8 Reasons Why Digital Companies and Platforms Validate Tax IDs
TLDR; We’ve spent years working on tax number validation products both in-house and at Fonoa. We’ve identified 8 key reasons why digital companies and platforms validate tax IDs. They range from the more general faced by most organisations (supporting input tax recovery, e-invoicing and digital reporting) to more specific (Data Sharing and invoicing on behalf for marketplaces).
During my tenure at one of the world's largest rideshare platforms, we dedicated an inordinate amount of time to “tax identities”. We spent months (probably years) building and perfecting tools and processes to validate Tax Identification Numbers (TINs, or Tax IDs for short) and other ancillary tax information provided to us by counterparties.
This was all to do with the changes shaking up the platform and digital economy (or “gig economy” as people called it in 2016) being introduced. It included deemed supplier rules, data sharing obligations, invoicing on behalf, etc.
Ensuring we knew the identity of our platform sellers - in our case, drivers, couriers, restaurants, and the occasional Kitten Delivery Company (yes, you read that right) - was essential.
I spoke to many colleagues at other e-commerce giants over the years. And I quickly realized we were not alone. All of us were looking for a global Tax ID validation solution, but there wasn’t one available.
So we built. And rebuilt.
We built it because “Fonoa Lookup” wasn’t invented yet. We rebuilt because we made mistakes.
But why? What was the underlying problem we were solving for?
Below are 8 reasons why tax validation is essential for international digital businesses and platforms/marketplaces.
I’ve added a short section on why automation in this process is the only answer, although after reading through the reasons, I’m not sure you will need any convincing!
1. Being Compliant with Digital Reporting and e-Invoicing
TLDR; Tax IDs are a common requirement in digital reporting obligations. Checking your tax IDs helps to ensure that reports are not rejected or that you don’t face desk audits and complaints.
E-invoicing and digital reporting regulations are popular among the tax authorities as they improve visibility over transactions in their economy, empowering them to enforce tax controls more efficiently. The European Commission recently credited the fall in the VAT Gap to introducing such measures across the Member States.
As part of the reporting requirements, many countries require sellers to include the tax ID of the customer in the report. The inclusion of an inaccurate ID can have several consequences, including:
- Transactions are rejected, requiring investigation before the transaction can be reported causing issues for both the seller and the buyer (they may not be allowed to recover their input VAT/GST).
- Transactions are accepted only to resurface sometime later as part of a desk audit from the tax authority (asking questions about the ID and your processes for checking them).
Both rejection and desk audits are time-consuming to resolve. This is where automated tax ID validation tools come in to prevent the issue from arising at all. Leading enterprises periodically validate their entire data set to ensure their master data is up to date and that transactions can be reported correctly in a timely manner.
Automated solutions are a convenient and efficient way to check an entire data set - some enable bulk validations (tens of thousands of records) in minutes across multiple markets.
2. Maintaining Margins
TLDR; Distinguishing between business and non-business customers in cross-border trade impacts whether or not tax is charged. Getting this wrong will at least upset your customers; at worst, it will cost you your margin because you may have to pay the missing taxes out of your own pocket.
Customers typically fall into one of two categories for indirect tax purposes: businesses or consumers. Generally, on cross-border transactions, digital service companies would only charge indirect tax to non-business consumers.
Therefore, to determine whether tax is charged, these companies must verify the customer's business status and keep proof. Verifying a customer's status varies by country and generally consists of validating a tax ID against a database; simple format checks are not good enough because they can be easily duped (in many places, the format is as simple as “11 digits”).
The challenge is that this needs to be done at checkout - which is why some companies either
a) skip this step,
b) rely on very simple and error-prone validation checks (only testing the format); or
c) adopt a position of all customers are B2B or B2C.
The downside, of course, is that getting the above wrong may mean that you have undercharged or overcharged VAT/GST on your sales. The former posesposing tax scrutiny risk, the latter bad for your margins.
