E-invoicing mandates and intercompany transactions

Editor: Mary Van Leuven, J.D., LL.M.

The global surge in continuous transaction control (CTC) systems is a trend that cannot be overlooked. These CTC systems manifest as electronic invoicing (e-invoicing) or digital reporting mandates, compelling taxpayers to submit all transactional data to tax authorities in real time or near real time. Specifically, over the past decade, more than 30 jurisdictions have enforced some form of e-invoicing mandate, and a majority of the Group of 20 economies have implemented or are planning to introduce such a mandate within the next few years.

Like all reforms, certain aspects create more challenges than others. While many commentators will point to the lack of harmonization and interoperability, which imposes significant burdens on businesses striving to comply with these mandates, this Tax Clinic item zeroes in on a specific transaction type that often causes complications for companies: intercompany transactions.

Intercompany transactions are commercial and financial exchanges between two or more entities within the same corporate group. These transactions can range from the exchange of goods and services to the transfer of resources or funds. They are a vital practice in multinational corporations with subsidiaries operating in different regions worldwide. For many years, tax authorities have focused on intercompany transactions, particularly in relation to corporate income taxes and the necessary transfer pricing adjustments.

Overview of CTC mandates

Under CTC mandates, every invoice issued by taxpayers must be validated or reported to the tax authority before being sent to the client. To facilitate this, e-invoices and digital reports must adhere to strict requirements that dictate their format, content, submission time frame, storage, and, if necessary, correction process.

Failure to meet any of these requirements results in rejection of the invoice by the official e-invoicing platform. Since only CTC-compliant invoices are deemed legitimate, this rejection effectively blocks the transaction. To further bolster the effectiveness of CTC systems, some jurisdictions have implemented legal provisions stipulating that any invoice not validated or reported to the government will be considered nonexistent for all tax purposes. In practical terms, noncompliance with these mandates often results in the buyer being unable to deduct the value-added tax (VAT) incurred on the purchase and, increasingly, not being able to deduct the expense for income tax purposes.

Under existing CTC mandates, the validation or reporting of an invoice to the tax authority does not imply that the transaction itself has passed all levels of scrutiny to confirm the total tax compliance of the issuer or recipient. It merely verifies that the transaction supported by that document has been duly reported to the authority. However, the ultimate goal of a CTC mandate is to empower tax authorities to accurately determine taxpayers’ tax liabilities, with a current primary focus on transactional taxes such as VAT. For instance, in jurisdictions with VAT regimes, the data gleaned from CTC systems has enabled jurisdictions such as Chile, Italy, Mexico, and Spain to prepopulate large portions of taxpayers’ VAT returns (primarily on the accounts receivable side).

VAT and intercompany transactions

A VAT is a consumption tax levied in most jurisdictions across the world that applies to the sale of goods or services at each leg of the supply chain, with a credit provided when the item has been purchased for business purposes, until the item is purchased by the final consumer, who bears the ultimate burden of the tax. A VAT has formal invoicing requirements. In the absence of a valid invoice, a purchaser is unable to claim a tax credit. This creates an incentive for a purchaser to request an invoice. These invoices further create an auditable paper trail.

Since VAT applies at each stage of the supply chain, intercompany transactions generally fall within its scope even if no money is exchanged between entities (e.g., due to netting). This implies that each intercompany transaction should ideally be supported by its own invoice, even for cross-border transactions. However, in practice, especially for intercompany services, these transactions are often not recorded through the standard accounts payable and accounts receivable modules of enterprise resource planning systems that also record sales and purchase invoices. Instead, intercompany transactions are often treated as financial transactions, typically supported by summary documentation (e.g., spreadsheet calculations).

Consequently, the VAT treatment pertaining to intercompany services is often overlooked. While, in general, cross-border services should not bear any VAT in the seller’s jurisdiction, this is not always the case. For instance, in Mexico, only a limited number of cross-border services are not subject to tax and then only if they are considered to be “enjoyed” abroad. Marketing services provided by a Mexican subsidiary to the foreign headquarters would be taxed if the marketing pertains to the Mexican territory.

