Why India’s tax reforms are big news for international commerce 

Filippa Jörnstedt is a Regulatory Counsel at Sovos Indirect taxes such as VAT and GST account for more than 30 percent of all public revenue. When you consider the huge significance of their contribution, it’s little surprise that countries across the globe are looking at which technical means they can employ to maximise the collection of these taxes, and minimise levels of reporting fraud. Following in the tentative footsteps of nations such as the UK, which recently rolled out its Making Tax Digital initiative, this year will see India making a significantly bolder move toward digitisation of tax control. As part of a larger overhaul, the country has recently begun to tighten up its tax processes with the introduction of mandatory invoice clearance. But clearance e-invoicing is nothing new – in fact, it’s been almost two decades since it was successfully implemented in some Latin American tax regimes. So, what has prompted the Indian government to take this step now? And what will it mean for international businesses whose supply chain runs through India? Transforming India’s tax landscape After many years of discussion and negotiation among different stakeholders in the country, the Indian Government finally implemented a Goods and Service Tax (GST) in July 2017. Designed to replace and consolidate most of the existing taxes levied on goods and services at both state and federal level, the reform represented a significant simplification and streamlining of the country’s tax processes. The timing of this reform was no accident. India – in common with many other Southern Asian countries – is undergoing a seismic shift with regard to its industry and trading. The decision follows re-evaluation of the tax collection process and the challenges posed by a rapidly developing economy. As such, it’s moved from a concern to a key priority in order to support the country through this period of accelerated industrial growth. As a result, the regulation and monitoring of all transactional activity have now come into focus. To date, India’s taxation system has been largely paper-based. Although it does allow invoices to be exchanged in an electronic format, this tends to take the form of PDFs, and is still very much the exception. What this means is that India is currently a ‘post-audit’ jurisdiction, where the tax authority has no operational role in a company’s invoicing process and must rely instead on yearly audits as well as the periodic transmission of reports by the taxpayer. Seeking to address this, the Indian GST Council announced the formation of a special group of government appointees in early 2019 – the ‘Committee of Officers (CoO) on Generation of Electronic Invoice Through GST Portal’ – with the stated purpose of investigating the potential implementation of a mandatory e-invoicing system. The CoO was specifically tasked with analysing the clearance system currently being used by South Korea and comparing it to similar systems used with great success throughout Latin America and further afield – in Italy, for example – in order to better understand global best practices. From our experience at Sovos, countries broadly follow one of two paths: either mandatory real-time invoicing or real-time reporting. Some confusion is forgivable Following an announcement that India was going to make e-invoicing mandatory from 2020, the CoO was further tasked with assessing to what extent the country’s existing state-controlled platform – its GST Network – could serve as the central hub in a clearance-style e-invoicing process. In addition, it was specifically asked to investigate how the country’s existing eWaybill system, regarding the intra-state transportation of goods, could be recycled into a mandatory e-invoicing system. The CoO was then split into two sub-committees, both reporting to the Indian GST Council but working on parallel tracks – one on legal and policy matters, the other on developing technical specifications. These two working groups derived a form of legislation which requires taxable persons, or their service providers, to exchange B2B transaction data with the tax authority via a government online platform (IRP). Now, before a supplier can issue an e-invoice, that invoice must be authenticated through the generation of an Invoice Reference Number (IRN) by the IRP. This IRN, that will be generated by the IRP, will be necessary for invoices to be considered fiscally valid. The new system is set to be rolled out in several phases for B2B and B2G transactions, with the first phase already being implemented – albeit on a voluntary basis. The first mandatory phase is scheduled for 1st April 2020 and is intended for companies grossing above approximately USD 14 million to begin with. Over time, though, the government plans to make compliance with the new legislation mandatory for all B2B and B2G taxpayers, focusing on different-sized companies at different stages. What’s more, it’s also likely that the scope of the invoice data reporting regime will evolve and could turn into something far more complex. Even the way it’s currently being referred to is ambiguous and certainly not helping with clarity – most refer to the reform as an ‘e-invoice clearance system’ but in essence it doesn’t mandate the exchange of electronic invoices. In fact, it’s actually only referring to an exchange of invoice data and electronic reporting – so doesn’t actually mandate anything at all between two trading parties. With this in mind, the market could be forgiven for some confusion around which way the wind is blowing. It is true that, much like the eWaybill system that preceded it, the new process is based on the principle of the real-time or near-real-time generation by a central platform of an invoice number – in this case the IRN – which must then be included on the invoice itself in order for it to qualify as fiscally valid. But rather than entailing issuance of the invoice on a clearance portal, as is the case in Italy, this is a somewhat softer version of a clearance e-invoicing system. More than anything, it could even be described as pre-clearance without an e-invoicing mandate – after all, paper invoices (or PDFs) are still permitted. Managing international supply chains As a global manufacturing powerhouse, there will be many international businesses with supply chains running through India. These businesses must be especially diligent when it comes to their trading practices, or risk finding themselves facing charges of non-compliance with the latest regulations, with