3. Fraud Prevention
TLDR; Checking the tax identity of your counterparties helps you identify tax fraud as well as other forms of consumer fraud. They do this by highlighting unusual identities in your onboarding process.
Digital Platforms (e.g. Instagram, TikTok, Snapchat, Discord) may require sellers to provide tax credentials on signup (for data sharing, invoicing and e-invoicing, etc). Bad actors often use another business’s tax ID to get through these onboarding steps. The techniques vary in sophistication, but many simply take numbers they can easily find online.
Is that really Apple or McDonald’s signing up for your service through an online form intended for SMEs and ignoring your B2B enterprise sales channel? Probably not.
Put bluntly, the right tax number validation tool helps you identify companies that are unlikely to sign up to your services outside of your enterprise sales channels.
4. Ensuring Accurate Input VAT/GST Recovery
TLDR; recovering VAT/GST on your purchases is allowed only in cases where it was properly charged. In some cases, smaller vendors charge VAT/GST incorrectly by accident or as bad actors. Checking tax IDs helps to prevent this.
The reason why almost all companies check indirect tax numbers is to be sure that the tax (VAT/GST) your business is incurring on domestic purchases (and recovering as input tax) is charged to you by properly tax-registered suppliers.
An “input tax” is a levy paid by a business on acquired goods and services. An example is the VAT a business pays to its suppliers. Many businesses are entitled to recover this tax from the government under certain conditions.
Skipping such checks increases the risk of paying taxes that were incorrectly charged. When such errors are ultimately discovered (believe me, it’s a question of when, not if), the business will likely be saddled with the cost of the tax and the consequences of failing to implement appropriate processes to mitigate these risks.
For marketplaces and digital platforms, not only is this check important for general vendor onboarding, but it also plays a role when changing business models from an agent (connecting two parties) to a merchant (buying and reselling). This change brings a large number of vendors, some of whom may be small businesses or solo-entrepreneurs not as familiar with taxes (thereby increasing the risk of tax errors).
Multinationals also face country-specific challenges that automated tax validation solutions can help resolve. Take Japan; since October 1st 2023, recipients of goods and services require a qualified tax invoice to claim an input tax deduction. But did you know that a Japanese taxpayer ID also tells if your vendor is a “qualified invoice issuer”?
5. Submitting EC Sales Lists
TLDR; Selling across borders in the EU requires sellers to report such sales to governments. A key component of this report is a valid VAT number. Robust tax ID validation solutions help you maintain accurate data so your submissions don’t get rejected or flagged for a desk audit.
Perhaps the original reason for many European tax professionals to validate VAT numbers is to be able to accurately report the transaction in a Recapitulative Statement (aka the EC Sales List). Businesses in Europe supplying goods and services to business customers in another EU Member State on which the reverse charge applies are required to periodically report such sales to the tax authorities.
To make this report, it is critical to have the correct VAT number on file. Failure to have such an ID often means spending hours on email correspondence finding the number or taking a hit on the margins (the business simply pays the VAT out of pocket).
This is where more advanced automated TIN validation solutions come into play - ones that not only validate VAT IDs but can also search for IDs based on the name, to plug master data gaps (see TIN Search from Fonoa).
6. Performing Tax Calculation “On Behalf”
TLDR; many marketplaces and platforms are deciding to improve customer experience by supporting traders in tax compliance. Doing this accurately requires exact knowledge of the status of both the buyer and seller - which can be done using sophisticated Tax ID validation tools.
Digital Platforms and Marketplaces may (by law or by choice) take on the responsibility of calculating taxes for the underlying transactions performed by the underlying Platform Sellers. To make an accurate determination, it is absolutely crucial to understand the tax status of both the buyer and the seller.
In such situations, the tax number validation needs to return additional information about the taxpayer’s registration status indicating if they are entitled to charge VAT/GST.
For example, the information retrieved from the database needs to indicate if the taxpayer is under a “small business regime” or not permitted to charge taxes for some other reason (e.g., operating in a Special Economic Zone).
