Moving toward continuous transaction controls 

Christiaan van der Valk is VP of Strategy at Sovos Tax authorities around the world are committed to closing the VAT gap and are willing to use all the tools at their disposal to collect any revenue owed to them. As a result, continuous transaction controls (CTCs) have emerged as a primary concern for multinational companies looking to remain compliant with increasingly diverse VAT enforcement approaches. But such controls are nothing new. Before we look at the current environment, we’ll take a brief look at how we got here, and why. Introduction of controls Any company that trades beyond its national borders will inevitably have to contend with fast-changing and diverse local legislation, not least that around taxation. Until about twenty years ago, such challenges would have been concerned with accounting procedures, report filing, and the retention of documentary evidence. But, as businesses began to digitise their internal administrative workflows as a means of improving efficiencies, so they began to replace manual, paper-based invoicing processes with electronic alternatives. Bureaucracy and logistical complexity meant governments were slow to catch up, though, a fact that became increasingly problematic as more businesses adopted paperless invoicing processes. Tax authorities are, after all, extremely interested in an organisation’s invoices. Without the right tools to effectively audit companies’ digital invoice flows and archived transaction data, and without reliable guarantees of the integrity and authenticity of businesses’ digital workflows, many tax authorities were - understandably - reluctant to allow businesses to progress to full electronic, or e-invoicing. This frustration accelerated these authorities’ digital transformations, and saw the introduction of controls that would forever change the nature of VAT reporting. Closing the VAT gap Contributing more than 30 percent of all public revenue, VAT - which is sometimes also called Goods and Services Tax, or GST - is the most significant indirect tax for most of the world’s trading nations. As many governments use invoices and periodic reports summarizing sales and purchase invoices as primary evidence in determining the value of VAT, owed to them by organisations, the taxpayer itself plays a critical role in assessing the tax. VAT, therefore, depends on organisations meeting legal obligations as an integral part of their sales, purchasing, and general business operations. This, in turn, requires tax authorities to exert some control over business transactions, typically in the form of audits. Despite this, however, incidents of fraud and malpractice often mean that governments will collect far less VAT than they’re actually owed. This VAT gap is by no means insignificant. In Europe alone, it amounts to around €140 billion every year - 11 percent of expected VAT revenue. It’s little surprise, then, that tax authorities are enforcing various legal consequences for irregularities in VAT reporting, including administrative fines, protracted audits, and even sanctions under criminal law. While Europe has been slow to adopt digital tools to modernize the enforcement of VAT, over the last two months the EMEA region has seen huge shifts in government-enforced initiatives around tax enforcement, and these changes are set to continue throughout 2021 and beyond. Here, then, are a few of the key trends that could transform the way EMEA organisations approach regulatory reporting and manage compliance. Stricter, more frequent VAT reporting processes Rather than copying programs successfully implemented by Latin American governments in the past decade by imposing a clearance approach to e-invoicing, in which tax authorities take an active role, validating an invoice before the transaction is complete, many EU member states are taking smaller initial steps towards CTCs by first making their existing VAT reporting processes more granular and more frequent. Typically, member states can organise reporting processes, such as those concerning VAT returns, whichever way they like. But Article 234 of the EU VAT Directive contains much narrower constraints when it comes to e-invoicing, stating that they “may not impose on taxable persons supplying goods or services in their territory or any other obligations or formalities relating to the sending or making available of invoices by electronic means.” In an effort to bypass these constraints, countries including Poland, Spain, Hungary, and the UK (when it was still part of the EU) have over the past years introduced VAT reporting requirements that stop short of actually requiring digital invoices to be exchange, but that instead require companies to submit digital files with more granular transaction data - and often on a more frequent basis than traditional VAT returns. Since 2017, for example, all companies in Spain have to report inbound and outbound invoices within four days while, in Hungary, suppliers have had to report their sales invoices in real-time since the new requirements were introduced in 2018. EU e-commerce package and digital services Changes are being made to existing legislation established in 2015, extending the system to increase and facilitate reporting for taxable persons and intermediaries such as marketplaces for both intra-EU and external low-value goods and digital services sold to European consumers online. The EU has, for some time now, been gradually introducing new regulations to ensure that VAT on services is more accurately accrued in the country in which those services are consumed. Since January 2015, for example, the supply of digital services has been taxed in the EU country in which the end customer is located, usually resides, or has their permanent address. These changes have been accompanied by the introduction of a ‘one-stop-shop’ (OSS) system aimed at facilitating reporting for businesses and their representatives or intermediaries. Currently still expanding, this OSS system is set to play an important role in the EU e-Commerce VAT Package, which is due to