In today’s episode of VAT Talks we discuss digital reporting requirements (summitto’s confidential real-time reporting system falls under this umbrella term) with Michel Schrauwen, Managing Partner Indirect Taxes at Deloitte, and Oscar Smeets, Senior Manager Indirect Tax at Deloitte and lecturer at Tilburg University. Together they wrote an excellent article about the potential benefits of digital reporting requirements for the Netherlands, cautiously concluding that the Dutch government could save at least €1.5 billion on an annual basis. We discussed why both Michel and Oscar are so obsessed with VAT, how digital reporting requirements can help close the VAT gap and what would be the best approach to implement digital reporting requirements throughout the European Union (EU).
How did you end up in the field of VAT and could you tell a bit more about your current work?
[Oscar] “To be honest, I had to be a little bit persuaded. I was supposed to spend 3 months in Deloitte’s VAT team as an intern, but I actually really liked it, and I’m working there for over 8 years now. And slowly but steadily I moved from only tax consultancy towards data analysis and fiscal controls. In short this means assessing the VAT position based on data. What is very interesting to see in this field of work is the amount of data that is stored for VAT purposes, that actually does not play any role in the current VAT controls and compliance processes. At the same time, once a week, I work at the University of Tilburg to assist with an already existing programme, again about fiscal assurance and how the government could and should deal with all the different company data. And from there on, I have specialised myself in the area of compliance and how we could organise this in a more efficient way.”
[Michel] “I’m Managing Partner Indirect Taxes at Deloitte, which means that I’m responsible for all consultants working on VAT, customs and transfer tax. We are working a lot with data, as VAT is a transaction driven tax which means that a lot of the checks you have to do, but also the potential VAT refund you can request, is affected by the way you label the transactions. As large companies have a lot of those transactions going through their books, we make use of our own software and software of third parties to analyse and/or report those transactions. Besides that I’m also working with AI and tax law, and I provide legal advice to governments.”
What do you like most about VAT?
[Michel] “I think both Oscar and I are really passionate about our work. And this is not only confined to VAT, but also to customs as indirect taxes are everywhere. For example, if you go to the cinema you can (unfortunately currently you can’t due to Covid) buy popcorn, a soft drink, a beer and of course a ticket. Some of those transactions have a different VAT than others. Then there is also the discussion about e.g. a sugar tax. When you understand this puzzle, and see everything falling into place, you start to really enjoy it. Besides, for a lot of clients this is very complex which means you can actually help people. Furthermore, the legislation is relatively old and is not being modernised often. Therefore, the way the world looks now with e.g. complex value-chains does not correspond with the current legislation. This means that there is a lot of case law which helps to overcome these problems.”
[Oscar] “And that is indeed what makes VAT so interesting. It comes very close to the day-to-day work of businesses. As it is value added tax, you deal with questions as how does the company add value? Which transactions is a company doing? Therefore VAT is constantly evolving, because businesses are constantly evolving. Businesses will always try to find a strategy to improve themselves, which means that tomorrow different aspects could be relevant for VAT than the ones that were important today. And indeed, you will see that legislation does not move as fast as businesses do, which means VAT never sits still. Those kinds of things make VAT fun.”
You wrote an article in which you were pleading for the introduction of digital reporting requirements in the Netherlands? Could you explain what you mean by this and how it could help closing the VAT gap?
[Oscar] “We purposefully used the term digital reporting requirements or information requirements because we were looking for an umbrella term as we often hear people talking about SAF-T or specific forms of those requirements. What we specifically mean by digital reporting requirements is actually a regulated way of data formatting. So basically, setting bookkeeping requirements and how this data should be exchanged between the taxpayer and the tax authority. I like to call reporting requirements in its most simple form requirements on demand. Here companies need to have their bookkeeping ready when the tax authority asks them for information. So then they provide this information in a SAF-T format for example.”
“In our article, we focus on reporting requirements that go one step further. We focus on spontaneous requirements, where taxpayers have to provide information to the tax authority by default. This can be implemented in several ways. In Spain for example, with the SII system you need to report invoices and basically list them. But this spontaneous way of reporting can also be coupled with e-invoicing, such as in Italy or now in India.”
