There is a lot of fuss about clearance in the VAT world nowadays, but the problem seems to be that not everyone is following the same definition. The Italian VAT reporting system (SdI) is considered as a clearance model, but so is the Mexican system, and yet there are many differences. In this blog post we will try to explain what it actually is.
What is clearance?
Clearance is one of the design options when thinking of the implementation of a real-time reporting model. Previously we provided an overview of how real-time reporting models differ, but for this blog post it’s worth repeating that real-time reporting means that (part of the) invoice information is sent to the tax authority. This can be done as an (automated) additional reporting obligation, potentially coupled with mandatory e-invoicing. However, clearance is something different. So let’s start to get to a clear definition of clearance.
Clearance means “permission”, “consent” or “endorsement”. Applied to an invoice, clearance means granting official permission for the invoice (thereby legalising it) to be sent to the buyer.
Clearance of an invoice usually involves checking correctness of the structure of the invoice by an authorised party which can be held liable. Correctness can only be checked through syntactic checks (e.g. are all mandatory fields present and is the electronic message readable). Authorised parties may include only the tax authority, but also third party service providers.
Advantages and disadvantages of a clearance model
If we look at it in practice, in a solution such as implemented in Italy or Brazil the tax authority clears the invoice, meaning that it checks the correctness of the structure of the invoice. On the other hand in Mexico, third party service providers are authorised to clear the invoices.
What is important to stress in this regard is that no clearance model can check the correctness of the data provided on the invoice, but only the correctness of the structure. This is for instance happening in Italy, where the “Sistema di Interscambio” checks if all the boxes of an invoice are correctly filled in but does not check the correctness of the information provided. In other words, the tax administration can not make sure that the correct VAT rate is applied on the invoice.
Such a system can assure that the structure of the invoice is respected at every moment but it cannot automatically check for reporting errors or fraud. Let’s visualise the following via an example. In Germany there is a different VAT rate for basil plants (19%) than for molded basil (7%). In case someone issues an invoice for molded basil with 19%, a clearance system will not be able to detect the error, as it can validate the invoice based on its correct structure (all boxes filled). Nevertheless, fraud and errors are still possible.
On the upside of clearance, for the buyer there is no doubt anymore that one received a valid invoice, therefore audits based e.g. on excessive VAT claims should not be necessary anymore. As in the case of Italy all invoices are cleared by the TA therefore denying the deduction legally should not be possible anymore, which of course opens up a huge risk for the TA which we also mentioned here.
In order to further prevent fraud, validation by the customer, auditor or tax authority is needed, as they have more context about the transaction.
As we have seen, a clearance model can help to assure the quality of an invoice by making sure that all the required information is reported. Nevertheless, it cannot help to assure the quality of this information because within the clearance process there is not enough context to analyse the reported information. We hope this helps in understanding what clearance exactly is. In a next blog post we will dive deeper in the difference between a centralised and a decentralised clearance system.