Functional Architecture of the VAT Administration Information Systems

Differences in B2B and B2C Tax Invoices

The solution for the digital administration of VAT and other indirect taxes, e.g., sales tax, goods, and services tax, may include two major functional blocks:

• Administering the transactions between legal entities who are VAT payers with so-called Business-to-Business (B2B) Tax Invoices.
• Ensuring the completeness of revenue invoices in transactions with the private individuals, i.e., for the interaction of legal entities who are VAT payers (retail sellers) with the private individuals who are not VAT payers (consumers) with Business-to-Consumers (B2C) Tax Invoices. Often, this also applies to VAT non-payers using special or simplified tax regimes if the amount of transactions is below the established VAT limits.

Usually, the structure and format of B2B and B2C tax invoices differ in terms of the set of required data fields:

• We call a B2B tax invoice a full or standard tax invoice. It must contain the buyer’s taxpayer individual number (TIN) and other data. For example, in the EU, information required in all cases is:^[1]
  • Date of issue.
  • The unique sequential number identifying the invoice.
  • Customer’s VAT identification number (if the customer is liable for the tax on the transaction).
  • Supplier’s full name & address.
  • Customer’s full name & address.
  • Description of quantity & type of goods supplied or type & extent of services rendered.
  • Date of transaction or payment (if different from invoice date).
  • VAT rate applied.
  • VAT amount payable.
  • Breakdown of VAT amount payable by VAT rate or exemption.
  • The unit price of goods or services—exclusive of tax, discounts, or rebates (unless included in the unit price).
  • Extra information required in some cases:
    • Exempt transactions—a reference to the appropriate (EU or national) legislation exempting it, or any other reference indicating it is exempt (at the choice of the supplier).
    • Customer liable for the tax (i.e., under the reverse-charge procedure).
    • Intra-EU supply of a new means of transport—the details specified in Article 2(2)(b) of the VAT Directive.
    • A margin scheme applies—a reference to the scheme involved (e.g., travel agents).
    • Self-billing (customer issues invoice instead of supplier).
    • Person liable for tax is a tax representative—their VAT identification number, full name, and address.
    • Supplier is operating a cash-accounting system.
• We call a B2C tax invoice a simplified tax invoice. It also called a fiscal or cash receipt^[2] or sales slip^[3], and does not require a TIN or customer ID. For example, in the EU, information required is^[4]:
  • Date of issue.
  • Supplier’s VAT identification number.
  • Type of goods or services supplied.
  • VAT amount payable—or the information needed to calculate it.
  • Specific, unambiguous reference to the initial invoice and the amendment details (on a credit note, debit note, or other document treated as an invoice).

Business buyers can use input standard tax invoices for VAT deductions from output tax invoices. Typically, consumers can use simplified tax invoices for personal income tax deductions. If the buyer is not an individual, but an organization or individual entrepreneur, it is reasonable to use a simplified tax invoice for VAT and corporate income tax deductions so as not to create a standard tax invoice in parallel.

Four Generations of VAT Administration in B2B and B2C

Many governments choose between the second and third generations of digital B2B VAT invoices administration solutions, as mentioned in our earlier article. ^[5] That means the taxpayer must file:

• A tax return along with tax invoice registers; or
• Tax invoices and a tax return separately. The tax return may refer to the tax invoices registered with the tax authorities to confirm that the calculation is correct; or
• Electronic tax invoices and tax authorities will pre-fill tax return or automatically calculate tax liabilities.

In B2B tax invoice administration, the primary source of data is the taxpayer’s accounting or ERP systems. When receiving registers of standard tax invoices with tax returns from both the seller and the buyer, it is necessary to compare information from the seller with information about the same tax invoice from the buyer. This requires considering potential data entry distortions and mistakes made by the buyer after getting invoices from the seller.

If tax authorities register invoices, the seller files the tax invoice, and the buyer has access to the master record. There are solutions when both the seller and the buyer register tax invoices. The buyer, by registering a tax invoice, claims it for VAT deduction, but such solutions are quite unique.

Sellers can issue standard tax invoices both on paper and electronically. Obviously, tax authorities can register only electronic documents. Taxpayers must transmit a standard tax invoice to the tax authorities during the period, which is determined by law.

