A New Approach to the Digital VAT Administration for B2B

Benefits and Drawbacks of the Fourth Generation of VAT Administration Systems

Because taxpayers are always attempting to minimize their tax burden, the tax authorities face a significant problem in managing the VAT. For example, the taxpayer-buyer claims a VAT deduction based on a “paper invoice” without paying the seller. The seller does not declare the accrued VAT or does not pay it to the budget.

The result is a tax gap in favor of the buyer because of an understatement of VAT liabilities.

The only defense against this technique is the transition of the VAT calculation from the accrual to the cash method under the so-called fourth generation of the VAT administration system [1]. Following are the major elements of this system:

• The state sets up special accounts for paying VAT (deposit or control accounts) at banks or the treasury.
• When the buyer pays the invoice, it must make the separate payment of VAT into a deposit account.
• The seller receives payment for a product or service net of VAT.

The taxpayer has a balance of both input and output VAT for the reporting period. The only use of the money in the special account is to pay taxes. Taxpayers cannot withdraw cash or pay for goods and services from these accounts. When combined, these steps guarantee the taxpayers will pay the VAT obligations in full.

Implementing control accounts requires a significant overhaul of the VAT administration system. It entails switching to a new accrual system and, most critically, freezing the money of taxpayers in special accounts. Taxpayers regard the latter circumstance as the major drawback of this system. However, this method expedites VAT returns for taxpayers who are claiming a refund.

Virtual VAT Control Accounts

Is it possible to combine the current accrual-based VAT administration system with the advantages of VAT control accounts without freezing taxpayers’ money?

Imagine a centralized information system where the seller sends a VAT invoice to the buyer. It automatically calculates the output VAT for the seller and the input VAT deduction for the buyer. Further actions of the system users include the following steps:

• The buyer must pay the invoice in advance or by post-payment through the bank.
• The bank confirms the fact of payment in the information system.
• The system displays virtual VAT control account to the tax administration, with input and output VAT invoices and the VAT balance.

Tax authorities need to understand the VAT balance, the status of payment of the tax invoices and have a guarantee of the VAT payment. Here, the taxpayer can count on some privileges. The taxpayer’s bank can be a guarantor since it knows its client and has access to all its transactions.

A VAT refund is possible with the factoring plan. The bank pays the taxpayer a refund amount and then waits for reimbursement by the state. The bank can also provide client factoring for the entire receivable.

Benefits of the New Approach

This method does not change the existing VAT administration model, and expands its capabilities. The taxpayer has the choice—voluntary transition to the new system or keeping the current regime. The tax administration supports the principle of “backward compatibility” and creates the following additional benefits for the tax system and taxpayers:

• There is no need to freeze taxpayer assets in special accounts.
• Taxpayers under the new regime are more transparent to the tax authorities, seen as low-risk, and receive loyal treatment and privileges.
• Instead of the current tax clause buyer can invite the selling counterparty to join the new regime, forming a circle of low-risk taxpayers.
• If the incentives are meaningful, the group of low-risk taxpayers will expand naturally, cleaning up the VAT environment.

As a result, implementing the virtual VAT control accounts will provide the following benefits:

• Taxpayers get a coherent plan of what to do to mitigate potential VAT risks.
• Tax authorities receive a guarantee of VAT payments to the budget and reduced costs of the tax administration.
• Banks get new customers and new products that will bring them new revenues.

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[1] For more information, please refer to: Four generations of digital VAT administration systems. Anatoly Gaverdovsky. URL: https://taxtech.digital/2020/09/02/four-generations-of-vat-administration-systems/