Digitalization of Taxes: How to Improve Business Efficiency and Compliance

Imagine a world where paying taxes felt like using your favorite app. Automatic. Real time responses. User-friendly!

It’s definitely possible, but a long way off. Tax administrations need to undergo what’s called a “digital transformation” in order to meet us — taxpayers, business owners, citizens — where we are.

Here’s a look at the roadmap for the digital transformation of taxes, why it’s necessary, and what we can look forward to in the future.

What is digitalization?

Digitalization is buzzword, but what does it actually mean? There are actually a few different terms to define here.

‍Digitization: Converting something from analog to digital form.
‍Digitalization: Converting a business model to digital operations.

Simon-Kucher & Partners, the strategy consultancy, says that “digitalization … increases process efficiency and improves data transparency, and of course, it should help boost your top line.”And there’s one more term to know: digital transformation.

“We digitize information, we digitalize processes and roles that make up the operations of a business, and we digitally transform the business and its strategy.” - Forbes

When it comes to taxes, the change is not just digitizing invoices or digitalizing the filing of tax returns, but also undergoing a digital transformation of the industry.

And when it comes to this digital transformation, the brunt of the work is on the tax administrations’ shoulders. They will overhaul tax systems to provide streamlined, user-friendly experiences for business owners and citizens alike.

Why is the digitalization of taxes necessary?

“If tax administrations can effectively analyze all the information they handle, they can provide better services and become more efficient. This is the promise and potential enabled by digital transformation.” - Digital transformation of tax administration, from PwC

Taxes, as a system of revenue to sustain the state, is a fraught system. It’s out-of-date, filled with loopholes, and extremely hard to fully enforce. The digital transformation of taxes as a whole could be a solution to these innate problems — plus a response to the mountains of modern data that administrations now accumulate, and to mounting public skepticism of opaque government services.

Here’s a quick runthrough of the pre-existing conditions that a digital transformation could potentially cure.

Public demands for transparency

PwC contends that since economic crises in the last decade or so, there’s a public pressure for financial institutions and other government systems to be more transparent.

Massive amounts of data just sitting around

The tax system produces a ton of data, which administrations must learn how to process and effectively manage.

The revenue gap is huge, and widening

Low compliance: Partially due to the technology gap! Tax administrations don’t use cloud computing. Here lies a huge gap between how businesses operate and how the public sector operates. The public sector is bound by long-standing regulations, a lack of digital skills, and lack of education around the benefits of certain technologies.

“Developing nations lose nearly $1 trillion per year due to illicit financial flows. Most recent IRS gross tax gap projected loss of $458 billion in US in one year. Remedying this gap depends on the state of the economy and the administration’s ability to get taxpayers to voluntarily comply.” - PwC

Tax Fraud

This is pretty simple: people can get away with tax fraud because there’s little oversight.

OECD In 2017 the OECD urged the need to detect and prevent tax fraud. The right technology would lead to “better detection of crime, higher revenue recovery, and synergies that can make tax compliance easier for business and tax administrations.”

Developing economies have a few additional objectives:

• Include more taxpayers in the formal economy (i.e.- registering them in the tax system)
• Reduce tax evasion
• Counteract money laundering

Goals and expected outcomes of digitalizing taxes

The process of digital transformation is not just a natural direction of the tide of new technology, pushing an inevitable modernization of tax systems. This is a deliberate, hands-on transformation in the aim of specific objectives, expecting specific outcomes.

With data, tax administrations can use predictive modelling and analyze economic trends and the effects of policy changes. The insight gleaned from all this new information should enable improvements for taxpayers and tax agencies alike.

Benefits for taxpayers:

• Simplify compliance: Fewer interactions with the tax agency, real-time communication, personalized e-Services, simple forms
• Prevent tax errors: Data is automatically entered and calculated
• Various possible payment methods
• Faster refunds!
• Easier access to relevant info

Clearance models require all transactions between private businesses to go through the government so that the government can, in real-time, effectively audit, monitor and authorize dealings.

Benefits for tax administrations:

• Claim more revenue and close the tax gap
• Reduce operation times
• Decrease operating costs
• Improve risk management techniques and audit efficiency

Finally, the digital transformation of taxes should enable economic growth around the world. In 2016, G20 leaders urged countries to consider digitalization and further updating of their tax systems, arguing that such changes bring “well-managed data, pro-growth tax policies and tax certainty...which promotes investment and trade.”

PwC reinforces that all of these benefits and outcomes will be achieved through data.

“As administrations accumulate higher and higher volumes of taxpayer data, they’ll want to convert that information into actionable insight that helps them increase revenue, retain their country’s investment attractiveness, and ease their tax compliance burden.” - PwC

How governments can accomplish digital transformation

According to PwC, to successfully complete a digital transformation, tax administrations need:

• A secure and scalable tax compliance infrastructure
• Capacity to process huge amounts of data and draw insights out of it
• Capacity to automate and personalize services with AI
• Communication and collaboration platforms for Government-to-Government (G2G), G2B, and G2C interactions
• Flexible workplace and multi-channel platforms

To achieve all of the above, they’ll need to adopt (and adapt to) several different technologies that are already well-known to the private sector. Here are some of the technologies tax administrations need to embrace and employ:

• Cloud services
• Multi-factor identification
• AI
• Blockchains and bitcoins
• Advanced analytics
• CRMs
• IoT

Perhaps the most important factor, though, is a tax administration’s ability to offer transparency.