There are also four generations of digital VAT invoice administration systems for B2C segment globally:

Generation one	Lack of standardization of cash register equipment or Point of Sales (POS) solutions. Basic requirements for the composition of the details of the simplified tax invoice (fiscal receipt).
Generation two	Standardization of the structure of the simplified tax invoice. Secure storage of fiscal receipts in fiscal memory or similar device at the taxpayer’s point of sale. On-demand access to fiscal memory for tax officials.
Generation three	Like Generation 2, but with the secure automatic transmitting reports on daily turnover to the tax authorities via communication channels (e.g., cellular networks).
Generation four	Secure automatic transmission of each simplified tax invoice (fiscal receipt) to the tax authorities.

For B2C, the source of simplified tax invoices are POS systems ^[6] or cash register control equipment. With the development of e-commerce, there are specialized systems for this type of trade that manage orders and issue tax invoices.

There is more variation in the types for simplified tax invoices than there is for standard tax invoices, which can be correction (or corrective) invoices: ^[7]

• Simplified income and expense tax invoices.
• Simplified income and expense tax refund invoices.
• Adjusting simplified tax invoices.

In addition, for e-commerce, such as the sale of e-services, there may be no physical contact between seller and buyer and transferring a paper invoice is not possible. In traditional commerce, the buyer should transfer the simplified tax invoice to the seller immediately after the sale.

Important Decisions that Affect the Solution Architecture

Next, we describe the functional architecture of the digital VAT administration system in B2B and B2C, which depends on the following key decisions (ramification points):

• The seller submits a standard tax invoice to the tax authorities for registration. The buyer accesses this tax invoice and accepts it, either by confirmatory action or automatically, at the end of some period.
• The buyer can specify in which tax period he can take this tax invoice as a deduction if the law provides for a deferred tax deduction.
• When filing a tax return, the system automatically calculates input and output VAT based on information from the registers of standard tax invoices.
• Amendment of the input and output VAT is possible only with the correcting tax invoices (credit notes).
• The taxpayer files a VAT return as required by law.
• The seller submits a simplified tax invoice to the tax authorities when settling with the buyer and immediately sends it to the buyer in paper or electronic form.
• If the seller is a VAT payer, then all simplified invoices take part in the calculation of output VAT. If he is not—in the calculation of the tax base.
• Buyers can use simplified tax invoices for income tax and personal income tax deductions, under the law.

When designing the functional architecture of the digital VAT solution, we presume that the tax authorities have implemented the Core Tax Administration System for taxpayer registration, tax accounting, personal accounts, collection, audits; and a system for receiving electronic VAT returns: web portal, mobile application, or electronic returns.

We also suppose that the tax authorities have implemented an information system for the authorization and authentication of the taxpayer and his employees to perform legally valid electronic transactions. They also should set up official electronic channels of communication with taxpayers through personal accounts or other means to ensure that the taxpayer must view and respond to the communication from the tax administration.

Tax authorities should set up official electronic channels of communication with taxpayers through personal accounts or other means to ensure that the taxpayer must view and respond to the communication from the tax administration.

Tax authorities also should have integration with customs and other government information systems, which have information about taxpayers.

Common Architecture Components for Digital VAT Administration in B2B and B2C

Registration of Sources of Tax Invoices

Proper functioning of the VAT administration system and automation of data transfer to tax authorities requires deep integration with taxpayers’ accounting, ERP, POS systems, cash registers and e-commerce systems. There will be a tremendous amount of tax invoices, even in small countries. Manual re-entry is therefore inappropriate because it results in significant administrative expenses and data distortion.

It is necessary to develop a system for the registration of sources of tax invoices, including taxpayers’ accounting and other IT systems. After their authorization in the VAT administration system, the fiscal data transmitted automatically, and the taxpayer could not refuse to transfer or complain about corrupted data. Unlike for B2B invoices, it is important for B2C invoices to register the location of the POS system or cash register equipment. This will allow for the field tax audits.

Registration of the tax invoice sources implies their systematization or categorization, for example, by the type of taxpayer’s activity or by offline or online sales. Relating to the registration is the process of re-registration (changing the registration data) and de-registration if the source ceases to operate.

Collection of Tax Invoices

This function must work for both standard and simplified tax invoices and support the following capabilities:

• Receiving tax invoices via web and mobile apps.
• Acceptance of tax invoices through software interfaces (APIs) if there is integration with registered sources of tax invoices.
• Performing format and logical control of received tax invoices and generating a receipt of acceptance or a receipt of refusal with details of the reasons for refusal of acceptance.
• A data warehouse, which helps to create claims to correct errors and amend tax invoices.

