There is a big data revolution quietly brewing inside the U.S. Federal Reserve that’s going to fundamentally change the way corporate tax is reported and collected in this country. It’s called e-invoicing, and it will make it possible for the government to collect detailed transactional data in real-time, automatically at the point of each commercial transaction, instead of relying on quarterly filings compiled by the businesses themselves.
For many businesses, that transformation will increase efficiency and improve the accuracy of tax provision; for others it will create a data aggregation and reporting nightmare. For those who wish to avoid the latter scenario, now is the time to start taking a much closer look at what real-time reporting will entail and how companies will be expected to comply.
E-Invoicing: The Gateway to Real-Time Tax Reporting
First, some history on how the initiative came into focus. In a series of developments that were largely ignored by everyone outside of the deepest recesses of multinational corporate tax departments, a consortium led by the U.S. Federal Reserve and the Business Payments Coalition completed a pilot program at the end of the first quarter of 2023, which built an exchange framework for e-invoicing in the U.S. As part of the program, 73 participating businesses worked together to develop standards for accepting and processing electronic invoicing and payments in real-time.
While that framework, which could be launched as early as this year, is focused on streamlining business-to-business electronic payments, it is also important to note that it will create the backbone for real-time tax reporting to tax authorities. By working directly with the Fed to create a standardized approach to transacting sales digitally, these businesses are quietly paving the way toward a direct conduit between business transactions and tax authorities. Right now, it’s a voluntary initiative, but if history—and the path of several other tax authorities around the world—is any guide, it will be the first step toward a sea change in tax reporting for U.S. companies.
History as a Guide
The Federal Reserve made this clear way back in 2016, when it published its first thoughts on e-invoicing a paper entitled “U.S. Adoption of Electronic Invoicing: Challenges and Opportunities.” That paper, which formed the initial thesis for the e-invoicing pilot program, outlined dozens of examples around the world where the introduction of e-invoicing has improved tax compliance and tax revenue.
In Latin America, for example, which was a pioneer in real-time reporting, the report points out that the Chilean Treasury expected to raise $600 million in additional tax revenue annually from e-invoicing and that the Mexican Tax Administration Service claimed that for every dollar it invested in its e-invoicing initiative, it gained over $61 in tax receipts. The increased revenue came from a combination of reduction in bogus invoices and dramatically streamlined auditing and review processes. In fact, Brazil, which was one of the first countries in the world to mandate e-invoicing when it introduced its Nota Fiscal Electronica in 2012, now attributes 90% of its corporate tax audits to data anomalies it finds in automated reviews of e-invoices.
So, while the Federal Reserve and Business Payments Coalition pilot program is being pitched as a revolution in efficiency, transparency and digital payments modernization—which it is—businesses should harbor no illusion that it will also pave the way to a direct pipeline to tax authorities.
Data Challenges Abound
That’s going to put a lot of companies to the test when it comes to collecting all of the data on all of their transactions across every jurisdiction in which they operate in real-time. To put the challenge in perspective, consider that across the U.S., there are more than 11,000 different sales and use tax jurisdictions, each with a distinct reporting code and rate, some of which apply to different products and product types differently.
For example, the tax rate a retailer needs to collect for customers purchasing diapers in Pierce County, Washington can vary between 8% and 10% depending on whether or not that customer falls into any number of special districts, like the Regional Transit Authority Boundary or the Hospital Benefit Zone. Meanwhile, those same diapers would be tax-exempt in a state like New Jersey, Massachusetts or California which do not tax certain necessities, like diapers.
Today, details like those are managed by corporate Enterprise Resource Planning (ERP) platforms that include detailed, hyperlocal tax data and aggregate information across the organization to feed quarterly tax provision and reporting capabilities. However, getting every ERP to share standardized data across every transaction as it happens in real-time with a direct pipeline to the IRS is a very different story. While the technology exists to connect those dots, businesses are going to have to get serious about overhauling their operations to accommodate the changes.
They are also going to need to get comfortable providing a level of transparency to tax authorities which they have not historically had to do in the U.S. Those who spend the time sweating the details to get that formula right will be rewarded with increased efficiency and more accurate reporting. Those that don’t could be in for a long, expensive journey.