potentially damaging consequences. In addition to harming a company’s bottom line, for example, the resultant financial penalties could also jeopardise relationships with its customers, suppliers, and regulatory authorities. Compliance aside, the new system is also likely to prove disruptive to an organisation’s master data management. Until now, the checklist of information that by law needed to be included in an invoice issued in India would only have contained between around 20 and 40 items. The new system, however, is much more reliant on detailed data. From tax rates to issue dates, and dispatch-from to ship-to addresses, the new e-invoice standard schema comprises around 120 data fields, of which about 50 are mandatory. Taxpayers will be required to complete and upload these fields to the government’s GSTN using the machine-readable JSON file format. Only then will the IRN be generated and applied to the invoice by the IRP. It’s vital, therefore, that any organisation operating in India – as well as its suppliers and customers – is aware of the need to exchange significantly more invoice data than under the previous system. It’s worth noting too that, whenever reform such as this is rolled out, domestic businesses will immediately look over their existing processes to check that everything runs as it should. International businesses must take proactive steps to ensure they remain compliant. They simply can’t afford to be caught out. If they – or their trading partners – don’t issue invoices exactly as required by the new system, those invoices won’t be awarded the all-important IRN and won’t, therefore, be considered fiscally valid. No-one gets paid, and issues of non-compliance arise. A challenging economy India isn’t the only Asian country to transform its taxation system, of course. South Korea, Vietnam, and Taiwan are among other jurisdictions in the region to have also adopted similar models, in which the control infrastructure of electronic invoice issuance centres on government clearance. Given India’s physical and geographical size and its place in the global economy, not to mention the sheer scale of the reform itself and the extent to which this reform depends on new technology, the country can certainly be considered a front-runner in the region. There’s no doubt that other Asian countries will be watching its progress closely. If the new system is seen to work well and begins to prevent fraud and close the GST gap as intended, it won’t be long before other countries begin to follow suit. The actual nature of India’s economy represents something of a challenge, however. The roll-out structure of the new system is common to that deployed in most countries, and governments typically start with their biggest taxpayers, those responsible for the largest share of VAT or GST. To begin with, then, it will only affect the country’s largest companies. Those with a turnover of Rs 100 crore or more will be required to clear invoice data in the first instance, while those with turnover below this threshold will be able to participate on a trial basis. Once this threshold has been passed, though, it remains to be seen how much will change for the country’s smaller companies – of which there are an unusual amount. With a largely labour-based economy, 95 percent of companies in India are ‘micro-enterprises’ – one or two-people operations – compared to an average of 50 percent elsewhere around the world. But it’s here, at the smaller end of the spectrum, where most GST-fraud takes place. Respectful – perhaps even fearful – of the taxman, larger companies will tend to be ultra-diligent when it comes to reporting. After all, much of their global reputation depends on their being seen to stick to the rules. They need to be able to explain where their money is at any given time. In Europe at least, small to medium-sized businesses tend to be more prone to serious VAT fraud, the most serious of which is Missing Trader Intra-EU Fraud. By creating a structure of linked companies and individuals across EU member states, criminals are able to abuse both national and international trading and revenue-accounting procedures, essentially charging VAT on the goods they sell without reporting and remitting it to the tax authorities. Assuming the likelihood of similar schemes operating in India, it will only be when the country’s many smaller companies are required to comply with the new e-invoicing scheme that we will really begin to see what impact, if any, it is having on tax fraud and the GST-gap. On course for significant change If successful, India’s new e-invoicing system will be beneficial for both government and businesses alike. For one thing, it will provide greater transparency into the country’s taxation system, effectively putting the government closer to every taxable transaction in order to help close the GST gap and reduce fraud. What’s more, its use of the JSON-based e-invoice schema and associated APIs will help reduce the administrative burden on businesses, and continuous reporting will over time eliminate the need for manually-entered GST returns. But if international businesses are to continue trading in India without fear of falling foul of the new regulations, it is crucial that they – and their trading partners – ensure they remain entirely up-to-date with what’s required, whenever and wherever a change in those requirements may occur. Whatever the future may hold, it’s clear that, with this bold reform of its existing taxation processes, India is on course for significant change. E-invoicing has been a legal possibility and, indeed, a practical reality for a number of years now, with many companies already issuing PDF-based electronic invoices. As a result, the next step needn’t necessarily be a huge leap of faith. Given the size of the Indian economy, and the significant role it plays in global manufacturing, there’s no doubt that this reform of its invoicing and tax reporting processes will have a huge impact – not just on local businesses, but also on international commerce. And with more countries across Asia and the wider world set to introduce clearance-style e-invoicing and reporting systems over the coming years, the tax landscape will soon be transformed beyond recognition. If they are to continue trading across international borders, it’s important that businesses are ready to transform along with it.
Given the size of the Indian economy, and the significant role it plays in global manufacturing, there’s no doubt that this reform of its invoicing and tax reporting processes will have a huge impact