All of that data we talked about? Taxpayers are rightfully concerned with privacy, security, and protection of their data. So much so that the EU just overhauled their data privacy regulations.

In order to even begin using some of those technologies listed above, such as move tax applications and data to the cloud, tax administrations need public approval. In order to gain public approval, they need to improve confidence and trust. So, tax administrations must be concerned with data governance, and then share their policies and processes openly with the public.

PwC suggested some elements of data governance that could help develop public confidence:

• Data classification
• Stewardship models
• Change-control mechanisms
• Enhanced encryption
• Increased identification, identity and rights management

In short, the argument for transparency is this: transparency will improve the agency’s public image, allow the use of new technologies, and thereby increase taxpayer satisfaction and voluntary compliance.

The technology gap

Where tax administrations stand today is far behind businesses and citizens. Agencies face a long road to full digital transformation, full of adoption and adaption, to match how taxpayers use current technologies.

Given the private sector is already building on all of these technologies, with product offerings of every sort, it begs the question: Can the private sector help the digital transformation of taxes, and if so, how? As the financial sector evolves, cloud adoption in financial services becomes increasingly vital, bridging the technology gap and ensuring seamless integration of digital solutions in tax systems.

Role of third-party software in digital transformation of taxes

“Third parties also have an important role to play, as they may be best capable of providing integrated solutions that take complexity away from the taxpayer.” - PwC

To help their modernization, tax agencies can work with third parties, such as data holders, tax service providers and industry associations. For example, PwC suggests a hybrid cloud setup could help with the transition: tax data is in the public cloud, while taxpayer personal info is in a private cloud.

Through sharing knowledge and business rules, plus making appropriate data available, governments can enable third parties to integrate the tax system in their service offerings (to citizens or businesses). An obvious example is developing APIs to connect software apps directly with national tax agency systems.

‍Third-party software could help taxpayers with any of the following elements of tax compliance:

• Tax registration
• Tax invoices, e-invoicing
• Tax calculation
• Tax collection
• Data storage: e-books, customer location evidence, digital invoices
• Threshold tracking
• Tax reports
• Tax filing

Which countries have digital transformation initiatives underway?

The United Kingdom is, by far, the most advanced in the world. The HMRC has vowed to move the British tax system completely online over the next several years, through a legislative process named Making Tax Digital. You can read all about the UK’s tax digital transformation and the requirements for VAT-registered businesses in our article: Making Tax Digital: How to follow UK’s VAT guidelines.

Other regions undertaking digitalization of taxes, to varying degrees

Australia

Australia has “Alex,” a virtual tax assistant, which answers questions about general taxation. One step toward more personalized services using AI.

Azerbaijan

Azerbaijan has no less than 62 digital services for taxpayers, including e-declarations, e-chancellery, e-registration, e-audit, and mobile identification. In an interesting quasi-marketing strategy, the country has social incentives to motivate people to voluntarily comply, with social network activity on Facebook, Twitter, and Youtube.

Brazil

In Brazil businesses can e-file their accounting and tax records. Because of this, the country has put in place early stages of digital oversight. Federal authorities can electronically exchange corporate income tax data.

Canada

In Canada, e-invoicing is possible but not legally required. Supporting tax documentation can be sent electronically. Plus, taxpayers can use a mobile app to access tax info and receive tax reminders.

China

The State Administration of Taxation of China is undertaking digitalization as part of their “Internet + Tax” action plan. The goal is to reduce compliance burden by providing “comprehensive eServices as a smarter tax authority by 2020.”

Colombia

Starting in 2019, Colombia requires e-invoicing.

Estonia

In Estonia, about 95% tax returns are done through e-filing. The country offers one-click tax return, where the taxpayer basically just needs to verify and submit, and receives a refund in 5 days.

Hungary

Hungary Fiscal cash registers to tracks retail B2C sales through fiscal cash registers. From July 2018, all VAT-registered businesses must submit domestic B2B invoices with VAT amounts over 100,000HUF (about €320). These invoices must be in XML format and sent within 24 hours. You risk hefty fees if you don’t comply.

Indiana in the US

The state of Indiana offers a one-stop tax portal for business users and a cloud-based identity management system for citizens.

Ireland

Ireland has digitalized the tax process for the country’s Local Property Tax (LPT), or national property register. They’ve developed a support structure for self-assessed taxes, targeted to an audience with little tax knowledge. Plus, Ireland has mandatory e-filing for certain tax categories.

Italy

Italy’s on a mission to close its VAT gap and improve agency efficiency. From January 1, 2019, B2B e-invoicing is mandatory for all companies.

Lithuania

Lithuania uses an electronic declaration system and online identification for taxpayers. Other resources include an online self-service portal called My STI, a mobile app, and pre-filled VAT returns.

Mexico

Mexico offers a special application for cloud-based tax collection, so entities can pay taxes in minutes. Taxpayer information is automatically entered and calculated, so filing can be as simple as one click. Then tax returns are deposited in their bank account within five days!

New Zealand

New Zealand’s tax has undergone digital transformation for its “Significant Enterprises” segment, nearly 600 taxpayer groups. The NZ tax agency monitors key performance data.

Spain

Spain has a VAT policy called Immediate Supply of Information (ISI), which involves real-time tax reports of electronic books, e-invoicing and e-filing, and fraud detection. However it’s only required if your annual taxable turnover is above €6 million or if you submit a monthly VAT return.

Zimbabwe

The Zimbabwe Revenue Authority has agile customer support with extended webchat hours.