Lost In Transaction: The Cost Of Erroneous Tax Data
There is a big difference between managing direct taxes, such as corporate tax, and indirect taxes, such as sales tax and value added tax (VAT). While for corporate taxes, it is irrelevant where the customer is located or the goods are shipped to, for indirect taxes, every transaction detail matters and is crucial to determining where a transaction is subject to tax. The most important source of this transaction data are invoices. Invoices are of particular importance in the field of VAT since they are the means through which VAT is charged and they grant the right to deduct VAT paid on purchases. In the European Union, it is mandatory to issue invoices when you sell goods or provide services to another business, and the VAT law provides a long list of items that an invoice must contain.
International trade and detailed tax legislation can make VAT management a notoriously complex area for many companies. In companies with a high volume of transactions where thousands of invoices are booked every day, it is very likely that not all invoices are properly checked before being recorded in the accounting system. Even with processes in place to perform regular checks of invoices, some errors can still go unnoticed. This may stem from a failure to identify certain country-specific requirements or an ignorance of local legislative changes. Invoice errors that pass unnoticed through accounts payable and receivable spread like a contagious virus throughout the organisation, moving from database to database and ultimately ending up in tax returns. Incorrect invoices often reside in the accounting system until they become visible during tax inspections by which time it’s often too late to correct them and avoid penalties.
Purchase invoices with missing data
While companies generally make sure that sales invoices that they issue comply with legal requirements, they frequently underestimate the importance of checking the legal correctness of purchase invoices. Purchase invoices are very important in VAT countries where the tax to be remitted to the tax administration equals the difference between the tax collected from customers (output VAT) and the tax paid to sellers on purchase transactions (input VAT). Missing or incorrect invoices generally preclude a company from deducting input VAT even if the tax was paid to the seller.
What happens if a purchaser deducts VAT charged to it in error by its sellers? For example, the purchaser receives an invoice showing VAT but no tax is actually due on a transaction. The Court of Justice of the European Union (CJEU) decided that if a company pays an incorrect invoice and deducts the incorrectly invoiced VAT, this tax amount must be added back to the company’s tax liability. The right to deduct input VAT is limited to situations where taxes are duly charged. In other words, the purchaser is required to verify whether the purchase invoice shows the right tax amount and cannot rely on the seller’s tax determination decisions.
What happens if an invoice shows the correct tax amount but contains other errors (e.g. an incorrect address of the seller or a missing invoice number)? The CJEU clarified that an input VAT deduction may not be disallowed if the content of the invoice allows the tax administration to verify who is liable to pay VAT due. The purchaser may deduct input VAT even if the invoice is incomplete and some data is missing. However, the key question that remains unanswered is: which data may be missing for the right to deduct input VAT to exist? When is a document so incomplete or incorrect that it no longer constitutes a valid invoice? Unfortunately, the CJEU has not specified the minimum mandatory information that must be displayed on invoices.
Sales invoices with overcharged tax
What happens if you charge too much VAT on a sales invoice? Well, you have to remit the overcharged tax amount unless you correct the invoice. An important rule of the EU VAT law says, “VAT shall be payable by any person who enters the VAT on an invoice”. This means that if you show a tax amount on a sales invoice by mistake, you have to remit this VAT to the tax administration even if no transaction takes place. The aim of this rule is to eliminate the risk of loss of tax revenue for the tax administration, which could arise if the purchaser deducts the VAT shown on the invoice but the seller fails to remit it. However, a recent decision of the CJEU clarified that the obligation to pay the full amount of VAT shown incorrectly on an invoice does not apply if the purchaser is a consumer who is not entitled to input VAT deduction. This decision is a welcome development for taxpayers as many EU member states required businesses to remit any VAT shown on an invoice even if there were no risk of tax revenue loss.
Failure to issue invoices
What happens if a sale takes place but an invoice is not issued at all, despite the obligation to do so? Does the seller have to remit any VAT? Is the purchaser allowed to deduct input VAT that has not been invoiced to him? The CJEU has recently decided a case in which two parties concluded a sale-and-leaseback agreement specifying the sale price and the tax amount, but the seller did not provide the purchaser with any invoice for this transaction. The Court ruled that a written contract may be recognised as an invoice as long as it mentions the VAT amount and contains other information necessary for the tax administration to ensure that the conditions to exercise the right to input VAT deduction are met. This decision does not imply that invoices are no longer needed, but merely states that in exceptional circumstances other documents may have the same effect as an invoice.
In recent years, the CJEU has shown more empathy towards taxpayers regarding the strict invoicing requirements and invoicing errors. Sellers are no longer required to remit VAT erroneously shown on invoices if they sell exclusively to consumers. Purchasers may deduct input VAT if the invoice they receive does not contain all the legally prescribed data. Yet, it is not clear what elements are allowed to be missing for the right to deduct to exist.
When managing VAT on purchase transactions, it’s important to heed the advice of US President Ronald Reagan: “Trust, but verify.” Companies should check that purchase invoices meet all relevant tax rules rather than trust that the seller complied with the tax legislation. VAT is a tax on revenue rather than profit. If VAT errors occur, companies may be required to remit an additional portion of revenue to the tax authorities, often negatively impacting their financial health. With the increasing number of transactions, the volume of inaccurate data is increasing. As tax audits generally cover multi-year periods, even small VAT calculation errors can add up to massive sums.
The opinions expressed in this article are those of the author and do not necessarily reflect the views of any organisations with which the author is affiliated.