How and why are EU economies digitising VAT collection?

By Christiaan Van Der Valk, VP of Strategy and Regulatory at Sovos

Traditionally, indirect taxes like VAT require businesses to play the role of tax collector, interpreting and following complex rules around the applicability and rate of taxation. This inevitably leads to gaps between expected revenue and actual revenue collected – be it due to honest mistakes or intentional tax evasion. For instance, the latest data available show the EU’s current VAT gap sits at around 11%.

For decades, complex, time-consuming audits were governments’ key tool for closing the VAT gap. But across Europe, we’re now seeing the sweeping digitisation of VAT collection, significantly enhancing authorities’ visibility into the transactions happening on their turf. This completely changes how businesses – especially those which operate across multiple jurisdictions – must approach internal VAT reporting processes and structures.

Let’s look at two methods EU tax authorities are using to digitise VAT – and examine how they’re affecting multinational businesses.

CTCs – the rise of real-time transaction reporting

CTCs (continuous transaction controls) require businesses to submit transactional data in (near) real-time to a digital platform designed by their local tax administration. CTCs are nothing new. In fact, they originated in Latin America back in the early 2000s and have long been widespread across the continent. European adoption of CTCs has been much more gradual, due in part to pre-existing tax enforcement infrastructure and e-audit advances.

Recently however, we’ve seen a significant uptick in the rollout of CTCs across the EU. Italy and Spain have led the way, with Poland and France also recently embarking on their own CTC journey. It’s worth noting that there’s no standard European model for this. EU rules dictate that each tax authority can set up its own regime, so these tend to vary significantly by country. However, the basic three step principle stays the same:

1. Suppliers send an invoice in a specified format to tax authorities or licensed state agents. This typically includes a form of supplier authentication, as well as integrity controls on the invoice data. The tax administration may either return an approval code, or simply send the invoice to the buyer.
2. The invoice is sent to the buyer using a method required or allowed by law.
3. On receiving the invoice from the supplier, the buyer typically conducts a final compliance check with the tax authority. If the tax administration platform sends the invoice to the buyer, formal compliance of the invoice is implicit.

Looking forward, we can expect CTCs to quickly become the norm across Eastern and Southern Europe. However, adoption will likely be slower in Northern Europe. It’s expected that the roadmap for CTCs will become clearer after the European Commission publishes its recommendations following its VAT in the Digital Age initiative.

Europe’s SAF-T renaissance – powered by big data

SAF-T (Standard Audit File for Tax) is an international standard for the electronic export and auditing of tax accounting data in a standard format. Much like CTCs, it’s also nothing new. The OECD’s Committee on Fiscal Affairs first created SAF-T way back in 2005, allowing governments to freely adapt it to suit audit systems, or use it as a basis for prefilling tax declarations.

What warrants the inclusion of SAF-T in this list is that we’re now seeing more European countries implementing the standard – Romania and Hungary in 2022, and potentially Ukraine in 2023.

SAF-T enhances how tax administrations audit for both direct and indirect taxes. In a nutshell, this means tax authorities no longer need to physically visit businesses to extract and interpret wide-ranging corporate data. Instead, businesses will send them a standard machine-exploitable format with detailed transaction information. It’s worth noting that data format and the method of data disclosure varies by jurisdiction.

The emergence of AI and ‘big data’ technologies have likely catalysed this recent SAF-T renaissance in Europe. It’s now significantly easier for tax authorities to ‘digest’ enormous quantities of transaction data and spot any suspicious patterns.

What do these trends mean for multinational businesses?

In times of economic turbulence, VAT digitisation is a no-brainer. Firstly, it enables governments to raise more tax revenue by closing the VAT gap. One area of focus for EU tax authorities is supply chain VAT, which is particularly prone to both errors and fraud. Within the EU, VAT is paid on goods and services supplied, as well as the intra-community acquisition of goods and import of goods. Applied correctly, it should be cost neutral for most businesses. However, too many multinational businesses overlook the impact of indirect taxes like VAT when building out their global supply chains, leading to unnecessary confusion which may soon be penalised.

Secondly, digital VAT reforms enable authorities to benefit from granular, up-to-the-minute economic data. This data is gold dust and can provide better models on the impact of fiscal or monetary policy interventions, which we’re likely to see more of as EU economies grapple with inflation and rising energy prices.

To prepare themselves for the inevitable and ensure resilience, multinational businesses should start working to digitise internal processes and structures around tax compliance and reporting. Within this, they must also consider VAT compliance when building their supply chain strategy. Those who fail to act now risk potential operational disruption and cashflow issues further down the line.