Tackling tax leakages in the 21st Century – What lessons can Nigeria learn from the OECD (3)?

The last two editions of our InsideTax publication have focused on tackling tax leakages in the 21st century.  Without doubt, the need for revenue authorities to develop awareness of possible sources of tax leakages in this era and evaluate tenable approaches at combating the problem cannot be over-emphasized. Specifically, in the last edition, we considered a common tax evasion scheme – sales suppression – vis-à-vis the various ways in which it can manifest, consequences and technology-based counter measures prescribed by the Organisation for Economic Cooperation and Development (OECD).

In this edition, we will conclude the series by evaluating false invoicing as a tax evasion scheme, relevance in Nigeria and possible adaptation of counter-measures prescribed by the OECD to the Nigerian situation.

False invoicing is perpetrated by deliberate fabrication or inflation of purchase invoices in order to unjustly claim expenses which were not genuinely incurred for tax purposes.  In this regard, a taxpayer presents invoice for a transaction where none was issued by a vendor or inflates the invoice issued by a vendor. While sales suppression schemes seek to under-report revenue, false invoicing seeks to over-report deductions. The common end goal is reduction of profit and consequent tax liability. In addition, false invoicing may also reduce eventual value added tax (VAT) payable by a taxpayer where fictitious input VAT has been used to offset a reasonable portion of the output VAT.

The withholding tax (WHT) mechanism may be viewed as a deterrent to false invoicing.  This is because a perpetrator may have to weigh the consequence of having to account for WHT on false invoice amount, on one hand, vis-à-vis savings to be made from tax on profit, on the other hand.  However, the concept of “outright purchase and sales of goods in the ordinary course of business”, for which WHT is not applicable easily weakens this deterrent.

According to the OECD, the popularly acclaimed method of combating false invoicing is the adoption of electronic invoicing (e-invoicing) system1. Essentially, businesses are required to issue invoices to customers electronically and retain records of the invoices in electronic format. The electronic invoicing system provides additional features to ensure integrity of data and identity of creator. In this regard, digital signatures are created for invoices generated in order to guarantee authenticity of the invoices and confirm that they have not been altered after creation.

To ensure utmost effectiveness of e-invoicing in addressing false invoicing, sales invoices are required to be registered or otherwise provided to the tax authority.  As such, false or inflated invoices can be identified by automatic matching of the data for the purchaser and seller.

More than twenty one (21) countries around the world have implemented e-invoicing. Such countries include Argentina, Bolivia, Brazil, Colombia, Costa Rica, Ecuador, Guatemala, Italy, the People’s Republic of China, Peru, Rwanda and Uruguay where significant impact of the solution has been recorded.

A critical review of the e-invoicing solution shows two (2) basic requirements:

• Mandate requiring suppliers to issue, retain and share electronic invoices with relevant tax authorities (RTA)
• Technical ability of RTAs to accept and utilize the information

While the mandate appears to be a legislation issue, technical requirement on the part of both taxpayers and tax authorities emphasizes that an e-invoicing solution is technology driven. Therefore, advantages, concerns and recommendations made in respect of technology tools for combating sales suppression in our last article remain valid here.

However, a particular challenge with e-invoicing will be verification of offshore invoices.  Offshore vendors are not be bound by the local mandate, particularly for transactions that are completed offshore. Therefore, this category of vendors are not obliged to share their invoices with local tax authorities. However, this concern is somewhat allayed by possible collaboration between countries on information exchange.

Another concern of e-invoicing will be in respect of participants in the informal micro-economic segment. Transactions here are usually cash-based and mostly unsupported with invoices.  Before e-invoicing is implemented in Nigeria, some of the pertinent questions to ask in this regard include:

• Will the inability of players in the informal micro-economic sector to issue electronic invoices invalidate such expenses for tax purposes or can this mean “disenfranchisement” of players in the informal sector from supplying goods and/or services to compliant taxpayers?
• Will setting up e-invoicing be relatively cheap and easy for players in this sector to adopt?

These concerns are valid but we do not think they should undermine the expected benefits from e-invoicing solution.

The above notwithstanding, it is envisaged that e-invoicing will be useful in bringing a lot of players in the informal sector to the formal economy and consequently, tax net. For example, in Mexico, the introduction of mandatory e-invoicing has brought 4.2 million micro‑businesses into the formal economy. Testimonies of this nature give more credence to adoption of the technology-based solution.

We are aware that Federal Inland Revenue Service (FIRS) checks false invoicing, where put on enquiry, through circularization. In this regard, FIRS writes to a vendor to confirm a buyer’s transaction with it. The vendor then checks its records and makes representations to FIRS on enquires made, based on available information. A drawback of this approach is heavy reliance on vendors’ records which may be incomplete. Further, this approach may constantly over-burden vendors, especially as considerable time may be spent while responding to FIRS’ circularization request. The question then is; how can Nigeria move from this current state to the electronic invoicing system.

Nigeria may, after all, not be far away from achieving this feat considering that FIRS may integrate electronic invoicing as part of the VAT monitoring system discussed in the last edition of our InsideTax. This is because a system that monitors the sales invoicing of a company invariably monitors the expenses of another. The system may only require few adaptations and widening of the net of focus.

While it is important to state that technology tools are not a single fix to the problem of tax leakages, substantial progress can be made in high risk areas if implemented effectively. Therefore, technology-based solutions should always be complemented by other tools available to tax authorities, including legislative measures, effective enforcement, taxpayer consultation and international co-operation.