How EU Countries Are Following Latin America’s Digital Tax Transformation to Narrow Their €151 Billion VAT Gap

Christiaan van der Valk
August 8, 2018

Europe is in the midst of a digital transformation, and taxation is one of the key areas of investment. As governments across the EU seek to reduce their combined annual VAT gap of €151 billion, we’re increasingly seeing the introduction of state-controlled, real-time IT platforms that place national tax administrations at the heart of business transactions.

By placing themselves between the supplier and buyer of goods and services throughout the EU, governments are able to analyse invoice and other tax-relevant data in real-time, on an entirely new and completely unprecedented level.  And it’s this digital transformation towards real-time control that is helping reduce the VAT lost through error and fraud. As a direct result, the pressure is on and businesses must ensure that their invoices are correct, and that they determine their indirect taxes with 100% accuracy. Non-compliance can lead to a delay in global supply chains, leave companies unable to reclaim tax, and in the worst cases result in sanctions and fines.

Digital tax leaders

The introduction of these platforms in Europe may give the impression that the EU is at the cutting edge of digital tax.  This is not the case.  Europe and the rest of the world are following the lead of Latin America, who introduced similar initiatives more than a decade ago.

In countries such as Brazil, Chile, and Mexico, their governments now have complete visibility into the flows of goods, services, and money, moving in and out of businesses. What this means is the local tax administration knows what tax is due on an unprecedented level of granularity. Mexico, for example, has an electronic auditing program that after collecting comprehensive transactional data from trading partners, automatically compares it to their monthly tax reports. If the system finds discrepancies, it automatically issues an eAssessment with interest and penalties.

The end goal of all these developments will enable a tax administration to tell businesses how much tax is due based on their own authenticated transaction data.  And because that data has been harvested by the government, from your own systems in real-time, anyone who disputes the assessments will have a significant challenge disproving their assumption.

The digitisation of tax in Europe

In Europe, the EU commission recently paved the way for individual countries to mandate real-time ‘clearance’ of electronic invoicing. This move has been triggered by a request from Italy, Europe’s fourth-largest economy with an annual VAT gap of €35 billion, which has become the first EU country to introduce mandatory eInvoicing based on such controls for all domestic invoices by 1 January 2019.

The introduction of digital tax and real-time reporting is putting pressure on businesses to respond. For years in Europe, we’ve had systems in place that left the obligation of VAT declaration to individual companies.  It was then up to tax administrations to verify reported input and output VAT through retroactive onsite audits. These legacy rules are now changing rapidly, and irreversibly. The digital transformation of tax law enforcement is reversing the ‘self-assessment’ nature of VAT collection, disrupting decades of establish business practices in the process.

How can businesses keep up with the digital transformation of tax?

Governments are now controlling the innovation agenda, and business finance and accounting departments are being forced to respond to their digital transformation imperatives. In a recent survey, 45% of CFOs cited the increasing costs of compliance as the number one barrier to growth in their businesses.

In a large multinational company, indirect tax touches every department, from finance and IT, to supply chain, procurement, and sales. It’s therefore crucial that businesses adopt a centre of excellence for indirect tax that draws together a multidisciplinary team into a single, unified operation. This has always been true, but as tax goes digital, and tough clearance mandates take force, such cross-functional collaboration is vital. This team can then work to identify and implement the right strategies and solutions to automate and implement the control processes that bring together the four key challenges of digital tax:  eInvoicing, eArchiving, eReporting, and tax determination.

