VAT Compliance Update, Part 2: Split Payment

In Part 1 of this blog series, I examined real-time reporting obligations and the likelihood of their adoption across Europe. Real-time reporting means tax authorities can detect suspicious transactions at an early stage and prevent fraudulent activities. However, this may not occur at all if fraudsters never receive value added tax (VAT) from their customers in the first place. This is what split payment seeks to achieve.

What is a Split Payment System?

Split payment is an alternative VAT collection system. Under the traditional system, the supplier collects VAT from customers and reports all transactions in a VAT return. Depending on the outcome of the return, VAT may be due from the business, or it could be refunded by the tax administration. In a split payment system, the customer pays VAT directly to the tax administration or to a blocked bank account of the supplier that can be used only for tax purposes.

Split payment is an effective anti-fraud measure as it removes the opportunity for suppliers to charge VAT and disappear without remitting it to the tax administration. However, it has a negative impact on a supplier’s cashflow position. Suppliers end up in a refund position (excess input VAT) because their input VAT can no longer be directly offset against output VAT. In other words, they pay VAT on purchase transactions but do not receive it on sales transactions.

Split Payment in Europe

Italy was the country in the European Union (EU) to introduce mandatory split payment: starting on 1 Jan 2015, split payment applied to payments made to public authorities. The scope of Italy’s measure subsequently extended to companies controlled by central and local public authorities and companies listed on the Milan Stock Exchange.

Split payment will become mandatory in Poland starting on 1 Nov 2019. It will apply to certain B2B supplies (e.g. electronics, metal, scrap, fuel, construction services) above PLN 15,000 (USD 3,800). Most of the eligible transactions are currently covered by the reverse charge mechanism, which moves the responsibility for the reporting of a VAT transaction from the seller to the buyer. Split payment will apply to both residents and non-residents; non-resident suppliers will have to open a bank account in Poland to be able to receive split payments.

Any introduction of new measures is frequently accompanied by new penalties. This is also the case in Poland. The supplier will be liable for 100% of the tax due if the words “split payment” are not included on the invoice. If a customer fails to split the payment despite the legal obligation to do so, a penalty of 100% of the tax shown on the invoice or up to 720 times the daily rate will apply. Additionally, the costs of the goods purchased will not be deductible for corporate income tax purposes.

Split payment may be implemented upon authorisation by the European Commission (EC). Both Poland and Italy were granted such authorisations. Romania also applied for permission. However, the EC objected to the proposed Romanian system because it raised concerns regarding its proportionality and compatibility with EU law.

What the Future Holds for Split Payment

Will split payment spread across Europe? Not very likely. The EC considered this measure as a potential general means to combat VAT fraud but came to a negative conclusion. In a 2017 report, it found no strong evidence that the benefits would outweigh the costs. Some countries (e.g. the Netherlands) have explicitly rejected split payment in favour of other anti-fraud policy measures.