Learn why Tax ID validation at checkout is essential and how to implement it effectively for seamless indirect tax compliance.
There is such a thing as the perfect checkout flow. It’s quick, clear, effortless, accurate and cost-efficient. It asks for only what it truly needs, and what it requires is easy to find.
This process is commercially critical to the company’s success. Whatever is added will impact the overall experience and have a consequence on conversion. Adding unnecessary friction is a no-go.
Many companies have already optimized adding items into the basket, and several have perfected the payment process part (some have it down to “one-click”). But very few have mastered the tax component. That component often requires three things: rules, rates and buyer details. It’s the buyer details (tax IDs) that often create friction and are painful for both sellers and buyers.
Until recently, insisting on tax IDs at checkout was considered unnecessary friction, until tax managers pointed out that it means sacrificing nearly 20% of revenues or losing customers altogether. Today, in-house tax professionals are already engaged in discussions about how to (not if) include tax ID collection and validation in the checkout process to accommodate indirect taxes like VAT and GST. Those who get it right often end up saving or generating their company millions of dollars of additional revenue or reduced tax costs.
A checkout flow or process is a series of steps in online commerce that a customer has to take to purchase an item from your company. Sometimes, different names like the purchase journey, checkout or buying funnel are used. An ideal checkout process should enable the customer to go from selecting an item to a processed payment as fast as possible. At the same time, the checkout process should also protect the business from fraudulent activities and enable regulatory compliance.
The core components of most checkout flows vary depending on the cost of fraud and regulatory compliance requirements such as information to determine the correct tax treatment (VAT/GST or Sales Tax).
In any case, the first time a customer buys (guest checkout) requires more data entry than future purchases, as smart companies encourage loyal customers to create an account and reduce friction for their next purchase.
The checkout process is critically important in e-commerce because the design and execution impact sales conversion (concluded sale or not). A poorly designed checkout process increases the likelihood of “cart abandonment” or failed sales transactions due to customers leaving/stopping without completing the purchase. A survey by the Baymard Institute shows that 48% of cart abandonment cases are driven by additional costs like shipping, taxes and other fees being considered too high. Another 16% abandoned because they couldn’t calculate the total-order costs up front (meaning too little information on taxes and other costs).
Selling online requires companies to determine if indirect taxes like VAT and GST apply. This is usually influenced or driven by the B2B vs B2C nature of the transaction. In cross-border transactions, the challenge extends beyond merely identifying the buyer’s details. Companies must evaluate not only if taxes are due but also which countries’ taxes apply.
It is critical to understand who you are selling to and in which capacity (B2B or B2C) they are buying from your company. Note that unless you do this absolutely right, you will be overcharging or undercharging customers, which will impact their customer experience and have financial consequences.
Charging incorrect or unmaintained tax rates means the price towards customers comes out incorrect and too high, which results in a lower conversion and a disadvantage compared to competitors with more accurate tax controls. Moreover, charging tax when no tax should be charged at all is a dealbreaker in B2B sales.
It is important to note that in many countries worldwide, B2C sales are required to show the full indirect taxes applicable at checkout, which are part of the price. They cannot be added after the fact. For example, in the USA, prices are generally shown net of sales tax, while in Europe, VAT must be included in advertised prices.
If you don’t collect and validate the relevant customer data, you won’t be able to accurately charge VAT and GST on sales transactions.
Collecting too little taxes on sales means companies are impacting their gross margin. Even if you don’t charge and collect the right amount, tax authorities still expect to receive the right amount of tax from you as a business. The customer, however, has already paid and won’t pay you extra after the fact.
The customer, however, has already paid and won’t pay you extra after the fact.
Not validating the customer’s indirect tax ID leaves you open to treating a B2C transaction as B2B with this result.
Customers exploiting this gap may commit fraud, friendly fraud, or simply make errors, but the extent is hard to quantify because companies tend to downplay the issue to avoid paying uncollected taxes. Governments enforce this during audits but do not publicly share anomaly data.
Over 100 countries have introduced rules that require businesses to register for VAT locally when selling cross-border to B2C buyers. For businesses that sell only B2B, this essentially introduces a tax ID validation requirement, as that is the only way they can prove that they have no local registration requirement.
To determine if and what indirect taxes apply to an online sales transaction, customers need to have all relevant variables of the transaction. This starts with understanding if the customer is buying as a business (B) or a consumer (C).
In order to fully determine what indirect taxes apply, the following should be considered:
Tax IDs play a crucial role in points 3 and 4, determining where a tax is due and who is responsible for paying it. In indirect taxes, a business buyer is usually a company, but it can also mean an individual with a registered business activity, like a sole proprietor. A Consumer is any individual who has no registered business activity and who typically buys for a personal purpose.
Validating the customer’s tax identification number (tax ID) is the least friction way to assess this. However, true validation goes beyond verifying the character length, syntax, or performing algorithmic checks (such as calculating the checksum digit). Accurate tax ID validation necessitates real-time verification of customer information against official tax authority databases.
Validating through official government databases is the way to go.
Our data shows that local validation in EU countries globally results in more successful tax ID validations, with specific countries seeing over a 40% increase in successful validations when compared to the VAT Information Exchange System (VIES).
However, these government databases are fragmented and not easy to use. They tend to change and require an understanding of mechanics in each country, and performance and content vary across countries. This means care should be taken to integrate tax ID validation into your checkout process to minimize cart abandonment and leverage this as a value driver in the process.
At Fonoa, we are used to resolving such complexity as our customers rely on us as a single source for validation across the world. Based on our experience in the digital economy, we have built-in functionality that enhances the overall checkout experience and minimizes friction.
There are a couple of considerations for integrating tax ID validation into your checkout process to ensure you maximize the user experience and minimize friction.
Accurate tax calculations are essential for optimizing cashflow and margins. Fonoa helps you achieve precise tax treatment on every transaction, enhancing financial efficiency. Whether you're charging tax, protecting accounts payable (AP), or handling withholding taxes, Fonoa ensures accuracy and reliability, helping you avoid liabilities and improve overall financial management.
Most providers only verify tax ID formats or perform basic syntax checks, while some check VIES exclusively. Fonoa goes beyond, covering 110+ countries with direct access to local official databases. This ensures you receive the most up-to-date and comprehensive information, fast.
To discover how we can support you and your business, speak to our teams today.
A step-by-step framework to help businesses manage their indirect tax filings and achieve compliance in a streamlined, efficient, and scalable manner.