“The follow-up question is then how can such systems, and mainly the spontaneous ones, help in reducing VAT fraud and closing the VAT gap. It is important to note that an estimated ⅓ of the VAT gap is due to VAT fraud. The rest is lost because of other reasons. So you need something that has a broader effect than anti-fraud only. We started looking into if and how reporting requirements can help close the overall gap.”
“We found a couple of factors. The most logical one is that the detection rate increases. This is called, with a fancy term, objective detection risk. Simply put, it is harder to hide anything from the tax authority when your transaction history is already reported to the tax authority.”
“Then, there are two other ways in which similar systems contribute in closing the VAT gap. First, there is also something as a deterrent effect, which is the subjective detection risk: how does a business assess the chance of being caught. This will increase the threshold of committing fraud. Second, empirical research shows that the willingness to be compliant increases at the moment that a tax authority operates in an equitable manner. In other words, compliance increases if taxpayers see that everyone is treated the same way. We believe that when everyone has to report the same data, and if controls are based on that same data, it will contribute to the image of the tax authority as a just and equal enforcer of law. Additionally, it is no news that the Dutch tax authority does currently not have a great reputation in this area and we think that the introduction of digital reporting requirements could give the tax authority a welcome boost which could increase compliance even beyond VAT.”
[Michel] “Furthermore, the article was also meant as a bit of benchmarking. We knew that there were these two countries in the EU that implemented similar measures in a different way. Both with the idea to reduce the amount of errors, just as Oscar just said ⅔ of the VAT gap are due to mistakes. We wanted to test which method was better and see what the experiences were in those different countries, what are the challenges for both the government and businesses. Then, we tried to apply the result to the Netherlands.”
Do you have a preference for either one of those systems for the Netherlands?
[Michel] “I don’t think you can put it that simply. You do see that the VAT gap in Spain is very much comparable to the Dutch VAT gap. So, from that point of view it might make more sense to implement a Spanish-like system in the Netherlands. On the other hand, a system such as in Italy comes with a lot of benefits for large companies because it is coupled with e-invoicing which results in significant savings through e.g. automation. Therefore, I think both systems have their pros and cons.”
[Oscar] “I agree. I think that at first these systems seem to be very different, but that this is not the case in practice. The information that you have to share is very similar, but in the end it is all about how you set up such a system. So, how can you set it up in such a way that businesses are not negatively affected, while at the same time all relevant data end up at the tax authority in time.”
“With the Spanish system you have to report invoice information after sending or receiving an invoice. And only at the moment that someone in your value-chain does this, you will be able to see this information. This is what I like about the system, because at the moment a company says ‘I have sold you product Y’, you can look this up in the system. Although this is not e-invoicing, it does facilitate easy checks. The Italian system goes one step further, as that is basically mandatory e-invoicing. This makes data processing even easier. However, in the Italian system there is the so-called single point of failure as there is one centralised invoice clearance system which has to respond in time and has to be available for everyone. If something within the system breaks, or if it turns out that something is wrong with the security, and the tax authority cannot check the data anymore this could potentially mean that no one will be able to send invoices anymore.”
“So again, there are pros and cons. I think the most important thing when a government is considering implementing such a system is that you create a sense of public support. For example, it should be fast, facilitate businesses, and guarantee privacy and confidentiality. People need to trust the technology, which technology is then used is less important. As long as it works.”
[Michel] “There was another reason why we wrote this article which is related to COVID-19. First, we noticed that tax authorities have to increasingly perform their checks digitally due to COVID-19. Digital reporting requirements could be a good solution to this problem. Second, all the costs governments currently incur to support restaurants, the cultural sector and other businesses, need to be paid back at some point. And just as with the previous crisis, there will be people saying ‘okay, we need to levy taxes to pay off our debts’. During the last crisis this annoyed us, because why would you introduce a new tax if you could collect the existing ones in a more efficient way. Then you could earn at least €1.5 billion on an annual basis, and maybe even €2 billion.”
And how did you come to this €1.5 billion that the Dutch government could potentially save on an annual basis?
