of digital invoices. These approaches provided different levels of customer value, but both were legally possible and widespread within Europe.

Looking into the Numbers

With these two different approaches from providers now well-established, it is beneficial to investigate the numbers behind them. To begin with, B2B invoicing in the region has nearly doubled between 2015–2019. Billentis estimates that the total number of electronic invoices sent in Europe in 2015 was 4.8 billion, and for 2019, 8 billion. Of course, it is worth considering that the numbers for 2019 would have been closer to 6 billion if Italy had not mandated e-invoicing from that year onward. It was also thanks to Italy that service provider-facilitated volumes grew faster than in-house solutions; prior to 2019, both grew at a near-identical pace. But this speaks to a growing trend that we will examine shortly.

There also has to be some consideration of the fact that e-invoicing varies in its description across Europe due to the lack of consistency in approaching it: some insist that only structured data that allows B2B automation is “real” e-invoicing; others only consider documents that use a technical method guaranteeing integrity and authenticity of the file rather than internal business processes fall into this category.

But accounting for this, the numbers are still clear, with Billentis data showcasing a growth of the EU market for transaction providers for the same time period at 74%. Looking specifically at those providers not in-house deployments, there is a market growth of more than 100%. These numbers are also supported by extrapolating from statistics published by the European E-invoicing Service Providers’ Association (EESPA), which has data on file up until 2017 showing the same trends.

However, the most interesting numbers come from our own examination of our partner data, focused on those that have made a conscious decision to include VAT e-invoicing and e-archiving compliance as part of their EU services. These vendors have decided to shoulder the burden of tax compliance for their customers, placing it as an essential foundation of their technology in the same way that GDPR would be for data privacy compliance, removing the onus for tax compliance from customers.

To examine these organizations, we looked solely at those that already had a healthy amount of activity in the EU prior to 2015 and removed any that were part of mergers and acquisitions deals that would have greatly affected the statistics on their growth. Using this approach, vendors with invoicing and tax compliance as a cornerstone of their transaction management offering showed a total growth in European e-invoices processed of 364% for 2015–19. That is a staggering five times faster than the general market, and 2.5 times as fast as more general service provider growth.

What is Driving This?

With numbers so striking, it is clear that the overall trend in e-invoicing globally, to aid governments with ensuring accurate, real-time tax data and close VAT gaps, is filtering down to companies looking for transaction providers to work with.

Italy may have led the way to begin with, but more countries are digitizing their tax and invoicing processes, from South East Asia all the way through to creative new solutions in Europe.

Following in Italy’s footsteps, EU member states are increasingly rebelling against the constraints of the VAT Directive in terms of more aggressively pushing for e-invoicing. Finland—not usually a country that is quick to sidestep EU rules—has recently made smart changes to their e-invoicing system to circumnavigate the EU VAT Directive, allowing buyers to require digital invoices from their suppliers.

France also took unusually audacious steps to enshrine an obligation on the government in its 2020 budget law to roll out mandatory e-invoicing with tax “clearance” starting in January 2023 latest.

In another example, the Polish Ministry of Finance recently announced plans to implement a centralized e-invoicing platform by 2022. These plans are justified: since it began transforming its taxation systems, Poland has significantly reduced its VAT gap from 24% in 2015 to 12.5% in 2017 and is on track to reduce it even further.

Looking for change further than in Europe, huge manufacturing bases such as India have recently introduced legislation requiring the transmission of invoice data to the tax authority in real time for approval and registration—a decision that will influence many different European organizations that rely on India as part of their supply chain.

Those lessons learnt from LATAM in the early part of the 21st century are beginning to bear fruit, with tax authorities across the globe searching for ways to make their tax processes smarter, more accurate and to shift them away from only being verifiable after the fact: and customers are noticing this.

Looking to the Future

For businesses that use transaction management software, the need to remain compliant with the shifting aspects of digital tax has never been clearer. And so, their choice in service providers is beginning to reflect the growing complexity and technological expertise needed to keep compliant with globally shifting invoicing and tax legislation.

For the providers of software that manages business transactions with suppliers and customer, they must embrace compliance as something without which their services would have very little customer value. This observation applies to a much broader set of enterprise software segments than in the old world of VAT compliance, as tax administrations turn their attention to collecting data in real time from the actual business data exchange process rather than accounting systems that are essentially transaction data repositories.

To better understand what the future may look like, it is interesting to look in the rear mirror and observe what has created a huge distance between the leaders and the laggards in the European e-invoicing market to date. Without a doubt, those who have chosen to make compliance an integral part of their mission have a competitive advantage that cannot be underestimated going forward.

With VAT compliance becoming an ever stronger driver behind e-invoicing growth, it will become imperative for many different types of enterprise software to put accurate, automated compliance at their core. And there is only one way that the market is moving—on a global scale.

Christiaan van der Valk is VP of Strategy, Sovos

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