For too long, there was scant attention paid by businesses across the globe to the paradigm shift in transaction tax enforcement. Thankfully, however, many corporations have recently heard the wake-up call and are starting to look for effective measures to stop tax regulation from undermining their digital transformation agendas.
Clearance, where the approval of a tax administrator is crucial to stating that a business is tax compliant in regards to a specific event or transaction, is a growing area of indirect tax reclamation. In fact, most experts believe that this is what tax administrations across the globe are working towards as their dominant method of their continuous VAT control systems. Think about it: clearance may be required for anything from tenders and bid applications, to emigration, to general proof of good standing.
Still, clearance is difficult and, in some ways, can be seen as a complicated procedure. One false move and a business or supply chain could well be plunged into turmoil as they grind to a halt. Effectively, clearance of business transactions is open-heart surgery on the lifeblood of SMEs and multinational supply chains alike. Together, these organisations drive the world’s economy, which citizens depend on to collect public revenue. Tax administrations engage willingly and knowingly in this economic balancing act, as they have no other choice.
But clearance and similar tax digitisation approaches can also have undeniable benefits in terms of claiming appropriate levels of tax without the friction and administrative burden caused by clumsy form-based VAT returns and the subjectivity of manual audits. These new methods of auditing transactions much closer to the moment that they occur have the potential of being ‘under the hood’ of business applications, rather than the cumbersome and separate tax compliance processes that companies are forced to maintain today.
At any rate, clearance systems are only going to increase. Originating in South America, the waves lap ever-closer as established European economies such as Italy have now added in real-time e-invoicing, clearance-based systems.
The division between reporting and clearance
First of all, it’s important to distinguish between clearance and reporting — and terminology tells only half the story. Reporting is the one-way electronic submission of business transaction data to tax administration platforms. Historically this has revolved around the obligation on businesses to file periodic VAT returns and similar reports in countries with other indirect taxes (like sales tax in the US).
Recently, some European and other countries have started moving the digital version of these reports from online forms to more automated versions by increasing the granularity and frequency of these reports. Crucially, reporting means that there’s no need for approval from the tax administration for the relevant data and continued business processing to be valid from a tax perspective.
By contrast, clearance does require the tax administration’s approval of data transmitted to it in real-time — so SMEs and enterprises alike should ensure they’re aware of the difference.
Delving into the intricacies of these differing types of tax digitalisation, companies need to be cognisant of some important organisational and IT consequences of the difference between digital reporting and clearance. Because online technology is involved these processes may look similar, but it is important to consider that reporting and invoicing are historically dealt with by very different teams and systems in most companies. VAT returns and other forms of periodic reporting are usually the purview of tax teams which have time and tools to manually gather and curate data from different systems that they then consolidate into reports.
As reporting requirements move away from filling out – online or offline – forms towards the transmission of data files with transaction information, businesses must prepare for migrating these processes away from manual tax routines and into their transactional systems that manage the exchange of sales and procurement data with customers and suppliers.
In the case of clearance systems, however, tax administrations obtain production data from such transactional system ‘on the fly’ and create a major new risk in the automation of physical and financial supply chains because they must clear this information before the trading partners can perform specific subsequent steps towards completion of the transaction. The tiniest error in an invoice or inconsistency with other documents your trading, logistics or finance partners submit in real time, and your supply chain can stop in its tracks.
Each method enables tax administrations to leverage modern technologies in such a way as to get their hands on data more swiftly than ever before. Since the price of transferring and storing data has decreased significantly over the years, both methods nowadays usually require taxable persons to send the tax administration in question one set of invoice data at a time. As such, it’s understandable that the non-initiated observer views these methods as more or less the same. One fundamental difference between the two, however, becomes illuminated when looking at the data that is transferred from the taxable person to the tax administration.
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Deeper than definitions
The first method of digital audit-based reporting often requires many different file formats. While some countries, such as Spain and Hungary, define their own XML standard for these purposes, others — such as Portugal and Poland — are fully or partially based on the SAF-T specification issued by the Organisation for Economic Co-operation and Development (OECD). A SAF-T file contains invoice data as well as various other data about the underlying supply from the Enterprise resource planning (ERP) system, plus any other systems used by the reporting taxable person.
For the second method, clearance, taxable persons only need to send the invoice and any other business data relating to the transaction step that the tax administration seeks to receive, record, and approve. An example from the standards world (although not broadly adopted yet), that has been designed to support this process for invoices is the ISO 20022 Invoice Tax Report message.
In terms of why these systems are growing in popularity and what the future holds for Europe with regards to them becoming active, it’s important to first paint a picture of history. Between 2000 and 2010, the first clearance implementations arose in countries like Chile, Mexico, and Brazil, which were inspired by this high-level process template. Since then, countries in Latin America and across the world have introduced similar systems, but each time introducing local variations.
Over the past few years, EU countries have increasingly turned towards the real-time and near-real-time controls that have already enabled many countries in Latin America to narrow their VAT gaps. Italy, for example, is migrating rapidly to a fully real-time clearance by repurposing its online service for the management of public procurement messages. In tandem, Hungary has chosen a reporting model that requires real-time registration of invoice data in electronic format, but the invoice exchanged between the parties doesn’t have to be electronic and the tax administration doesn’t clear the transaction as such.
Making tax digital by April 2019
The full consequences from a tax collection perspective of these first countries implementing continuous VAT controls have yet to be seen. However, if they are as encouraging as those published in Latin American countries, it is reasonable to expect that more countries in Europe will follow their example. In the UK, when it comes to clearance, the current position lacks clarity. Still, considering the legislation that says it’s imperative for every company in Britain to make tax digital by April, the UK may follow Italy’s suit after not too long.
In the business world, over time, VAT compliance will be based on computer code, not law — a development that holds the promise of making tax simpler, more objective and less cumbersome to administer. Tax administrations will have to collaborate towards harmonisation and standardisation for these benefits to outweigh the costs to trade and commerce of today’s cacophony of digital tax mandates.
If a reasonable level of standardisation of continuous control technologies can be achieved among countries, in cooperation with the businesses that have to comply with them, these new approaches can go a long way towards removing remaining frictions and risks from business transactions and benefit all of society — everything from enterprises to SMEs to the citizens that depend on their services and revenue.