Digital Tax Administration of VAT, GST, and Other Indirect Taxes in B2B

Features of the Digital Tax Administration for VAT and Other Indirect Taxes

In this article, we will go over the key aspects of how tax authorities can digitally administer the value-added tax (VAT), sales tax, the goods and services tax (GST), and other indirect taxes. Let us analyze them based on the example of VAT.

It is critical to understand the distinguishing factor that makes these taxes unique and leads to specific digital tax administration procedures. Taxpayers may deduct taxes from their purchases for all these taxes, even though they are known by different names in different countries.

This feature encourages the buyer to ask the seller for the required tax documents, and the seller must prepare a tax invoice and provide it to the buyer. It is crucial to realize that with this strategy, deductions might outweigh tax obligations. In this situation, the government budget must refund taxpayers.

States can set lower tax rates for groups of goods and services that are socially significant, as well as a zero rate on exports of goods and services.

Using different tax rates for different goods also affects deductions. This diversity of options poses a major challenge to the administration of these types of taxes.

Differences in the Methods of the Tax Administration for B2B and B2C Transactions

Tax administration of VAT usually distinguishes two types of taxable transactions.

• Business to Business (B2B)
  • Transactions involving legal entities and business owners who are VAT taxpayers and are using the general tax system.
• Business to Consumer (B2C)
  • Transactions involving VAT non-payers (people or businesses under simplified tax regimes) and VAT taxpayers (such as retailers).

Retail store sales to consumers are an example of a B2C transaction, while wholesale sales from manufacturers to distributors are a B2B transaction.

In B2B and B2C tax administration, the major challenges with VAT include:

• The administration of VAT deductions is a priority for the tax authorities in the B2B sector because the buyers’ requirement to deduct input VAT ensures the accuracy of accruals.
• For B2C transactions, tax administration focuses on ensuring that revenue accounting includes all invoices (fiscal receipts) issued by sellers.

The difference of administrative tasks for B2B and B2C leads to distinct models of VAT administration. Below, we will discuss details of the digital indirect tax administration in the B2B sector.

Features of Digital VAT Administration in B2B. Key Elements of the Tax Regime

When administering VAT and other indirect taxes in business-to-business transactions, take into consideration the following aspects of the tax regime.

Tax Reporting Period	Period of reporting a VAT return. The standard tax period is a quarter, but there are countries that reduce the tax period to 1 month.
VAT Payment Deadline	Deadline for full or partial payment of taxes. To ensure that budgetary revenues are consistent, the state typically manipulates the tax period and the payment period.
Input VAT Reclaiming Period	The time limit for a taxable person to reclaim input tax The buyer can transfer the deduction to a future period if desired.
Features of VAT on Imports	When is VAT charged, at the time of importation or later? When goods enter the country and when customs duties are due.
Features of VAT on Exports	Is there a zero rate on exports and how are taxpayers able to confirm it?
Different VAT Rates	For different goods and services or categories of taxpayers.
Terms of VAT Refund to a Taxpayer	VAT refund terms, procedures, and conditions for taxpayers Some nations allow cash refunds, while others give credit for VAT or other taxes.

Simple and Complex Tax Gaps for VAT

Tax Gap is the difference between taxes legally owed and taxes collected by tax authorities via voluntary, enforced, and other past due payments. The figure below shows the primary causes of the indirect tax gap and benefits of digital VAT administration.

The primary goal of VAT fraud is to lower the amount of tax that the taxpayer must pay. He can claim deductions for transactions that did not actually occur or inflate the value of legitimate transactions.

If the tax administration cannot compare invoices from the seller with invoices given by the buyer for a deduction, then it must rely solely on the data reported in the tax return. Audits can find discrepancies only during a manual counter check on the buyer and the seller, which takes a lot of time and efforts. Given that they can be quarterly or even monthly in some countries, the tax authorities cannot scale it to all taxpayers in the country for all tax periods.

The simple tax gap is the difference in the VAT amounts calculated for the buyer and the seller. It is important to consider not only the presence of correspondent invoices but also the fact of non-payment of tax under the filed tax return. The tax invoice is also void if the taxpayer does not file a return.

Tax authorities can quickly find a VAT gap by comparing the VAT reports from the buyer and seller. As a result, taxpayers who want to reduce their tax liability build intricate chains involving more than two sellers and buyers. That helps to avoid buying from a seller who will not file a tax invoice or tax return, and will not pay VAT. The goal of the fraud scheme is to build a chain in which there are no simple gaps between the links all the way to the last link, where there will be a simple gap. This seller will not pay the tax and may disappear after completing the transactions.

We refer to such a chain of taxpayers as a “Complex VAT Gap”. The primary goal of the tax administration is to find the taxpayer who receives gain from the VAT optimization and to match him with the seller in the chain with the simple VAT gap.

In this context, we use the following terminology to refer to taxpayers who engage in a complex tax gap:

Beneficiary	The individual taxpayer who gains from the VAT optimization.
Terminal (or terminal company)	Seller at the tail end of the chain where there is a simple VAT gap.
Technical companies	Taxpayers in the complex VAT chain.

