Robert Kugel's Analyst Perspectives

Automation Addresses VAT Tax Challenges

Written by Robert Kugel | May 16, 2024 10:00:00 AM

Value-added tax is a consumption tax levied at every point in a supply chainfrom production to final sale. It’s based on the difference between the cost of production and the selling price of a product or service, or the value added. Sales taxes are different in that they are generally collected only at the final point of sale to the ultimate consumer. Enterprises collect the value-added tax from customers when they sell goods or services and remit the collected VAT to the relevant national or local government entity. This method is used in many countries as an efficient way to collect tax revenue while reducing the potential for double taxation at different stages of production and distribution.

VAT tax automation refers to using technology and software to streamline and manage Value-Added Tax compliance processes. This can include automating the calculation, reporting and filing of VAT returns and ensuring enterprises comply with VAT regulations and requirements. VAT tax automation can help businesses be more productive, cut costs, reduce errors and ensure compliance with tax laws.

Governments around the world are looking to increase tax revenues and the efficiency with which they collect them. Many countries are moving toward digital VAT reporting and compliance, requiring businesses to adopt digital systems to manage VAT obligations. In fact, ISG-Ventana Research asserts that by 2027, at least one-half of enterprises in countries that levy value-added tax will use software automation to adapt to increasingly complex and demanding regulatory regimes and reporting requirements while ensuring accurate and efficient compliance.

In addition to making tax collection faster and more efficient, countries hope automation will increase revenue by eliminating non-compliance and fraud. One simple form of non-compliance is not filing a tax form and not paying the tax owed. This scheme involves issuing fake invoices to claim illegitimate input tax credits, overstate expenses or underreport sales. A complex example of fraud is the so-called carousel, describing the circular way transactions flow through a fabricated supply chain created by a group of legal entities working together to sell (or pretend to sell) goods to each other. There are many permutations of how this is carried out. In most cases, at least one entity, known as the “missing trader,” charges and collects the tax but does not remit it, shutting down without a trace shortly thereafter.

To improve compliance and reduce fraud, countries are making a fundamental shift in how tax-related data and payments are collected, going from a push model to an approach where tax authorities pull the data from businesses, increasingly in a digital format. Because there are two sides to a transaction, digitizing VAT data at the source facilitates the discovery of unmatched transactions and the detection of suspicious activities. Applying artificial intelligence techniques to these large data sets can increase the chances of spotting non-compliance and fraud.

Because time is of the essence for enforcement, countries are also implementing real-time reporting requirements for VAT transactions. “Real time” in this sense is relative; in the context of tax, it does not mean the same thing as in computing and may refer to intervals of several days. There are three general forms of tax reporting, including:

  • Real-time reporting: As the name implies, enterprises are required to provide VAT-related data in a specified form at the time of the transaction or shortly thereafter.
  • Electronic invoicing: With this real-time reporting, taxpayers submit transaction details or invoices electronically. To help ensure full compliance, in some jurisdictions, businesses cannot complete a transaction with a customer until it is registered in real-time with tax authorities. This is similar to credit card authorizations except that the necessary VAT information is collected.
  • Standard Audit File for Tax: The Organization for Economic Co-operation and Development attempted to create a standard electronic format to facilitate tax data collection. Despite its name, there are significant variations in this format across countries.

The list of countries requiring rapid digital reporting is long and growing, including:

  • The United Kingdom, where the Making Tax Digital for VAT regime went into effect in 2019 for most U.K. VAT-registered enterprises. Businesses must push the VAT return data directly from an ERP system or spreadsheet to His Majesty’s Revenue and Customs systems.
  • Spain, which requires certain businesses to electronically submit invoice information to tax authorities within a few days of issuing the invoice.
  • Italy, with its Sistema di Interscambio system, which mandates the electronic submission of invoice data to tax authorities at the time of issuance.
  • Hungary, which has implemented real-time reporting for certain enterprises, requiring submission of invoice data to tax authorities in real time or near-real time.
  • Poland, with Jednolity Plik Kontrolny, its version of a reporting system.
  • And China, which implemented its Golden Tax Project in the 1990s to combat a high incidence of non-compliance. China mandates using information technologies to collect and submit data to a centralized matching system under the control of the tax authorities to reduce the incidence of fraud.

Moreover, tax authorities are increasingly using advanced data analytics and AI to identify patterns and anomalies in VAT transactions, enabling the effective detection of potential fraud. Tax authorities also collaborate across borders to share information and intelligence on inter-territorial transactions, enabling them to identify and address VAT fraud that spans multiple jurisdictions. (In the U.S., a similar approach was adopted by individual states decades ago to ensure that out-of-state vehicle owners paid their parking tickets.)

Indirect taxes include VAT as well as sales and use taxes in the U.S. and other countries. This also includes general sales tax in countries such as Canada. Compared with fiendishly complex indirect tax countries such as Brazil, India and the U.S., VAT is straightforward but can still be demanding, especially for enterprises that operate in multiple countries, which is common in Europe. Initially, there was some level of standardization in the European Union, but rates have increased and diverged across the EU, and their application has evolved differently in member states. Moreover, taxing digital products to increase revenue has been increasingly popular. Automation can help ensure that businesses remain compliant while boosting productivity and reducing risk.

VAT tax automation uses technology to streamline and manage compliance processes, including calculation, reporting, and filing of VAT returns, ensuring enterprises comply with VAT regulations and requirements. This involves automated data collection, as software collects and aggregates transaction data from all necessary sources, including sales, purchases and expenses. Doing so can make the accounting staff more productive, especially if the data must be collected from multiple systems, and substantially reduces the risk of errors and omissions. The software applies the correct rates to calculate the VAT due on transactions and generates invoices with the appropriate VAT amounts based on the applicable tax rates.

In principle, VAT can be a straightforward form of taxation. In reality, the subtle differences between, for example, whether a bakery item should be taxed as a cookie or a cake make application more complicated. Automation software subscriptions typically monitor changes in VAT regulations and ensure that enterprises remain compliant as rates and classifications evolve. Systems typically generate country-specific reports and filings and, in some cases, facilitate electronic submission to tax authorities.

Centuries ago, Louis XIV’s finance minister, Jean-Baptiste Colbert, is supposed to have said that the art of taxation is plucking the goose in such a way as to procure the largest quantity of feathers with the least amount of hissing. In search of revenue, governments are now making tax calculations more complex with selective adjustments to rules and rates to avoid hissing from more vocal constituents. And to ensure compliance and reduce fraud, tax authorities are increasingly imposing digital, real-time filing. In response, I strongly recommend that enterprises adopt VAT tax automation, which is available either as part of an ERP system or as a stand-alone product.

Regards,

Robert Kugel