Rob Janering explores the impact of real time reporting and digitisation on VAT compliance in the EU.
At the time of writing this article, there has been a flurry of stories published that detail how Europe is continuing to struggle with the “VAT gap”. The VAT gap represents the difference between expected VAT receipts and what is actually received. On latest estimates, its value is around €150 billion with at least a third being lost to fraud.
The EU has made reducing the VAT gap one of its primary objectives and to this end there are a number of projects underway to achieve that. This includes the introduction of a VAT mini one stop shop (MOSS) in 2021; a fundamental change to the rules for B2B intracommunity movements of goods from summer 2022; and the quick fixes from January 2020.
However, whilst all these actions will help to reduce the gap, many EU member states are taking unilateral actions of their own. The availability of new, emerging technologies is facilitating this, and consequently the landscape surrounding VAT compliance is beginning to change at a rapid pace. Businesses will find it almost impossible to avoid being impacted, so the need to manage and adapt to the new environment will be crucial.
Because there are so many changes happening at once, we’ve broken them down and given a short explanation below of each one.
VAT is unique in that although its burden ultimately falls on the end consumer, it is the supplier of the goods or services that has to collect and remit the tax. Historically, though, tax authorities have only received information about the VAT collected by businesses when periodic VAT returns are submitted. These are often received on a monthly or sometimes quarterly basis, some time after the relevant transactions have taken place.
The information displayed in these returns is also limited with respect to allowing the tax authorities visibility as to whether the amount of VAT declared is correct. For instance, the UK VAT return has just nine boxes to complete, with two of those reserved to show the total sales and purchases made. Other EU member states havE more complex detailed returns to complete, but the level of information shared usually ends at a breakdown showing the value of supplies made subject to different VAT rates.
To combat these shortcomings, many tax authorities have added a requirement to submit transactional records which show details of the supplies made, such as descriptions, values and VAT treatment applied. Visibility of these records allows the tax authority to be much better informed and allow it to challenge incorrect tax treatments. It also allows tax authorities to compare the data provided by the supplier and the customer in a transaction, to see if it is consistent.Previously, this would not have happened unless a tax inspector visited the business or records were requested as part of an audit.
The methodology of choice to do this across Europe appears to be via the Standard Audit File for Tax (SAF-T), an OECD conceived creation. Poland, Portugal, Luxembourg and Austria are just a few of the nations that require businesses to submit these records. However, the issue for business is that at the moment most of these SAF-T requirements have different properties. The information that Poland requests is therefore not consistent with, say, that which Portugal wants to see. And on top of that, the entities required to submit the files also differ across countries with the obligations applying to all businesses in some locations but restricted in others. All of this creates complications and a lack of certainty for business.
The EU is reportedly looking to create a standardised SAF-T but at this point in time, there are no details on that and it’s not clear what power it would have to enforce its adoption. Therefore, the challenge for business is to ensure that different reports can be created that meet all the different requirements; and also that the submission of these is managed in a competent way to remain compliant.
Real time reporting
Real time reporting (RTR) is an evolution of transactional reporting, in that it requires the submission of information relating to individual supplies. However, the point that differentiates RTR is that instead of supplying the information on a monthly or quarterly basis, it must be submitted in or close to real time.
For example, Spain implemented the Immediate Supply of Information (SII) obligation in the middle of 2017, which requires information to be submitted within four days. In Hungary, though, the timescale is to report the transaction immediately (at the time the invoice is issued) and this also must be done without human intervention. Greece is likely to be the next member state to make RTR obligations. Unfortunately, however, there is an inconsistency in approach as to how member states must comply with the rules: Spain requires all businesses subject to revenue thresholds to comply, whilst for Hungary it is restricted to established businesses.
It was in South America where RTR was first developed and hence it’s no surprise that Spain was an early EU adopter of the process. The advantage it gives to tax authorities is that transactions can be monitored as they happen and thus errors or mistakes picked up more quickly when compared to receiving periodical reports. This can be done with greater efficiency because some of the reports include details of both supplier and recipient, allowing for comparisons to be made. Given that VAT is a transactional tax being accounted for all the time, this is very important to help with the battle against fraud and reduce the VAT gap.
The downside for business is that RTR requires an investment in new technology and processes. In Spain, it’s enough to access a portal which can connect with the tax authority and, if automation of reports is not possible, have someone manually create and upload them. In Hungary, though, the need to submit information and have no human intervention means that business software and systems must be able to run the required reports, format them and then communicate that to the tax authority. In both countries, non-compliance can lead to significant financial penalties.
Another South American invention is e-invoicing. This differentiates itself from the two other types of reports described above because it requires a business to submit details of its transactions to the tax authority ahead of the supply taking place. The tax authority verifies the transaction and then, if satisfied, issues the VAT invoice to the recipient on behalf of the supplier.
This method means that the tax authority can effectively act as an adjudicator before the supply takes place and ensure that the right tax treatment is applied. It eradicates the need to adjust any errors because, in theory, they should not happen. It also gives visibility on the tax payable and repayable in real time, which helps the tax authority to manage its fiscal position.
At the moment, many EU member states require e-invoicing to be applied when businesses make supplies to public bodies. However, Italy and Hungary have rolled the obligation on to supplies made between businesses with Hungary, adding an approval number to the system which the recipient needs in order to deduct any VAT costs. This helps to push compliance because, if that does not happen, VAT costs will be irrecoverable.
This requires the supplier to access a tax authority managed central portal and ensure that transactional information can be uploaded to verify and help create the invoice. In that respect, it is similar to RTR and hence creates the same obligations to understand and better manage transactions. The pressure to do this is increased, though, because getting it wrong will lead to financial penalties and non-issue of the invoice, which could prevent customers from paying.
VAT compliance is only going in one direction, but this shouldn’t be seen as a negative or problem by businesses. Digitisation, when harnessed properly, can bring real benefits. For example:
In the UK, HMRC’s requirement that businesses stop filing VAT returns by manually filling in boxes but instead via an automated API link should reduce errors. For instance, transposition errors could lead to overpayments of VAT or amounts being erroneously claimed for, which then require time and effort to explain.
A review of the VAT treatment applied to sales and purchases, to ensure that transactional data is correct, will give certainty that the correct amounts are being declared and recovered. If this has not been right in the past, then opportunities might exist to charge lower, more competitive prices or to increase VAT recovery and reduce overall costs.
To meet the growing demands of tax authorities, businesses will need to make some investments. Whether this is a review of data flows, checks on the VAT treatment or the purchase of new software, meeting the new compliance obligations will help to ensure that costly penalties and tax audits are minimised, whilst benefits are accrued to the business. Embracing this new future won’t be easy but doing so will make the process far easier than it might be.