Understanding the mathematics involved in creating a complex VAT gap is essential. By adding a technical company, the beneficiary raises the chain’s cost. Typically, each technical company is worth at least 1% of the transaction’s value. Therefore, ten technical companies in the chain should disregard the optimization effect if the VAT rate is 10%. When the national budget makes tax refunds in cash, fraudsters are significantly more motivated to commit tax evasion, so authorities need to consider this issue as a top priority.

Four Generations of VAT Administration Systems

There are four main generations in the VAT administration system.

The following table lists major characteristics of VAT administration systems.

Generation	Features
Generation 1	Paper document exchange. Taxpayers file a general VAT return, input, and output VAT, detailing of rates, and calculation of VAT payable or refundable.
Generation 2	Taxpayers send a register of VAT invoices along with the tax return. Registers of sales, purchases, agency operations, and operations with VAT non-payers.
Generation 3	Electronic invoices replace registers with mandatory transmission to tax authorities. Automatic calculation of VAT payable or non-declarative approach.
Generation 4	A revolutionary approach for VAT with the VAT calculation in the moment of payment (cash method): The buyer’s payment includes the principal amount and the amount of VAT. VAT amount goes directly to a dedicated tax account. Critiques dismiss this method as burdensome for business, but it is the only one that does not require a collection of tax invoices and is fraud-proof.

Most countries in the world apply second- and third-generation VAT administration systems.^[1] The complexity of implementing digital VAT administration systems depends on the following factors:

• Number of taxpayers in the country.
• Quality and cost of Internet access.
• Level of automation of accounting processes and accounting systems.
• Number of business transactions and others.

It is important to introduce the explicit status of the VAT payer for eligible taxpayers. In contrast to what tax administrations often do, they should not assign the VAT status automatically. The taxpayer must intentionally register as a VAT payer and accept the responsibilities that come with it. If the tax administration discovers violations, it should have the authority to revoke this status, depriving the offenders of the ability to claim deductions on VAT invoices.

The next steps are to decide if the administration needs to collect VAT invoice registers as supplement to the general VAT return, and how to compare buyers’ and sellers’ data. For example, they may introduce a single “golden” invoice record that both the buyer and the seller should use for calculating the tax base and taxes payable.

The overall architecture of digital VAT administration should also include a part responsible for the B2C sector with the use of the Online Electronic Cash Registers (OECRs).^[2]

With the first generation of VAT administration, the tax administration is completely blind. The second and third generations provide the necessary details to build a digital VAT administration system. But even these generations are not 100% proofed against the use of bogus tax invoices.

How Digital Tax Administration Can Help in the Elimination of the Simple and Complex VAT Gaps

Digital Administration of the Simple VAT Gap

For the digital administration of the simple VAT gap, it is necessary to build and automate the following processes.

Tax administration should repeat this process as many times as needed to close the simple tax gap. The digital tax administration system runs the entire process automatically under the control of tax employees without direct contact with the taxpayers.

Besides automating processes, it is necessary to implement a straightforward incentive system to encourage territorial tax authorities to improve and refine the system. Incentive system should use just one indicator: the ratio of the total tax gap to the amount of deductions.

Digital Administration of the Complex VAT Gap

For the digital administration of the complex VAT gap, it is necessary to build and automate the following processes.

The Roadmap for Implementing the Digital VAT Administration System

The transition to digital VAT administration is a complex project, as it affects all VAT taxpayers in the country, including non-residents. Therefore, tax administrations should implement it consistently and in stages.

DTT helps tax authorities in the development of the digital tax transformation strategies and roadmaps to reduce the tax gap, create additional revenue sources and decrease tax administration costs.

Figure 8. DTT’s Approach to the Tax Gaps Analysis & Development of the Digital Tax Transformation Strategy.

The project roadmap may include following important stages and tasks.

	Stage	Key Tasks
1.	“As is” analysis and development of the Digital VAT Administration concept	Analysis of VAT administration methods. Development of the digital VAT administration concept. Development of the electronic formats for VAT return and invoice.
2.	Development of the IT-system for collecting electronic invoices and returns	Development of the business and system requirements by working with tax administration users, taxpayers, and vendors of accounting systems. Development of the policies and processes for collecting tax invoices and returns. Design, development, and implementation of the Digital VAT Administration IT-system.
3.	Digital administration of the Simple VAT Gap	Implement digital tools to minimize or close the simple VAT gap.
4.	Digital administration of the Complex VAT Gap	Implement digital tools to minimize or close the complex tax gap.

The methods presented in this article produce remarkable results over a brief period. For example, one of our tax gap reduction projects resulted in an increase in VAT revenue in the B2B sector from $30 billion in 2014 to $75 billion in 2021, or by a factor of x2.5.

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

[2] Read more: Effective Transition to Electronic Tax Invoices in B2B and B2C. Anatoly Gaverdovsky. URL: https://taxtech.digital/2020/11/02/electronic-tax-invoices-in-b2b-and-b2c/