Companies need to identify vendors that can support them in the coming decades when tax administration across Europe, and the globe, will introduce wildly varying local requirements. The following high-level functional categories will need to be addressed in each of the key geographies that you operate:

  • Regulatory mapping – You’ll need to be able to issue invoices in the mandatory structured data formats required for the exchange of data with the tax administration platform.
  • Regulatory transaction orchestration and process alignment – Your e-business transaction platform will need to be able to send and receive different types of transactions, both to and from, the tax administration platform. Examples include specific types of invoice processes (e.g. cancellation, contingency issuance or confirmation, buy-side acceptance or rejection) and increasingly, similar processes for other types of tax-relevant documents. Your business and trading partner’s data exchange process may need to be revised to ensure that the mandatory data exchange with the tax administration platform can be performed as required. You and your customer may never have thought to use a supplier invoice cancellation message, but in some countries, you’ll need one to comply with tax law. Many countries with real-time invoice controls integration have started requiring additional data – such as invoice approval, payment and finance status messages – to be created in a structured, electronically signed format and registered with the tax administration. In addition, real-time control systems often create dependencies on clearance approval in the logistics process for goods transactions; this leads to a need for process re-orchestration including adding capabilities for printing additional transport documents with visual security information that associates them with the approved invoice.
  • Residual reporting – Whilst the overall trend is towards real-time controls of business transaction data, tax administrations will also be requiring non-transactional data of tax relevance to be sent to their cloud platforms. Over time, therefore, we expect periodic reporting to change in nature and become focused on accounting information, fixed assets, inventory data and the like.
  • Authentication and security – Most real-time or near-time tax administration platforms require a combination of country specific transmission and security methods to ensure the integrity and authenticity of eDocuments.
  • Tax determination – When every line of every invoice is available for deep analysis, it becomes imperative to ensure that tax determination decisions are 100% correct.
  • Archiving – The “cleared” eDocument and any periodic reports you send electronically to tax administration platforms will need to be securely stored and available for audit for many years.

Planning for change

With the right strategy, advanced preparation, and through the implementation of the right systems and solutions up front, businesses can help to reduce the friction between their company and governments. In doing so you can benefit from the cost-efficiencies, automation potential and innovative trade finance options, that come from real-time tax controls. In effect, you can convert the burden of the mandates to a competitive opportunity for your business.

But, ensuring you comply on the first day that a new eInvoicing mandate is introduced is not enough. You must ensure that you have a robust change-management process in place. That means taking organisational measures to ensure that any change to the law or technical specifications in a digital tax system are monitored, interpreted, and implemented within your company’s systems and processes in a timely manner.

Overcome short-termism: think both local and global

To comply with an imminent eInvoice clearance mandate, such as the Italian mandate that takes effect for all established companies on 1 January 2019, you might decide to opt for a local vendor with local knowledge, and this may provide some level of comfort to your regional team. But it’s important to understand how their solution will fit into your global compliance strategy. Many local vendors will only offer part of the solution, covering domestic and some cross-border scenarios for invoicing. But, many will be unable to support the ever-changing period reporting requirements – such as the new cross-border report that is applicable in Italy in certain scenarios. Also, many of these local vendors will not support eInvoicing in other countries, which means that you could be left with a patchwork of local providers and local solutions as more governments issue similar mandates.

By choosing a global provider with a complete solution that covers domestic and all forms of cross-border transactions, as well as the associated reporting, archiving and tax determination challenges, there will be efficiencies for both your local and global teams. Rather than building up a patchwork of providers, that may over time make it impossible for you to further roll out global systems and best practices, you should seek a provider who has local specialisms combined with a global reach. This approach will allow you to focus on your core business, while an expert vendor takes care of the ever-changing aspects of indirect tax as governments make their digital transformation.

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Christiaan van der Valk

Christiaan Van Der Valk is vice president, strategy. Elected a World Economic Forum Global Leader for Tomorrow in 2000, Christiaan is an internationally recognized voice on e-business strategy, law, policy, best practice and commercial issues. Formerly co-founder and president of Trustweaver (acquired by Sovos), Christiaan also holds long-standing leadership roles at the International Chamber of Commerce (ICC) and the European E-invoicing Service Providers Association (EESPA). Over the past 20 years, he has presented at and authored key papers for international meetings at the Organisation for Economic Cooperation and Development (OECD), the Asia Europe Meeting, World Trade Organization and several other UN agencies. Christiaan earned his Master of Laws degree from Erasmus Universiteit Rotterdam.
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