[Oscar] “There is not too much data available about the impact of such systems, and that is one of the reasons why we wanted to write this article and make a rough and conservative estimation of the amount of money the Dutch government could save by implementing digital reporting requirements.”
“What we did is, we took detailed tax income data of Spain and Italy, where there is a very clear pre-implementation and post-implementation situation. During this period no VAT rate changes or any other relevant fiscal measures were implemented. So, we simply checked the tax income the year before implementing digital reporting requirements and the year after, of course corrected for macro economic growth. What we saw in Spain, which is especially relevant for the Netherlands as that country is best comparable in terms of compliance readiness and size of the VAT gap, is that the VAT income grew a couple of percentage points more than the economy. Because everything else remained roughly the same, we carefully drew the conclusion that this has to do with the introduction of reporting requirements.”
“Because of the similarities between the Netherlands and Spain, we dared to extrapolate these figures we found in Spain to the Netherlands.”
Do you see a trend within the EU of countries implementing similar solutions?
[Oscar] “Yes. I think that for a long time, Member States really awaited the actions of the EU and the Organisation for Economic Cooperation and Development (OECD) in terms of harmonisation. An example is the development of SAF-T. However, in practice this harmonising role of the EU proved to be very difficult. In the past Member States did not agree on the initiatives that we put forward by the EU. Therefore, many Member States decided to do something themselves. So, there is definitely a trend of national initiatives visible. We already discussed Italy and Spain, but there are also things happening in Lithuania, Poland and Hungary. Furthermore, France started a public consultation in the market to gauge what businesses think of this development. And this trend is also visible in the rest of the world.”
[Michel] “Look at the Middle-East for example. Saudi Arabia started investigating the possibilities, just as the UAE. What you see is that we as the Netherlands, who were always perceived as a very progressive country in terms of the automation of taxation, now suffer from the law of the handicap of a head start. We are falling behind countries that start from scratch, which is quite remarkable.”
With all those different systems, do you still see the possibility for harmonisation within the EU?
[Michel] “Ideally, there would be just 1 uniform system for the entire EU, that can be implemented within the next 2 years. In that way, you would really create a level-playing field. However, the experience is that it is very hard to reach a consensus on the EU level. This also has to do with the fact that many believe that you could retrieve a big share of the lost VAT by modernising VAT legislation. Personally, I think you should indeed modernise VAT because a big share of the VAT gap is caused by genuine mistakes. But that alone doesn’t cut it. I believe every country should implement such an electronic reporting system. Preferably, this would be an EU wide system, but if that doesn’t happen I think it wouldn’t hurt if the Netherlands would just go ahead with implementing their own solution. They can always adapt the system when there actually is an EU wide system, but at that moment companies will be at least already used to reporting information to the tax authority. Besides, if the requirements stay roughly the same, it would not be a very big investment to switch to the new system.”
“Furthermore, this argument can also be turned upside down: what happens if you don’t implement electronic reporting. Then you would end up in the situation that you need to levy €2 billion and the government needs to inform teachers, nurses and pharmacy assistants about the fact that tax rates will increase to raise more money. I don’t think this is the best way forward, I think you owe it to all those people to levy existing taxes more efficiently and minimise fraud and mistakes.”
In earlier blog posts we discussed the potential shift of the burden of proof, in case of the implementation of a real-time reporting system. Do you think that, as the tax authority then would have all data from the very start, the tax authority will become the one that ‘knew or should have known’? If so, do you think this is problematic?
[Oscar] “I do think this is a situation that could occur. The question is, is this a problem? Currently all the information lies with the company, but this will be moved to the tax authority when digital requirements are implemented. This will reallocate the power and knowledge within the market. One of the most important changes these systems will bring about is that the tax authority will know more about the companies than the companies themselves, because the tax authority also has information about their trading partners. Besides, in most systems business owners only have access to their own data and to the invoices that they send and receive. This raises some fundamental questions regarding the legal protection of businesses by the government. This is inherent to the formal fiscal law that is actually written to allow the tax authority to close the information deficit (which is inherent to a post audit system) by gathering information and protect the taxpayer from too much power of the government.”