7. Staying Compliant with Data Sharing
TLDR; collecting and checking the tax data provided by Platform Sellers is no longer an option. It is mandatory. Tax ID validation plays a pivotal role in confirming the tax information you were provided is accurate and ready for submission to the authorities.
A growing trend globally is for tax authorities to enlist the support of Digital Platforms and Marketplaces (think Uber, Booking.com, TikTok, OnlyFans) to ensure taxes are paid by the underlying Platform Sellers.
One of the most common requirements introduced in recent years has been to create the obligation to collect, validate, store, and periodically share tax-relevant information with tax authorities. This obligation is colloquially referred to as Data Sharing.
You may have already heard of the sixth amendment to the EU’s Directive on Administrative Cooperation (aka DAC7) which is being enacted into local legislation across Europe and primarily aims to gather data for income tax purposes. This is just one example, but there are many more being introduced globally (Australia, Canada, Turkey, UK, etc).
8. Applying Accurate Withholding Tax Rates
TLDR; several digital platforms and marketplaces must withhold taxes from sellers operating via their platforms. The amount of tax withheld is directly affected by the tax status of the seller. This status is communicated by the tax number on file.
In addition to Data Sharing, another common requirement introduced in recent years on platforms and marketplaces has been to calculate, withhold and pay taxes on behalf of platform sellers. This refers to both income taxes as well as consumption taxes like VAT and GST.
Importantly, different information is often needed for income tax and indirect tax purposes. While
there is a degree of overlap, there can be fundamental differences relevant for TIN validation.
For instance, some countries have different tax identification numbers for income tax and consumption tax, while others use the same tax number for both tax types. Sometimes, the personal tax ID becomes the business tax ID when the person registers a business. Whether the number is the same or different may also depend on whether the taxpayer is a legal entity or a natural person.
In some cases, the length or format of the number may be enough to determine the tax status. In others, you must retrieve additional information from the national database to apply the correct withholding tax rate.
Should you automate Tax ID validation?
TLDR; Yes. it is prohibitively costly in time and resources to do a comprehensive validation manually in real-time. Manual processes serve a purpose only in specific instances.
I do not think any of you working in a multinational business or digital platform need convincing that the above requires automation. But, to “kick the (proverbial) dead horse” here is my take.
Your choices are:
- Dedicate a department;
- Skip validations; or
And remember that digital companies and multinational platforms are typically faced with these three realities:
- High transaction volumes
- Global presence
- 24/7/365 sales
So option one - make the Buyer Operations or Vendor Onboarding team responsible for validating 1+ million transactions across 100 territories between 2am - 4am? Good luck. And Option two - ignore the issue and leave it up to tax to fix downstream (again manually) isn’t really done anymore after CFOs discovered the cost of non-compliance.
This leaves only one option - automation. And the next question is should you build or buy - I won't go into that here as we’ve already shared our thoughts in this Bloomberg thought piece: Why and How a Business Should Build a Tax ID Validation Solution.
Manual processes do have a place (and no, not only in the past).
- Temporary fix: you can dedicate low-added-value man-hours to the task but only temporarily. A comprehensive, robust process at a large multinational company cannot be done manually long-term (I mean, it could, but you’d need the budget).
- Final check: if you don’t need real-time validation but simply want to double-check a manageable number of ID’s before filing.
- Customer support: if you genuinely need to check only one ID for a specific purpose, then yes, a manual may be the way to go. But even then, you need to know precisely where to look and what to look for.
How can Fonoa Help?
If this article is relatable, we’ve felt your pain too which is why we built tools to address the Tax ID validation challenge. Our Lookup solution is the leading product on the market which supports tax ID validation with government databases in over 110 countries.
If you are interested to learn more about our capabilities just reach out to our teams who can provide you with more information.
For more information about this topic, you can also download our Essential Guide to Tax Number Validation or learn about validation techniques in Why You’re (Probably) Validating Tax ID Numbers Incorrectly... and How to Get Them Right. Alternatively, subscribe now to Fonoa Digest for the latest indirect tax updates and TaxTech insights - on a cadence!