What is Value-Added Tax?

Value-added tax or VAT can sometimes sound a bit complex, however, when you break it down it can be described as a process where tax authorities such as the government, collect a percentage of the value added at each step of a manufacturers economic chain. Ultimately, the VAT process ends with the consumption of the goods or services by consumers.

Global VAT processes involve three key players – the supplier, the buyer, and tax authorities (the government). VAT charges are paid by all parties in this chain, however, only businesses can deduct their input tax, which in some countries is referred to as their “VAT deductions.”

Infographic of The Global VAT Processes Breakdown

VAT has a huge impact on the global economy, and it is by far the most significant consumption tax system used around the world. With 162 trading nations, VAT contributes more than 30 percent of all public revenue.

Infographic about VAT, the Predominant Form of Global Consumption Tax

Although governments have used VAT across the world since it was first introduced in the 1950s, there are some major global VAT changes taking place right now that companies should be aware of. One of these major changes is the widening global VAT gap and introduction of CTCs (continuous transaction controls).

The VAT compliance gap and introduction of CTCs

Globally, companies are responsible for correctly processing and reporting their VAT. If done correctly, this enables tax authorities to audit and control their global business transactions. However, despite governments putting audits like these into play, fraud, malpractice, and human errors cause governments to collect significantly less VAT than they should.

Globally, it is estimated that the VAT gap has grown to over EUR€500 billion – which equates to around 15 to 30 percent of VAT that should be collected worldwide.

As a result of the rising VAT gap, governments worldwide have put in place some new and updated rules and regulations, as well as penalties.

Top 8 consequences of VAT non-compliance

To reduce the widening VAT gap, tax authorities are enforcing different types of legal penalties and regulations. VAT non-compliance is a serious criminal offence in some countries; thus, companies need to be certain they can quickly and easily prove their global VAT compliance, otherwise they will face these eight consequences.

Infographic of Top 8 Consequences of VAT Non-compliance

A closer look at CTCs vs. VAT compliance regulations

As mentioned earlier, companies that can’t prove their compliance with CTCs are expected to be more heavily penalized than those found guilty of VAT non-compliance. One of the main reasons behind this is that, as the name suggests, tax authorities will be using CTCs to control company transactions continuously, rather than every three months, like in the UK.

A recent Mexican law is an example of where the government has applied CTC regulations. The law makes invoicing for, non-existent operations a felony, which in turn can be classified as tax fraud or organized crime.

To remain compliant with global CTCs, it is paramount that companies identify these six legal requirements that depend on strict compliance change management.

Infographic of Top 6 Legal CTC Requirements for Global Companies

CTC and VAT compliance trends around the globe

Companies that are planning to expand their business globally should become well accustomed with these VAT and CTC trends for EMEA, AMER, and APAC regions.

1. VAT compliance and CTCs in Europe, the Middle East and Africa (EMEA) 

Governments throughout EMEA have begun to increasingly use CTCs as a result of the convergence of three major EU-level and Member State legislations (the Chapter 5 VAT Directive, EU VAT Directive modification Directive, and the EU Directive). Some new updates to take note include:

  • One of the main reasons for CTCs adoption across the EU is to make existing VAT reporting processes more granular and frequent. In a nutshell, this is what CTCs are all about, making sure companies can prove VAT compliance on a continuous basis, rather than traditional, less frequent VAT returns.
  • E-invoicing is also becoming widely accepted in this region. Countries like the UK, Poland, Spain, and Hungary have been among the first to introduce new VAT requirements. These new rules require companies to provide digital files (e-invoicing) with more granular transaction data to be submitted. This is meant to take the place of less frequent VAT submissions, which most companies are used to.
  • Now, however, Italy is the only European country that has full-fledged, mandatory CTC e-invoicing in place. Other EU countries have only made CTC e-invoicing an option.

2. VAT compliance and CTCs in The Americas (AMER)

  • VAT recording proceedings are much different for companies throughout the Americas (U.S, Canada, Mexico, South America) compared to those in the EU. For one, governments in Canada, North and South America are currently placing more emphasis on accurate record retention practices rather than the invoice creation process. However, this is slowly changing in AMER, as the global trend has begin moving drastically in the opposite direction, with tax authorities focusing on rethinking the invoice creation process – the introduction of CTC e-invoicing is one example.
  • Companies in AMER need to start adapting their systems to CTC e-invoicing today, as the cohesive collaboration between tax authorities in the Americas is increasing notably. For example, in order to combat tax evasion and fraud, the Mexican tax authority (SAT) has recently implemented an extension to the standardized Mexican electronic invoice process. Tax authorities put this new process in place for companies involved in export transactions from Mexico to the U.S. and Canada.
  • Additionally, VAT non-compliance in Latin America (South America, Central America, Caribbean Islands, and Mexico) is not an option. Their e-invoicing compliance is rather a binary proposition – a compliant invoice is either issued, received, or neither. The consequences of issuing or receiving a non-compliant invoice are much stricter in Latin America than any other AMER region. For example, administrative penalties for VAT non-compliance can, in certain cases, exceed the actual transaction value – in Brazil, penalties can be up to 150 percent of the transaction value.

3. VAT compliance and CTCs in Asia Pacific (APAC) 

  • Governments in the APAC region have become trail blazers in the field of electronic invoicing. Influenced and inspired by Latin America’s tight restrictions on CTCs, countries like China, Indonesia, and Taiwan are either introducing partial or complete mandatory e-invoicing within the coming years.
  • Electronic VAT invoicing in China began roughly two decades ago, with a then called “Golden Tax System.” This consisted of a taxation platform for reporting and invoicing, as well as legislation regulations and legalities around electronic signatures. Now, companies in APAC can issue invoices via the national system with software certified by the tax authorities.
  • The government in the APAC region is also working on setting out clear standards for e-invoicing. This involves clearly defining the security and operational requirements, along with data exchange standards for companies. Companies in Asia in particular have begun using these standards.

Technologies role in the future of global VAT compliance

CTCs are becoming the future for companies looking to take their business to global markets. Why? E-invoicing enables companies trading in international markets to record their business transactions with their suppliers on real-time transmission. The development of IT technology since the 1950s has been a critical factor in this advancement.

Additionally, according to recent research by PwC, it takes 27 percent less time on average to comply with VAT obligations in countries where businesses pay and file VAT online. Since 2008, over 26 economies have adopted the electronic filing and payment system. Technology and CTC e-invoicing is paving the way for global companies to become more efficient in their business proceedings, as well as help reduce fraud and evasion.

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