E-Invoicing and the Shadow Economy

    By Richard Downs | Small Business

    E Invoicing and the Shadow Economy image 9 4 TNE blog img Downs 300x210E Invoicing and the Shadow EconomyA.T. Kearney in association with Visa and Dr. Friedrich Schneider writes a yearly report called The Shadow Economy in Europe, which looks at the “legal business activities that are performed outside the reach of government authorities.”

    With new invoicing legislation across Europe, which we blogged about here, governments are starting to combine invoicing legislation with tax evasion legislation.

    In Europe, the shadow economy is worth a staggering €2.15 trillion Euros. With the recent economic downturn, no wonder containing it has become an area of focus for many European governments.

    The report defines the shadow economy in two distinct areas:

    • Undeclared work such as cleaning work, crop collection, and construction day labouring
    • Under reporting in high cash businesses such as bars, taxis, and other service-based small businesses

    The country breakdown makes for some interesting reading. Where I live in the UK, there is an estimated €189Bn in the shadow economy whereas Bulgaria has €13Bn lurking in the shadows. To gauge how large an issue this is for a country, it is best to show the numbers in relation to GDP. The UK comes out at 10% (in the lower quartile), Bulgaria sits atop at 31% of GDP, and Switzerland has the lowest at 7% of GDP. Overall, the shadow economy is decreasing as governments tighten legislations and deploy more advanced detection methods; over the last 25 years, the share of VAT as a percentage of total taxation has almost doubled from an 11% average in 1985 to 19.2% in 2009.

    So how does invoicing legislation help governments shift GDP out of the shadows and into the light?

    The changes in invoicing legislation that came in at the beginning of 2013 required, amongst other things, that both electronic and paper invoices have equal treatment (EU Council Directive 2010/45/EU). As such, Portugal was the first to introduce a central check-in system for both paper and electronic invoices of any company with revenue greater than €100,000; as of January 2014, any invoice that companies send or receive must be logged into the new Portuguese system. Portugal also mandated that banks must also provide retailers’ POS information to the same tax administration system. The Big Data challenge must be immense, but my hard-wired Excel brain thinks a pivot table or two might just do the trick (or at least point them in the right direction). I also wonder how long it will take before there is enough statistical information to build up trading histories of each industry, cross referencing similar company A vs. similar company B, trend and pattern analysis; Big Data on a government scale!

    Portugal is not alone in their invoice check-in systems and at only 19% of GDP in the shadow economy, it is middle of the road in terms of troubled states. Rumours are rife that Greece, at 24% of GDP in the shadow economy, is next to shine a light into this dark corner of commerce. Outside of Europe, this practise is also commonplace (Latin America, Russia, Turkey, and China are examples).

    So, does this work? For Europe, at least, we will have to wait and see Portugal’s VAT revenues in 2014/15, but other regions of the world are pointing towards the positive. Defeating the shadow economy is a complex issue with many interlocking causes, and invoice check-in systems are only a contributing factor. They assist with easier detection and combined with better rules, controls, and penalties provide one half of the answer. It sounds simple when you think about it, but the best way to remove “cash in hand” style work is to remove the cash. Cash displacement is the second half of the answer to this puzzle. I can travel the London Tube, hop on the bus, and pay for my daily newspaper all without cash (or removing my card from my wallet). There is also the growing number of smartphone apps that I can use in bars and restaurants to order and pay for drinks directly from my phone; even my gardener now expects me to wire him money instead of cash or cheque. There is a very compelling graph on page 15 of the report showing the correlation between electronic transactions per countries inhabitant and the shadow economy GDP – the more electronic transactions the lower the % of Shadow GDP.

    The cashless society is a long way off and goes part way to remedy the B2C side of the equation. For the B2B side, invoice check-in systems appear to be working and growing and I expect those countries with high shadow economy GDP percentages or countries implementing new electronic invoicing legislation to broadly adopt them.

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