In addition, to prevent tax evasion, ensure fair taxation, avoid double taxation, and promote transparency and fair competition, jurisdictions require prices on intercompany transactions to be at arm’s length. This arm’s-length standard is established based on local legislation, and the Organisation for Economic Co-operation and Development (OECD) has provided detailed guidance on methods to use to determine the arm’s-length price. However, determining the VAT treatment applicable to transfer pricing adjustments in itself can be complicated. While VAT laws in a few jurisdictions refer to the wording of their corporate tax laws, the issue is often left silent. For instance, there is no clear VAT guidance established by the European Union (EU) or the various tax authorities of the 27 EU member states. Initial observations of the matter highlight that transfer pricing adjustments should only be considered within the scope of VAT if they can be attributed to a good or a service effected “for consideration.” In this case, the transfer pricing adjustment should result in the issuance of a credit or debit note that formally documents the adjustment to the initial intercompany invoice.

Effects of CTC mandates on intercompany transactions 

Since CTC mandates focus on VAT, and since intercompany transactions generally fall within the scope of VAT, these transactions should in principle be subject to CTC mandates. However, as the implementation of these mandates vary, businesses must first assess which transactions are in scope of the specific CTC mandate: domestic transactions, business-to-business transactions, cross-border transactions, etc. Therefore, intercompany transactions will be affected only in jurisdictions with broad mandates. In those jurisdictions, businesses will therefore have to update their systems to ensure that the required CTC data on intercompany transactions is communicated to the einvoicing system.

Even in jurisdictions with a narrower CTC mandate, businesses should start ensuring that their intercompany transactions meet local VAT and invoicing requirements. Based on experiences with mature CTC systems, tax authorities tend to expand the scope of CTC mandates so that intercompany transactions can be caught at a later stage.

With respect to transfer pricing adjustments, translating these adjustments into individual invoices may be more or less difficult depending on the transfer pricing methodology used by the taxpayer and the local VAT law. An additional complicating factor is that under CTC mandates, price adjustments relating to an already issued invoice generally need to be reflected through debit or credit notes, which refer to the original e-invoice in the system.

Therefore, if the transfer pricing adjustments are the result of the application of traditional transaction methods, identifying the invoices that will need to be adjusted may not be that difficult. However, if the arm’s-length prices are identified as a result of transactional profits methods, adjustments may not be that simple. This becomes further complicated when there are time limitations to modify e-invoices and when the adjustments are made for transactions that can be subject to different tax rates or treatments.

Moreover, even in countries where transfer pricing adjustments are not in scope of a VAT, making these adjustments only on the income tax side would disrupt the purpose of the e-invoicing/ digital reporting systems. Tax authorities may therefore create specific e-invoices for such transactions. This happened in Mexico, where the tax authorities have established specific guidance on how to document transfer pricing adjustments via the e-invoicing system.

More data, new tools

Given the significance of intercompany transactions, companies cannot overlook the impact CTC mandates will have on the reporting of these transactions. As a preliminary step, companies can review their VAT treatment and begin issuing VAT-compliant invoices to be prepared when a jurisdiction implements a CTC mandate. This is a manageable initial step, as the transition to CTC mandates results in a substantial digital transformation for multinational enterprises, necessitating a strategic response, including comprehensive assessments of current tax-compliance processes, informed decision-making, and the implementation of a global strategy.

As CTC mandates are expanding, tax authorities around the world will gather an increasing amount of data allowing them, in the near future, to perform realtime audits of the transactions carried out by taxpayers. While the current focus is on improving VAT compliance, it is not inconceivable that the same data could be used for corporate income taxes. In this respect, intercompany transactions and related transfer pricing adjustments could be an ideal target for tax authorities.

By leveraging the data gathered through CTC systems in combination with new artificial intelligence tools, tax authorities could further scrutinize arm’s-length prices adopted using the accepted methodologies, leading perhaps to an overall reconsideration of applicable transfer pricing methodologies. The rapid and constant flow of e-invoicing information could indeed help automate many of the processes needed by tax authorities and taxpayers to perform transfer pricing studies, audits, and overall compliance.

Editor notes

Mary Van Leuven, J.D., LL.M., is a director, Washington National Tax, at KPMG LLP in Washington, D.C. Contributors are members of or associated with KPMG LLP. For additional information about these items, contact Van Leuven at mvanleuven@kpmg.com.