The data quality of tax invoices is critical for VAT administration. If the quality is inferior, taxpayers will complain about tax authority errors and try to evade responsibility for the deliberate reduction of VAT liabilities, which is unacceptable. By identifying inaccuracies in tax invoice data in real time, contacting taxpayers to request corrections, and penalizing them for not doing so, tax administration will keep errors to a minimum.

Visualization and Management of Tax Invoices and Data Aggregates

It is especially important to show taxpayers how the tax authorities see them. This allows you to avoid unnecessary questions, divergence of views and unnecessary proceedings, including in court. Therefore, it is necessary to:

• Show all tax invoices that tax authorities registered for the seller and the buyer.
• Show aggregated information, including correction tax invoices.
• Show the tax base or part of the tax base that is associated with tax invoices.
• Receive feedback from taxpayers on correcting the tax base through correction tax invoices.

Also, the taxpayer can decide to submit standard tax invoices to a deduction in a convenient period if the tax law is flexible enough to allow it.

Managing Discrepancies and Violations

This is the most vital component of the solution, which must detect violations and discrepancies in both B2B and B2C invoices. It is a system that may run in periodic or real-time modes. It detects discrepancies in tax invoices and generates a set of data to generate correction claims to taxpayers:

• Errors in tax invoice data during format-logic control.
  • There are two types of errors:
    • Errors that prevent the tax authorities from accepting the tax invoice; and
    • Errors that tax authorities have found after accepting the tax invoice.
  • The system accumulates, processes, and communicates all found errors to taxpayers for correction. It is extremely important to ensure the quality of the tax data.
• Discrepancies in B2B invoices:
  • Discrepancies between tax returns and tax invoices.
    • It is necessary to analyze the taxpayer’s liabilities as calculated from the tax invoices and in the tax return, so that they have 100% match. And it is vital to analyze the flow of correcting tax invoices and returns constantly, as discrepancies can appear any time, including past tax periods.
  • Discrepancies between the seller’s and the buyer’s tax invoices.
    • If the system uses one primary tax invoice entry from the seller, there should be no discrepancies in the data. The seller and the buyer resolve all disputes through correction tax invoices.
    • If tax administration chooses a model with two tax invoices, it is necessary to compare invoices from the seller and the buyer, considering all correction tax invoices and identify discrepancies, which may be on the seller’s side and on the buyer’s side.
  • Discrepancies that may arise because of the status of the declaration.
    • For example, a seller who has generated tax invoices and must calculate and pay tax has not filed a tax return or has filed it but not paid the tax.
  • Specialized discrepancies that arise during import or export operations, i.e., discrepancies between tax invoices and information from customs.
• Discrepancies in B2C invoices
  • Any discrepancies on the standard tax invoices also apply to the simplified tax invoices if they reveal a buyer who is eligible for a deduction and is attempting to take advantage of it.
  • Discrepancies between the registration data of the source of simplified tax invoices and information on the conduct of its activities from geographic information systems, the Internet, and other sources.
  • Discrepancies in the comparison of tax invoices with data on payment terminals, including their turnovers.
  • Consumer complaints that the merchant failed to issue a simplified tax invoice should also serve for discrepancy identification.

Claims Management to Eliminate Discrepancies

As discussed above, it is especially important not only to generate discrepancies in real time and show them to tax officials, but also to generate tax claims to eliminate discrepancies and send them to taxpayers in automatic mode. Taxpayers must confirm that they receive the tax claims and respond within the timeframe specified by law. The response should comprise filing an adjustment to the tax return that corrects the discrepancies.

Automation of this process is necessary because the number of objects of tax control is large, the number of tax invoices is huge, changes because of the correction are constant and manual response to them is simply impossible.

Integration with Financial Institutions

For the effective administration of VAT, it is extremely important for tax authorities to receive information about taxpayers’ current accounts, payment terminals, and transactions on them, which they can receive from banks and processing companies. This will allow to understand who should transfer standard or simplified tax invoices and who transfers them, as well as to ensure the completeness of data.

Tax Officer Workplace

To ensure the work with tax returns, tax invoices, discrepancies, and claims, it is necessary to create an integrated workplace for a tax officer, which will collect all the information for the tax control.

