Why CTCs will be the lynchpin of the VAT landscape in years to come
Christiaan Van der Valk, VP of Strategy and Regulatory at Sovos shares his thoughts on the importance of continuous transaction controls (CTCs) within the VAT landscape in the UK.
EU countries suffered an immense loss of €134 billion in VAT revenues in 2019, due to tax fraud and insufficient tax collection systems. As well as this, the UK VAT gap from 2020 to 2021 was estimated at £9.8 billion. Based on these current trends, the EU have predicted that closing the VAT gap will take at least 13 years within its jurisdiction and the UK will also face the same challenge on a similar scale.
In light of these alarming statistics, it comes as no surprise that countries are rethinking their tax collection systems and turning their attention to digitisation. One key approach that countries globally are considering is the adoption of continuous transaction controls (CTCs). This will enable governments greater visibility into companies’ transactions and tax liabilities.
So how exactly are CTCs going to change the future of the tax landscape? Let’s delve into how CTCs work, which European countries are embracing them, and how UK businesses can prepare for this rise in digitised VAT collection.
An overview of CTCs
The CTC process requires businesses to submit their detailed transactional data electronically to a tax administration platform approved by each country’s tax authority. This submission will take place in real or near real-time when sellers and buyers have exchanged data, affecting obligations of e-invoicing and e-reporting.
The clearance model is a popular one amongst the economies that have adopted CTCs, and requires an invoice to be presented to and subsequently approved by a tax authority or government servers before the trading parties can continue with their processing. As a result, tax authorities are able to gain an unprecedented level of operational control and visibility into transactions. Providing tax enforcement support isn’t the only purpose of CTCs; they also generate vast amounts of economic data that can be useful for guiding fiscal and economic policy.
Which countries are ahead of the curve?
Whilst CTCs are on the rise worldwide, tax authority requirements will vary, and often include a diverse range of regulatory frameworks and specifications that evolve on a constant basis. Back in the 2000s, Latin America became one of the first regions to adopt CTCs. Countries including Brazil, Argentina, Peru, Mexico, and Chile were able to put entirely new systems in place and as a result, they now have a vastly improved mandatory control infrastructure helping to combat fraud and corruption. Meanwhile, Europe has been slower in transposing the legacy paper-based processes and compliance concept to the digital environment.
Initially, from 2001, the EU simply permitted electronic invoices for VAT compliance purposes but didn’t require them and didn’t take steps to capture transaction flows on a more dynamic basis. During this time, the periodic summary VAT return remained the principal source of information for control and audit of VAT. Among the first few economies in the EU to adopt CTCs was Italy. Back in January 2019, it became the first country in Europe to implement the clearance e-invoicing method for all B2B tax transactions, to combat the country’s sizeable VAT gap. Under current Italian law, all domestic transactions between Italian residents or businesses fall under this reporting method, however, it is expected to change from mid-2022. Through the same mechanism, the new regulations will see Italian companies being required to share cross-border transactional data with the country’s tax authority.
From the beginning of this year, Poland joined Italy in the adoption of e-invoicing, implementing a single centralised national billing system, on a voluntary basis. However, the voluntary basis only lasts until 2023, when all invoices must be issued and received using this system. With a VAT gap of roughly 25% around a decade ago, Poland’s progressive steps towards CTCs in the past years have reduced this to an impressive 10% in 2020, ranking them as one of the most successful EU performers in attempting to close their VAT gap. There is no doubt that the country’s plans to a CTC approach will only accelerate this trend further. The centralized, state-controlled Italian and Polish models however may come at the expense of less flexible business-to-business data integration along the broader set of supply chain messages in addition to the invoice, such as orders and advance shipping notices. The impact on continued innovation in supply chain automation – using technology advances such as blockchain or artificial intelligence – in the longer term also remains an area of speculation.
