Real-time compliance in the U.S.: There’s a lot of work to do

The use ofelectronic invoices that enable authorities to monitor transactions in real time has swept Europe and much of the world. (Read more aboutWhat U.S. sellers need to know about e-invoicing.)

The benefits, for tax collectors, are clear, panelists at this year’s Avalara CRUSH Global event said.

Real-time invoicing allows value-added tax (VAT) in Europe to bemore or less self-administered, said Gino Dossche, principal for EY’s U.S. VAT tax practice.

“It’s a very nice tax for the governments,” he said. “It’s very hands-off. The burden is on the taxpayers.”

It’s been a major change for businesses. European nations that used to allow companies to submit monthly or quarterly estimates of taxes owed are nowrequiring them to submit real-time data on transactions, Dossche continued.

“There’s definitely more data, more frequently, that needs to be reported,” he said. “For a business, that means you have to have a more holistic view around VAT compliance, because you cannot make up your report anymore.”

But for U.S. states and local governments to implement this kind of system, “there’s a lot of investment that needs to be made,” said Tax Foundation Executive Vice President Daniel Bunn. Many tax collection agencies are operating outdated systems that must be replaced before they adopt this kind of process, he added.

There are a few roadblocks to the adoption of e-invoicing and real-time compliance across the United States.

The big one: There’sno central taxing authority that could implement a nationwide real-time sales tax process. The United States doesn’t have a federal VAT, and under the Constitution, Congress cannot regulate commerce unless it occurs across state lines. Therefore, the federal government could only go so far as to establish real-time compliance standards for interstate transactions and foreign trade.

That means it’s up to the states, territories, and local governments that collect sales taxes to work out their own standards and processes, Armbruester said.

“Don’t expect one simple, seamless national solution,” she said. “The probability of that happening with 50 independent states is low. … They’re going to do what’s best for New York, what’s best for Connecticut, what’s best for California.”

Implementing new real-time processes will also require in-depth conversations between policy makers and their IT professionals so there’s clear understanding of what’s possible and what will need to change to make it happen, Armbruester continued. “It’s not just a technology lift, it’s a process change.”

And it won’t be easy.

To illustrate her point, Armbruester tells how one state tax agency recently required all businesses registered to collect and remit sales and use taxes in the state to update their passwords to access the state’s site.

The problem was that a significant number of businesses rely on third parties — tax accountants or automated tax compliance service providers like Avalara — to file their tax reports. Only the businesses themselves, and not their tax service providers, were able to make the password change. Many businesses missed the notification or simply didn’t make the change.

The result was challenging for third-party providers, Armbruester said.

Without a mechanism to file electronically, paper was the only option. “This left the tax department with significant volumes of paper to manually process and may have presented a staffing issue for them” Armbruester said.

Avalara engaged with the state tax agency, and while very responsive, there wasn’t an immediate alternative solution. “There are opportunities in terms of technology and process that we will continue to explore in partnership with the state tax agency,” Armbruester said. 

She said she’s encouraged about this and automation discussions like this happening with other tax departments in the U.S. as it represents a shift toward simplifying the complex world of tax compliance. “Any movement toward real-time compliance will require foundational changes leveraging digital-first thinking.”

There have been tentative first steps toward implementing real-time compliance processes in the United States.A working group is running trials on a model system and is expected to have a report recommending best practices next year. And in Massachusetts, Governor Charlie Baker has included funding forproposals for real-time compliance in five of his last six state budgets.

Armbruester said some parts of real-time compliance would be more straightforward than others. The reporting function would be “relatively simple if standards were widely adopted,” she said. But how and when companies would actually remit the taxes they collect is “a separate conversation.”

In a real-time reporting and remittance scenario, states will have to reconsider the common practices of commerce such as returned merchandise and cash transactions. These elements look different in a real-time environment and create new complexities to tackle.

“It’s not only complex but it invites opportunities for different tax agencies to solve for them in different ways,” Armbruester continued. That creates challenges for a business that needs to be compliant with multiple tax jurisdictions.

It’s going to take time to figure out answers that will work for tax collectors, taxpayers and the accountants and tax-compliance service providers that work with both, Armbruester said.

“Governments have to understand what their goals are, and then consider what technology and processes best help to achieve them,” she said.

Learn more about what Governor Baker has proposed for Massachusetts. You also can access our list of nations around the world that have digitized their transaction tax reporting.