To manage the efficiency of tax officers it is also extremely important to establish a simple and clear performance indicator, such as the ratio of the amount of discrepancies to the amount of VAT deductions, as well as to implement a motivation system aimed at minimizing this indicator.

Special Components for B2B Invoices

Aggregation and Visualization of the VAT Flow Between Taxpayers (Tax Relationship Tree)

Discrepancies in the tax invoices between the seller and the buyer are simple tax gaps. The digital VAT administration system can automatically eliminate them with tax claims. However, complex VAT optimization schemes use many links in the chain of taxpayers conducting VAT transactions.

It is necessary to visualize such chains so that tax officers can see them, analyze them, and be able to identify the beneficiary of tax evasion. This functionality aggregates tax invoice transactions, highlights input and output VAT, and shows discrepancies. To understand the roles of companies in optimization chains, it is necessary to use a risk management system. A taxpayer’s risk profile should reflect its intention to conduct proper business activities, rather than being a fictitious company set up to optimize VAT.

By analyzing the behavior of the taxpayer, it is possible to determine its role in the tax optimization chain: a terminal company, a technical company, or a beneficiary. As well as using information on the connections between businesses by shareholders or directors, it is also possible to use transaction data on the current account to confirm their legality.

Automatic Calculation of VAT Chains and VAT Fraud

The expansion of the previous functionality is an automatic calculation of chains of taxpayers created for tax optimization, their separation into separate entities, and the calculation of tax damage caused to the state by the beneficiary of tax optimization. Identification of such chains should lead to the opening of an audit on the beneficiary and the formation of the evidence base on the involvement of the beneficiary in the tax fraud.

Special Components for B2C Invoices

Motivation of Consumers to Request a Simplified Tax Invoice (Fiscal Receipt)

For simplified tax invoices, it is essential to support consumers’ motivation to request a tax invoice from the seller. Otherwise, especially if paid in cash, the seller will have no incentive to issue a tax invoice and record the revenue, forming a tax liability. He can use cash to pay “black” wages to employees and to pay suppliers, thus eroding the tax base and increasing the tax gap.

Tax administrations can use the following methods to motivate consumers to demand receipts:

• State or commercial lottery for consumers who have registered fiscal receipts in their name.
• A Tax-Free system based on tax invoices.
• Unconditional tax deduction for buyers on tax invoices.
• Conditional deduction for customers for certain types of goods and services, such as those related to education or medical treatment.
• Storing receipts in the tax administration digital platform and opening access to them to third parties, who can reward consumers with bonuses and cashback.

In countries that have a large flow of tourists, they may introduce a verification of tax invoices for accommodation when a person is leaving the country, which will dramatically increase the tax discipline of the tourism industry. A combination of different methods increases the value of the tax invoice for the buyer and ensures completeness of revenue accounting for the tax authorities.

Field Audits

To ensure the completeness of work with tax invoices, it is necessary to ensure that taxpayers use accounting and other information systems, as well as control and cash equipment integrated with information systems of tax and capable of transferring standard and simplified tax invoices.

To do this, tax inspectors need to conduct a field inspection of all retail facilities and retail outlets. This will make sure that they have the software and hardware, that it works and correctly transmits tax invoices to the tax authorities. We implement this function through a mobile application, which receives information from the tax and geographic information systems and allows a tax officer to check the points of sales in the territory and their compliance status.

---

[1] European Commission. Taxation and Customs Union. VAT invoicing rules. URL: https://taxation-customs.ec.europa.eu/vat-invoicing-rules_en

[2] A cash receipt is a proof of purchase issued when the buyer has paid in cash. Collins. URL: https://www.collinsdictionary.com/us/dictionary/english/cash-receipt

[3] A sales slip is a piece of paper that you are given when you buy something in a store, which shows when you bought it and how much you paid. [US]. Collins. URL: https://www.collinsdictionary.com/us/dictionary/english/sales-slip

[4] European Commission. Taxation and Customs Union. VAT invoicing rules. URL: https://taxation-customs.ec.europa.eu/vat-invoicing-rules_en

[5] Four Generations of VAT Administration Systems. Anatoly Gaverdovsky. URL: https://taxtech.digital/2020/09/02/4-generations-of-vat-administration-systems/

[6] Point of Sale (POS) system—is a solution for automation of retail trade operations.

[7] A correction invoice is a separate value-added tax (VAT) document, which contains the changes to a transaction that is already issued to a customer.