A more recent development to implement mandatory B2B e-invoicing clearance and e-reporting obligations for businesses was made by the French government – this will be a gradual, staged approach. With this change in regulation, comes the requirement for larger enterprises to issue e-invoices and e-reports. Additionally, companies based or founded in France will be obliged to accept e-invoices through the country’s CTC system from July 2024. Following this, the next stage will occur in at the beginning of 2025, which will see e-invoicing and reporting become mandatory for 8,000 mid-size companies. Finally, in 2026 the same obligations will apply to the remaining four million SMEs in France. France is taking steps to find a balance between a fully centralized CTC model – which is anticipated to benefit especially the country’s large base of small- and medium sized businesses – and the free exchange and evolution of supply chain automation where larger businesses are involved that want to use more complex or integrated data exchange methods than those offered by the state-controlled transmission system.
Not far behind France, the German government recently announced a plan to adopt CTCs in an effort to combat their fraud gap. Similarly, several Eastern European countries such as Romania, Slovenia, Slovakia, Serbia and Bulgaria have announced the same intention or have already started the implementation process. From this, it is clear to see that a growing number of countries across Europe and beyond are on the cusp of embracing some form of CTC approach in the years to come. It is only a matter of time before every European country adapts.
How does this affect businesses in the UK?
By 2030, there is high probability that CTCs will have been put into effect to some extent by almost every country that has VAT, GST, or other indirect taxes. Whilst the UK is likely to be one of the last European countries to adapt, the government did introduce a Making Tax Digital (MTD) initiative on 1st April 2019, which suggests progress is being made. With this initiative, VAT-registered businesses are required to keep digital records of invoices and use software to submit their VAT returns, if they reach a taxable turnover above £85,000. The same obligations will apply to VAT-registered businesses with a taxable turnover below £85,000, from April 2022.
A first step that UK companies should take to prepare for the digitisation of tax is to simplify how they handle transactional data. Many businesses today rely too heavily on manual processes and multiple data sources. When the submission of real-time data becomes a requirement in countries where they trade, it will be critical to ensure that all internal business operations are prepared to transfer live data for real time transaction to tax authorities as consistently and as controlled as possible.
What’s more, it’s imperative for UK businesses operating in Europe to maintain a strong understanding of EU legislation since it’s likely to be subject to further changes.
Ensuring total compliance where CTCs are implemented can be challenging for a lot of international companies. Many have historically viewed VAT as something to be addressed by local subsidiaries’ accountants. They then continue this view of VAT as primarily a local concern by adopting local solutions that combine business and compliance functionality for each region when CTCs come into force. This approach can create considerable challenges for a business to continue with its broader digital and finance transformation.
CTC methods usually begin with simple invoicing rules. As they evolve, they tend to cover a comprehensive range of physical and financial supply chains and customer data. Multinational companies can get themselves into a bind of unachievable global digitisation when they let the need for compliance drive their procurement of business systems in each country.
Additionally, the adoption of multiple standalone systems to connect to government platforms means allowing local software companies access to important business processes and data. Companies like this are often not equipped for the needs of larger multinational businesses. Therefore, more and more enterprises are adopting a modern integration strategy of decoupling compliance from business functionality. This enables the business to freely adopt the business application it needs to remain competitive while safely sharing data with governments through a loosely coupled single data tax compliance solution. An advantage of this is a significant reduction in the total costs and employee time to meet VAT compliance. Furthermore, a centralised compliance system allows leaders to make more effective strategic decisions, thanks to its capability of accessing data from all regions at a granular and aggregate level. Finally, given the increasing complexity and speed with which VAT legislation is changing, sticking to a single solution allows businesses to grow, adapt and scale as and when needed.
Whether it takes a year or a decade, the digitalisation of VAT in your markets is inevitable. Rather than viewing reforms as obstacles, IT leaders should view them as chances to enhance and streamline their financial systems. Corporations across the globe should allocate sufficient time and resources to strategic planning. To ensure an effective business approach for the years ahead, preparation is vital.