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Italy and the Real-Time VAT Control Big Bang

Italy inaugurated 2018 by confirming what experts had predicted: It is the first E.U. member state to mandate e-invoicing with real-time VAT controls. In so doing, it permanently closes the debate about the direction of European and global electronic invoicing regulation. VAT compliance v2.0 is now officially irreversible. How can businesses prepare for this world where governments leverage technology to get “inside” business transactions as they happen?

Electronic invoicing is on the decline — and rapidly so. No, I don’t mean companies have started exchanging fewer invoices in electronic format. I mean that the domain that we have in the past 15 years called “e-invoicing” is converging with the broader VAT compliance domain. Together, the two are morphing into what might be called “VAT compliance v2.0.” Before I explain what I mean by that term, I want to avoid any ambiguity and briefly elaborate on the future of e-invoicing.

Of course, electronic invoicing growth is set to accelerate. It’s just not happening as a lot of us thought it’d happen. I predict that by 2025 companies in industrialized and emerging economies will exchange more than 75% of all invoices electronically with tax administrations in real time or very shortly after the business invoice exchange process.

By contrast, I believe that about 40% of invoices will by that time also be exchanged in electronic format between the trading partners. This dissymmetry is not because the business case for governments to receive and analyze business transaction data in structured format is necessarily better than it is for companies. The reason is rather that most central governments have larger budgets, aren’t obsessed about meeting the next quarter’s financial KPIs and their decision processes tend to be more suited for longer-term planning.

Nonetheless, I believe that, over time, the obligation to create and transfer structured invoice data to tax platforms will also push businesses to accelerate their e-invoice adoption. By 2030, the transformation to fully electronic, mostly structured e-invoice exchange in all directions should be all but complete.

As mentioned, VAT compliance v2.0 isn’t only about e-invoicing. To me, it’s all about governments leveraging technology to get “inside” business transactions as they happen. In other words, a lot of the VAT action in process and technology terms moves closer to where sellers and buyers actually interchange sales/purchase transaction data rather than inside their internal business processes.

Let’s break it down. These are the principal functional components I believe businesses need to plan for in the move to VAT compliance v2.0:

  1. Regulatory mapping. There will be mandatory structured (nearly always XML based) data formats for the mandatory exchange of invoice (and possibly other) data with the tax administration platform.
  2. Regulatory transaction orchestration and process alignment. Your e-business transaction platform will need to be able to send and receive different types of transactions to and from the tax administration platform. Examples include specific types of invoice processes (e.g., cancelation, contingency issuance or confirmation, buy-side acceptance or rejection) and also, increasingly, similar processes for other types of tax-relevant documents. Your business and trading partner data exchange process may need to be revised to ensure that mandatory data exchange with the tax administration platform can be performed as required. You and your customer may never have thought of a supplier invoice cancelation message type, but in some countries you’ll need one to comply with tax law. And in some jurisdictions, particularly in Europe (and probably India), this type of exchange of business data with government control platforms will evolve by tax administrations slowly increasing the frequency, automation requirements and granularity around historical VAT reporting requirements.
  3. Authentication and security. Most real-time or near-time tax administration platforms require some combination of transmission security and data-level control technology requirements — usually some form of electronic signature and web server authentication based on public key certificates issued by a government-approved or government-controlled certification authority (CA).
  4. Tax determination. Since every line of every invoice will be available for deep analysis by the tax administration, it becomes much more important for both trading partners that their tax determination decisions are 100% correct.
  5. Archiving. Where archiving remains compulsory — which is currently the case in most countries with different forms of real-time or near-real-time VAT controls — the “legal invoice” and the “business invoice” exchanged between the parties, if different, needs to be archived and available for internal and tax administration audit.

As a test, let’s see how these functional components work for Italy, a newcomer to real-time controls, and Brazil, an old-timer that has had extensive clearance requirements in place since 2010.

In Italy, specifications tailored for the introduction of mandatory B2B and B2C e-invoicing, whereby the tax administration piggybacks on the pre-existing B2G (so-called SDI) platform, aren’t fully available yet. The analysis below, however, based on the current B2G specs, should be pretty close to the truth.

  Italy Brazil
Regulatory mapping A specific VAT invoice message format called FatturaPA XML is required. Over time, e-invoices in line with the European Norm (EN) developed by CEN will probably be accepted as well. Companies need the ability to map to and from various mandatory e-invoice data formats that differ depending on whether the invoice is for goods, transport or generic services.
Regulatory transaction orchestration and process alignment An invoice isn’t VAT compliant until it has successfully been sent to the SDI platform. The SDI platform may deliver the e-invoice to the buyer. The buyer may reject the e-invoice, and depending on the data exchange setup, the supplier may need to respond to such rejection. Invoices for goods must be cleared by a federal tax administration platform, while invoices for services must be cleared by municipality-level tax administration platforms. Unique processes exist for so-called “contingency” invoicing when the tax administration platform is inaccessible. Taxpayers need to be able to print specific invoice-based documents called DANFE to accompany transported goods.
Authentication and security The SDI platform requires the use of “qualified electronic signatures,” which currently are defined by the European eIDAS Regulation. In the future, the trading parties may be able to choose other means of ensuring long-term integrity and authenticity in line with VAT Directive Article 233. Connection from the supplier’s system to the SDI can be based on a number of different technologies, each with their own technical requirements for authentication, integrity protection and confidentiality assurance. Public key certificates must be used for electronic signing and authentication. These certificates must be issued to taxable persons by Certification Authorities that are recognized by the tax administration.
Tax determination The SDI platform currently does not seem to perform many VAT-related content checks on the invoice. In time, various sophisticated controls on the correct application of VAT will be added to the platform. With the heavy process dependency on the SDI platform accepting your invoices, you really want to avoid errors. Tax administration platforms perform several controls on the correct application of VAT. Process dependencies include not being able to ship goods until the invoice is approved by the competent tax control platform.
Archiving Complex technology and processes required for compliant archiving; the new law that mandates B2B and B2C e-invoicing via the SDI platform says that if the invoices are processed by the SDI the obligation to archive the same invoices is considered as fulfilled. However, it is currently unclear whether this also releases trading partners from their archiving requirements under other tax law, accounting law, commercial law or civil law. Taxpayers must archive their invoices and associated data for six years.

These examples show that there are strong conceptual commonalities between these two countries with real-time VAT control requirements. This is extremely important for enterprise and service provider experts with responsibility for strategic process and technology design.

It is equally important, however, to acknowledge that there are many differences in the way these two countries are moving toward VAT Compliance v2.0 — and this will be true for any other randomly chosen two countries with such controls. Indeed, Italy passed the law that mandates e-invoicing in defiance of a formal E.U. requirement that buyers are free to reject the receipt of invoices in electronic format.

The forces at play here are not exactly encouraging for those hoping to see some convergence of required processes or technologies for VAT Compliance v2.0 in the decades to come. For businesses to maintain some semblance of coherent and cost-effective response, they must avoid panic-fixing compliance the moment new requirements come out and instead consider automatic solutions that can guarantee compliance on an ongoing basis. Our view is that a fundamental understanding of what governments are up to in the digital economy will set business winners apart from losers. Only if you see the forest for the trees can you regain the initiative and stay in control of your own business automation planning.

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