be implemented in July 2021, and under which all goods and services - including e-commerce-based imports - will be subject to intricate new regulations around cross-border VAT reporting, as well as to changes in the way customs in all EU member states operate. SAF-T is here to stay The Organisation for Economic Co-operation and Development’s (OECD’s) Standard Audit File for Tax (SAF-T) will remain an inspiration for European tax administrations to obtain copies of taxpayers’ entire accounting books on their own systems. According to the OECD, SAF-T was designed to aid tax authorities in auditing both direct and indirect taxes, such as VAT, covering the “full set of business and accounting records commonly held by taxpayers.” A flexible standard, with the option for OECD members to adopt or adjust it as they see fit, SAF-T was adopted by Portugal in 2008. Originally designed to facilitate controls in a post-audit world, in which an audit is carried out long after a transaction has taken place, the SAF-T standard is nonetheless compatible with CTCs. In time, it could even evolve to complement them, given its ability to allow the periodic or on-demand provision of a variety of accounting records including but not limited to transactional data. Mandatory e-invoicing could be on the cards The Italian treasury was able to successfully recoup as much as €1.4 billion in VAT revenue in the first six months after mandatory e-invoicing was introduced in the country. Spurred on by this success, more European countries are determined to follow suit. In France, for example, e-invoicing for B2G transactions is already mandatory, with the last stage of its implementation rolled out at the beginning of January 2020. Since then, the French government has announced its intention to extend this mandate to cover all B2B transactions by 2025. According to an initial outline of the proposed e-invoicing reform, published in November 2020, France will follow the clearance method whereby invoices need to be submitted to a CTC platform before they can be considered legally valid. Following its implementation, certain flows not covered by the mandate, such as B2C and international invoices, will instead be subject to an e-reporting obligation. Poland’s Ministry of Finance has also taken concrete steps to implement a CTC system, based to some extent on the Italian model, at some point in 2021, while many other European countries, where e-invoicing is already mandatory for B2G transactions, are likely to follow suit and extend their mandates to B2B and other flows over the coming years. ‘Own the Transaction’ CTC model becomes more popular More tax administrations are looking not only to receive data from companies’ business transactions, but also to use legislation to make themselves the actual invoice exchange platform. Using the CTC platform in this way takes a tax authority’s interest in the exchange of data between the supplier and the buyer a step further than the classic clearance model. Fundamental to the design of the CTC function of Italy’s platform, its popularity appears to be growing as the adoption of CTCs spread eastward across the globe. It constitutes a core concept in both Turkey and Russia’s CTC legislation, for example. Jordan and Saudi Arabia appear to be moving in a similar direction, too. Both countries are exploring the concept of fully operating - or fully controlling, at least - the data exchange networks that underpin their respective national e-invoicing frameworks. The other digital transformation Businesses everywhere are undergoing a form of digital transformation, turning to technology in a bid to improve efficiencies and productivity and reduce costs. As part of this, the widespread adoption of electronic invoicing was of great concern to tax authorities, frightened of losing control over revenue collection. Looking to close their country’s VAT gap, many have now undergone a digital transformation of their own, employing CTCs in order to collect transactional data from suppliers and their customers. Wary of legal constraints within the EU VAT Directive that make it difficult to make e-invoicing mandatory, many EU member states have instead initially focused on making existing VAT reporting processes more granular and frequent via CTC reporting. In time, though, it’s likely they’ll adopt requirements for real-time - or near real-time - invoice transmission to the tax authority. As it stands, Italy is currently the only EU country to have fully implemented mandatory clearance e-invoicing, although this did require it obtaining an EU derogation from two Articles of the VAT Directive. As mentioned earlier, the Italian treasury was able to recoup €1.4 billion in VAT revenue in the first six months of mandatory e-invoicing. So it’s not surprising that more countries across Europe, such as France, Hungary and Poland, are beginning to follow its example. As more countries adopt CTCs, it’s likely that various forms of continuous VAT controls will co-exist, effectively forming an end-to-end audit package, allowing tax authorities to match transaction data from different periodic, real-time, and near real-time sources. Keeping track of and complying with the various types of controls can be problematic to businesses, though, especially those with a global footprint. Organisations can have a number of different priorities as they undergo a digital transformation - addressing different imperatives among lines of business, the need to find a productive balance of power between corporate functions and subsidiaries, and the impact of mergers, acquisitions, and divestments among many others. But, given ever stricter penalties for non-compliance, it’s vitally important that businesses make it a priority to understand how this other digital transformation is unfolding. Otherwise, as governments across the world look to close their VAT gap, they could easily find themselves swept up in a tsunami of global CTCs.
As more countries adopt CTCs, it’s likely that various forms of continuous VAT controls will co-exist, effectively forming an end-to-end audit package