Tax Revenue Suite (TRS) and VAT Administration for B2B

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Sources of VAT Gap

The administration of VAT in the B2B (business-to-business) sector involves trade transactions between organizations and individual entrepreneurs.

In most countries, VAT is paid if a taxpayer’s turnover exceeds a certain threshold within a specified period, such as a year or a quarter. Some taxpayers strive to underestimate their turnover to avoid entering the category of VAT payers.

An alternative to underreporting turnover is business fragmentation, where a taxpayer attempts to split transactions among related and controlled companies. In this case, there is a VAT gap^[1] due to the actions of taxpayers who essentially qualify as VAT payers but do not pay it in full.

On the other hand, the VAT taxpayer status is voluntary. Any taxpayer can become a VAT payer at their discretion. This leads to the rapid emergence of companies that can be used in VAT optimization schemes.

The basis for VAT optimization is the VAT Gap, which arises due to the following key reasons:

1. The taxpayer-seller did not file a VAT return, even though they have VAT obligations on invoices that their buyer claimed as deductions.
2. The taxpayer-seller filed a zero VAT return, even though they have VAT obligations on invoices that their buyer claimed as deductions.
3. The taxpayer filed a VAT return with obligations that do not correspond to their invoices and invoices issued to them.
4. The taxpayer filed a VAT return with obligations that correspond to their invoices and invoices issued to them but did not pay the VAT.

If tax authorities use the second generation of the VAT administration system^[2], where a master record of the invoice is not generated, and the VAT return is submitted together with invoice registers, there can be a gap with VAT invoices. The buyer claims deductions based on the invoices, while the seller does not show these invoices for VAT assessment.

We refer to such taxpayers as VAT gap sources or simply gap sources. Tax Revenue Suite (TRS)^[3] identifies them by comparing data from tax returns, invoices, and payment accounts for tax obligations. The system also requires access to the VAT taxpayer’s registration and accounting data to verify that the taxpayer was active in the respective tax period.

TRS identifies and marks the gap sources in each tax period, indicating the types of gaps and calculating the amount of the gap, i.e., the amount of missing VAT.

It is important to note that gap sources have a short lifespan as tax authorities need to quickly identify and restrict their activities. This can involve the forced removal of VAT taxpayer status or the blocking of bank accounts until the gap is resolved, and the VAT is paid. Since most gap sources are intentionally created, their owners simply abandon them to avoid paying VAT to the budget.

Technical or Proxy Companies in the VAT Optimization Chain

TRS also identifies a second group of companies known as technical or proxy companies. Their task is to distance the gap source from the taxpayer who declares reduced VAT. They issue fictitious or what is commonly referred to as “paper” invoices and attempt to claim deductions based on them, thereby reducing their VAT obligations.

If the original gap source issues such an invoice, the connection becomes evident, and tax authorities will deny the deduction. To prevent this from happening, it is necessary to create distance between the gap source and the taxpayer declaring reduced VAT. This is achieved by using a chain of proxy VAT taxpayers between the gap source(s) and the taxpayer who understates their VAT obligations.

Proxy companies share a common characteristic: their deduction ratio, which is the ratio of “VAT claimed as a deduction” to “VAT charged,” should be as close to 1 as possible. If this ratio is less than 1, the proxy company must pay money to the budget, increasing the cost of VAT optimization for the chain and the ultimate beneficiary. If there are multiple proxy companies, the net cost of VAT optimization is calculated as:

“Number of Companies” * (1 – Proxy Companies Deduction Ratio)

Additional information about VAT taxpayers can be enriched with data on other taxes, employee headcount, taxable assets, shareholders, management, and information from risk management systems, if available within the tax administration, aggregating all taxpayer data.

VAT Tree

TRS utilizes the “VAT Tree” module to analyze the chain of VAT taxpayers. It allows the aggregation of all VAT transactions among taxpayers, with markings indicating their types. The VAT Tree is constructed from a specific taxpayer’s perspective, either as a buyer or a seller.

The system builds the VAT Tree:

• From the buyer’s side, when investigating the gap source and identifying the taxpayers utilizing it.
• From the seller’s side when the aim is to find the gap sources of a particular company.

TRS Implementation Options and Integration Requirements

TRS offers two implementation options:

• Full implementation, including the receipt and storage of electronic invoices from taxpayers and handling invoice corrections and cancellations, or
• Partial implementation with integration with an existing electronic tax invoice management system.

If a country utilizes a second-generation VAT administration system, an algorithm for matching seller and buyer invoices needs to be added. TRS requires integration with the following data sources:

• Taxpayer registration and records.
• Tax returns.
• Taxpayer payment accounts.

Integration with risk management systems and other taxpayer data sources is also beneficial. Furthermore, TRS can be integrated with tax control event systems, ranging from desk audits to field audits. This enables the use of TRS data for decision-making regarding control measures.

TRS Digital Desk Audit Module (DDA)

The Tax Revenue Suite offers the implementation of the Digital Desk Audit module (TRS DDA) to enhance its operational efficiency. The TRS DDA automatically generates violation registries based on predefined algorithms, notifies taxpayers of the violations through electronic communication channels, and monitors the rectification of these violations through the submission of revised VAT returns or invoice corrections.

Implementing the TRS DDA enables the scalability of taxpayer interactions and reduces reliance on tax authority personnel.

A New Approach to VAT Administration in the B2B Sector

It is no secret that VAT and its administration present numerous temptations for corruption among tax authority employees.

The implementation of TRS brings about a change in the approach to VAT administration, aiming to eliminate these temptations through:

1. Centralization of VAT administration processes, which allows for the implementation of exterritoriality principles. This means dissociating individual local tax authority employees from contact with specific taxpayers.
2. Digital desk audit (DDA). Automating violation management eliminates the need for tax authority personnel to directly handle violators, and enables automated decisions regarding VAT reimbursement, where applicable within the country.
3. Employee motivation systems within the tax authority. TRS provides transparency and visibility into VAT gaps. To standardize VAT gaps, we propose relating the VAT gap to the total VAT deductions and aggregating gaps by territorial tax administrations, where applicable. The tax authority management can monitor the performance indicators of each territory and establish target indicators to reduce tax gaps. Any corrupt behavior by tax authority employees will negatively impact the territory’s performance indicators, creating significant internal barriers against corruption.

[1] The VAT Gap is the difference between the expected VAT revenue (or ‘VAT Total Tax Liability’ — VTTL) and the amount actually collected. European Commission. Questions and Answers: VAT Gap 2022 report. URL: https://ec.europa.eu/commission/presscorner/detail/en/qanda_22_7519

[2] Read more: “Four Generations of VAT Administration Systems”, A. Gaverdovsky. URL: https://taxtech.digital/2020/09/02/four-generations-of-vat-administration-systems/

[3] See more about Tax Revenue Suite at: https://taxtech.digital/tax-revenue-suite/