VAT gaps can generally be found in countries that collect indirect taxes. This hiatus has led many tax administrations to implement Continuous Transaction Controls (CTCs), through which transactional and accounting data are monitored in real-time or near real-time. However, even countries with sophisticated CTCs may encounter fraud involving missing traders and non-existent supplies. This creates holes in the VAT collection chain leading to significant shortfalls. Although taxpayers are used to validating incoming e-invoices and e-signatures, many governments have introduced additional validation requirements to tackle the loss of revenue.
Accepting losses due to invalid transactions is normally off the table for the tax authorities. Therefore, methods to pass the debt over to other taxpayers that are part of a VAT credit chain have been implemented. To ensure these methods don’t override proportionality requirements that typically exist in legal regimes, tax administrations generally expect taxpayers to carry out auxiliary checks before relocating the VAT cost in the chain. The thinking behind such validation requirements is to assign tax liabilities to taxpayers that know or should know that the supply or trading partner is in breach of the law. These obligations are varied. They can be as simple as checking the tax identification of the trading partner or as complex as ensuring that the VAT amount was collected by one of the trading partners.
Tax ID checks requirements
Among the simplest alternatives are the tax ID checks requirements. Here, trading parties must validate each other’s tax IDs before carrying out a transaction or payment. If the VAT amount is not paid because one of the trading partners is missing, and the checks were not done, the remaining trading partner is accountable for the VAT not collected. This technique has gained traction in the EU where exemptions granted to intra-community supplies depend on the correct information being provided by the interested parties in the recapitulative statement. In practice, suppliers must check the buyer’s VAT number through the VIES platform. If the information is incorrect (or if the trading party doesn’t exist), the supplier bears the VAT burden that otherwise would be the buyer’s responsibility – unless the company proves that the buyer’s VAT number was deemed valid in the VIES platform on the date of the supply.
Some countries have gone beyond ID checks and implemented other validations to be executed by the trading parties to ensure the taxes can be collected. What is not so different is the assumption that the negligent party will close the gaps in the VAT credit chain through joint liability with the other party’s VAT obligations. In Poland, for example, apart from the VIES checks performed in intra-community supplies, buyers must carry out payments to bank accounts registered with and listed by the Polish tax authorities. If a taxpayer pays into a supplier’s unapproved bank account, the payer is accountable for the supplier’s VAT obligations. In Mexico, despite early adoption of CTCs, buyers must check whether their suppliers are on an unapproved list (e.g. deemed to have issued fraudulent invoices or been part of sham transactions). Since invoices issued by unapproved Mexican blacklisted companies lack fiscal value, they cannot endorse VAT credit claims; consequently, the buyer assumes the VAT cost of the transaction.
A smooth VAT credit system that goes hand in hand with business processes is key to efficiency. Consequently, tax authorities should avoid imposing measures hindering a straight-forward credit-debit system. India is moving to a CTC system through which the tax authority will perform automated tax ID controls. Nevertheless, the country is still expected to keep its current framework through which buyers are only entitled to credit taxes if their suppliers had correctly collected the GST amount to the government treasury. On one hand, this approach makes an auditor of each taxpayer, whilst on the other hand, it causes an immense administrative burden for taxpayers that cannot rely on the payment presumption and must reconcile data that might not be readily available.
The validation of tax IDs and lists is a trend that affects both post-audit and CTC countries alike. Nevertheless, tax administrations of the latter category can leverage their systems to perform automatic checks and notify interested parties when the transaction is performed. This is the case in Italy, where the SDI (the centralized e-invoicing platform) checks VAT numbers – and also if these tax IDs are part of a larger VAT group – appointed in an e-invoice, rejecting documents with invalid data. In Brazil, these checks are also executed at the core of the multiple State e-invoicing platforms, as is also expected to happen in India.
The cost of noncompliance
The cost of noncompliance is high. The risk of becoming liable for unexpected VAT charges is particularly great since each inadequate tax ID or list check may hide a VAT cost associated with the supply. All in all, account payable and receivable systems must catch up with the trend and be able to either conduct required checks themselves or have the flexibility to integrate with government platforms or service providers to ensure that checks are duly performed.