“When a reporting system is implemented, this would require some adjustments. Currently, when you are involved in a fraud scheme, you need to prove you did not know, or could not have known about this fraud. Otherwise you lose your right on a VAT refund or you have to repay VAT. This idea was created in a world where the ones who had all the information, where the companies themselves. With a reporting system, the tax authority becomes the party holding the information. However, I think this problem is solvable as you could argue that ‘with great power comes great responsibility’. There will be an additional responsibility for the government to detect fraud and they will be able to do so because they will have access to new tools and data. Moreover, as you can see in the Spanish system, where a buyer could also see what the seller reports, it will be easier for all parties in the value chain to perform their investigative duty and provide the relevant data to the tax authority.”
[Michel] “The thing is, it will increase government revenue, even if the burden of proof shifted to the tax authority, and it will incentivize the tax authority to detect fraud faster which also results in an improved legal protection for taxpayers. What you need to ask yourself: if one of the ‘disadvantages’ of such a system is an improved legal protection for taxpayers, is it a bad thing? I don’t think so. On the other hand this means that the tax authority really needs to invest in their IT systems and we saw in the past that this could be a difficult process. Still, as I’ve always learned, as long as the measure will result in high enough returns it would be worthwhile to implement it, although I’m probably oversimplifying the situation. Another argument would be that the tax authority should have improved their IT systems already a while ago and maybe the implementation of a electronic reporting system could be an incentive to also update other parts of their IT system.”
“All in all, I don’t think that the shift of the burden of proof would be a problem, as taxpayers will be better protected. The other part of the equation is that if you are committing an error this will also be detected earlier. But again, this is a big advantage for the tax authority. So, based on the experience in other countries, I don’t think this is a problem.”
If you could give one piece of advice to the European Commission (EC), what would it be?
[Michel] “That’s a tough one. The implementation of reporting requirements would not only be beneficial for Member States, but also for the EU itself as the EU generates revenue from VAT that is levied domestically. On the other hand, I have to say that there are so many bright and clever people working with the EC who know way more about this subject than I do and probably I’m underestimating multiple things. We just hope that with our article, we can contribute to the ongoing discussion on digital reporting requirements.”
[Oscar] [laughing] “Indeed, it’s very difficult to give only one piece of advice to the EC for such a complex problem. On the one hand there is this enormous problem, the VAT gap, and on the hand there is the resistance from both businesses and Member States to change or harmonise the system.”
“I do think that electronic reporting systems could solve the problem and my advice would be to link such a system to current trends and developments in order to get the businesses on board as well. So, create a strategy and show why this should be something for every EU Member State and business. For example, the EC could grant an implementation period as companies need to move to the cloud or SAP HANA anyway. The EC could discuss with business organisations, and they would also have a better negotiation position with software suppliers that need to get the system in order.”
“I think the EC should create a sound idea of this strategy and bring the interests of all different Member States together as much as possible. And let’s be honest, no one wants to go to a situation where there are 27 different reporting requirements, all with their own characteristics and their own way to tackle the problem of confidentiality. If this happens we would be thrown back to 1960, when differing consumption tax systems pushed the EC to commission a study into what eventually became the current VAT system. Let’s skip these years of pain this time and move directly towards an actual solution.”
How would you bring across your passion for VAT to others?
[Michel] “A lot of people did not plan to end up in VAT, but they decided to stay and really enjoy it. I think that the most fun part of VAT is that it’s always evolving. What you currently see, which is something summitto is also trying to tackle, is that taxation is more and more affected by technology. This is not only the case for processing transactions digitally, but also in terms of applying legislation, explaining legislation through AI, applying case law etc. All of this together adds value, also for clients. We’re not at all finished learning and because VAT is very much transaction focused and very complex, I believe that by using software and AI VAT could be one of the first fields in taxation that could truly become a legal tech.”
[Oscar] “All in all, it is a tax where a lot of different things come together, and I really enjoy that. I think there are not too many fields of work where you are confronted with such a diversity of disciplines.”
We would like to thank Michel and Oscar again for their time and for giving their perspective on VAT. The opinions expressed in this article are personal. If you have any questions, suggestions or if you want to be our next interviewee, do not hesitate to contact us via firstname.lastname@example.org