INSIGHT: Stitching Together the Fabric of Digital VAT Compliance

Any major shift in a fundamental business function takes a long time and is filled with complications. Updates to tax services have been no different; over the last 20 years, countries ranging from Latin America through to Europe and Asia have begun to reap the rewards of digitizing their processes, making tax collection and records more accurate and real-time, and closing value-added tax (VAT) gaps that exist in all economies.

But not all tax processes are made equal. For every light digitizing of the process—as in Making Tax Digital in the U.K.—through to full clearance models as seen in Brazil, approaches differ by a great deal.

That is only exacerbated in Europe, where the EU VAT Directive currently does not allow for full e-invoicing to be introduced (unless a lengthy derogation is approved, as is the case in Italy), meaning that dozens of different forms of invoicing, reporting and auditing are in play across the region.

Automation: a Clear Advantage for all Stakeholders

Very few indirect tax experts disagree that removing friction—namely the paper-based processes—from tax auditing and reporting would be a bad idea. There are clear inefficiencies which need to be removed from the process.

Furthermore, the technology to exchange tax-relevant data digitally—as seen by the first pioneers of its use in Latin America—has been around for over 20 years. However, for that period of time, a large number of tax administrations across the globe have been averse to the change, relying on paper invoices and select, strict digital schemes, whilst businesses continue to be frustrated by having to periodically report on their tax and VAT information in a blunt and time-consuming manner.

In a period of global uncertainty due to the ongoing Covid-19 pandemic and the economic issues emerging due to extended periods of lockdown, sitting still and not engaging with digital, automated systems is costing governments money at a time where it could be used to create new jobs, bolster healthcare services or improve education.

Navigating the Maze

However, as previously mentioned, we are far from exploiting the opportunities present. Internationally, the introduction of continuous transaction controls (CTCs) is extremely messy, with a focus on designing domestic tax control platforms from scratch and little to no attention paid to the needs of transnational businesses. The result of the patchwork of different systems in place means that businesses engaged in different countries are having to constantly adjust their core enterprise and financial systems in order to comply with the different legislation to which they are subject. Compounding this is the fact that the more countries look to move from periodic reporting to a real-time or near-to-real-time system, the less room there is for businesses to make these adjustments and amend any errors.

At this point, multiple experts have concluded that trying to align with all of the different legislation means that e-invoicing for multinational companies is as expensive and resource-draining as traditional paper invoicing, nullifying the point of the entire shift. It is clear that something must change to ensure businesses and tax administrations alike are seeing the benefits of digitization.

Bringing Consistency to Digital Tax Systems

It was due to this increasingly complex landscape that, two years ago, the International Chamber of Commerce (ICC) approved a proposal to bring together practitioners and executives from both businesses and tax administration to discuss CTCs. It had become clear that the end goal for all administrations that were looking to digitize and automate tax processes was some form of CTCs, with the benefits from these systems obvious from their installation in front-runners in Latin America; so the conversation needed to focus on this goal.

The aim of these discussions was to establish a first inventory of good and less-good practices when it came to CTCs being developed, to try and set a benchmark for them, raising awareness of the issues that were increasingly emerging, and to try and work towards a clearer, better future for tax as it becomes more technologically-focused.

The results of the two years of in-person and virtual meetings were better than expected, with a set of basic principles being approved by the governing bodies of the ICC and adopted unanimously by the group, spanning public and private sector interests. The principles should form a foundational component of CTC strategy that will give guidance and additional benefits to tax administrations reviewing and benchmarking CTC regimes, both whilst they are being designed and also when in operation.

The full document containing expanded information can be found on the ICC website, but there follows an abridged overview of the agreed principles and their meaning.

Balance

• Economic benefits: CTCs need to consider a balance between legitimate tax collection interests and economic benefits, supported by a time-limited voluntary adoption of the new regime based on clear business benefits.
• Encourage automation: promote standards-based business process automation.
• Flexibility: accommodate existing business processes rather than creating entirely new documentation and ways of working, leaving enough flexibility to allow efficient processes to work across jurisdictions with their own processes and legal requirements.
• Proportionality: implement systems proportionate to the benefits being sought, so as not to burden businesses where it can be avoided.

Efficiency

• Provide data only once: avoid requirements for the same data being reported multiple times to the tax administration.
• Consistency: remain consistent and stable over time, and do not present businesses with contradictions and conflicts over different jurisdictions.
• Interoperability: be inter-operable among jurisdictions from a business, legal, technical and operational perspective.
• Harmonization: uniform in specifications both in domestic and international scenarios and across the public and private sectors. CTCs should also use standards (such as those for security) already widely used.
• Robustness and continuity: operationally stable, with appropriate response and processing times, with public service level agreements. There should also be ample data processing capacity and processes in place to continue transactions if an operational problem arises.

Holistic and Long-Term Strategy

Communicate a holistic and long-term strategy embedded into a broader strategy of the digitalization of public administration.

CTC implementation tends to start in one specific area—like business-to-business invoices—and then broaden further. The final aim tends to be the digitalization of many or all documents which are relevant for tax purposes, affecting payroll, point-of-sale information, transport and logistics and many other areas. CTCs need to share a transparent understanding of the end goal from the beginning of the process, to help business and administrators with coherence and solution architecture.

Cooperation

CTCs must be based on a shared common understanding between tax administrations and taxpayers such as private businesses. Key aspects of this include feedback from early adopters, close working relationships between the two parties when new CTC processes are implemented, and ongoing work and sharing to supply best practice findings and economic analysis.

Introducing or Changing CTCs

• Compliance timelines: both initial implementation and changes to CTC systems need clear implementation timelines and specifications communicated to end users, allowing them enough time to design and set up the systems that they will use. End-to-end testing should also be available to the taxpayer to test their set-ups with non-production invoices.
• Clear and exhaustive guidance: CTCs need to be introduced with technical, legal and process guidance for taxpayers, complete and available from one authoritative source.

Data Protection/Privacy

It is crucial that whoever oversees the CTC system treats the submitted data in accordance with legal norms for data privacy, protection and security. This should be prioritized during the designing of the system.

Trade Impact and Non-Discrimination

The CTC system should be designed to be as non-discriminatory as possible, especially between resident and nonresident service and technology providers. Non-domestic companies should be able to adhere to CTC requirements without mandatory usage of local technologies or vendors to do so. This must also work for nonresident vendors, who must be able to obtain credentials and gain access to CTC platforms subject to the legal requirements necessary.

The Importance of the Principles

In the tax world, we find ourselves at a crossroads: there is a sweeping desire to digitize and update processes, but also various political and practical constraints forcing countries to find their own models to gain these benefits. For the modern international business, this can descend into a nightmare of dozens of technologies, laws and time frames, which are constantly shifting.

But the future looks bright with major bodies such as the ICC recognizing the challenges and bringing together administrations and businesses to work towards a more seamless future. Time will tell about the impact of the principles as further tax regimes begin to future-proof, but the foundations have been laid for an easier future for businesses across the world.

Christiaan van der Valk is VP of Strategy with Sovos.The ICC Commission on the Digital Economy approved his proposal to put together a dialogue between practitioners and executives from businesses and tax administrations on the subject of CTCs, and he was directly involved in the development of the ICC principles.

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.