This blog is an excerpt from Sovos’ Annual VAT Trends report. Please click here to download your complimentary copy in full.
VAT requirements and their relative importance for businesses have changed significantly in recent years. For data that is transactional in nature, the overall VAT trend is clearly toward various forms of continuous transaction controls (CTCs).
The first steps toward this radically different mode of enforcement, known as the “clearance model”, began in Latin America in the early 2000s. Other emerging economies, such as Turkey, followed suit a decade later. And today, many countries in the Latin American region now have stable CTC systems where a significant amount of the data required for VAT enforcement is based on invoices. Other key data is harvested and pre-approved directly at the time of the transaction.
Common clearance system features
There are several high-level features and processes that many clearance systems have in common.
However, many variations exist on this reference model in practice; many countries with a clearance system have implemented extensions and variations on these “standard” processes:
1. OK TO ISSUE: Typically, the process starts with the supplier sending the invoice in a specified format to the tax authorities or a state agent licensed to act on its behalf. This invoice is ordinarily signed with a secret private key corresponding to a public certificate issued to the supplier.
2. OK/NOT OK: The tax authority or state agent (for example, an accredited or licensed operator) will typically verify the signed supplier invoice and clear it by registering it under a unique identification number in its internal platform. In some countries, a proof of clearance is returned, which can be as simple as a unique transaction ID, possibly with a timestamp. In some cases, it’s digitally signed by the tax authority/state agent. The proof of clearance may be detached from the invoice or added to it.
3. VALID: Upon receipt of the invoice, the buyer is often obligated or encouraged to check with the tax authority or its agent that the invoice received was issued in compliance with applicable requirements. In general, the buyer usually handles integrity and authenticity control using crypto tools, also used to verify a signed proof of clearance. In other cases, the tax authority or agent completes the clearance check online.
4. OK/NOT OK: If the buyer has used an online system to perform the validation described in the previous step, the tax authority or state agent will re-turn an OK/not OK response to the buyer.
The first “clearance” implementations were in countries like Chile, Mexico and Brazil between 2000 and 2010. They were inspired by this high-level process template. Countries that subsequently introduced similar systems, in Latin America and worldwide, take greater liberties with this basic process model.
Global expansion of CTCs
Europe and other countries passed through a stage allowing original VAT invoices to be electronic. This is without changing the basics of the VAT law enforcement model. This phase of voluntary e-invoicing without process re-engineering is “post audit” e-invoicing. The moment a tax administration audit comes into play is post-transaction. In a post audit system, the tax authority has no operational role in the invoicing process. It relies heavily on periodic reports transmitted by the taxpayer.
Largely due to the staggering improvements in revenue collection and economic transparency demonstrated by countries with existing CTC regimes, countries in Europe, Asia and Africa have also started moving away from post audit regulation to adopting CTC-inspired approaches.
Many EU Member States, for example, are moving toward CTCs not by imposing “clearance” e-invoicing but by making existing VAT reporting processes more granular and more frequent via CTC reporting. These countries will eventually adopt requirements for real-time or near-real-time invoice transmission. This is as well as electronic transmission of other transaction and accounting data to the tax authority. However, it’s not a foregone conclusion that they’ll all take these regimes to the extreme of invoice clearance.
CTC reporting from a purely technical perspective often looks like clearance e-invoicing, but these regimes are separate from invoicing rules. In addition, they don’t necessarily require the invoice as exchanged between the supplier and the buyer to be electronic.
The impact of CTCs on business
The VAT trend towards CTCs is obvious, but situations in individual countries and regions remain fluid. It’s important to align your company with local expertise that understands the nuances of your business and what regulations and rules you’re subject to.