Why Tax ID Validation at Checkout Matters

Intro

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.

Checkout 101

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).

If fraud cost is low, as in the case of digital goods, checkout can be as simple as item selection and very basic payment information. If fraud is very costly, such as in airline travel, checkout data can be extensive.
Similarly, if a company does not sell to other businesses (no B2B sales), there is usually no need to introduce friction into the checkout process by collecting tax information. But if the company has B2B sales, then it needs a method to verify that its B2B buyers have valid tax IDs.
Validation is a must for companies selling to a mix of B2B and B2C buyers, as otherwise, it is impossible to differentiate them accurately.

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).

Relevance of tax in checkout

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.

Overcharging tax

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.

Impact

Increase in customer support tickets (often expensive, between $5-$50 per ticket). Customers do not like to be incorrectly charged for taxes, and they don’t appreciate not receiving a tax-compliant invoice for their business. They will come back and ask for a correction which requires manual verification, and manually issuing a credit note and a new tax-free invoice.
Cart abandonment: not showing the total amount due or the correct amount of taxes applicable, leads customers to drop off.

Undercharging tax

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.

Impact

Potentially risking ~20% of net sales revenues: Tax authorities will reclassify your B2B transaction as a B2C transaction and ask you to remit the uncollected (20% on average) VAT/GST to them.

Registration requirements

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.

What is needed to determine and collect indirect tax on online sales?

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:

Nature of the Transaction: Is it a "supply"?
Nature of Supply: Goods vs. services.
Place of Supply: Where does it take place?
Who Remits the Tax: Seller or buyer?
Applicable Rates: What is the applicable tax rate?

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.

How to validate tax IDs in your checkout process?

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.

Best Practises: How to embed tax ID validation in your checkout flow successfully?

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.

Modelling: Assess the tax risk you are facing by implementing the different levels of checkout tax ID validation i.e., not doing it, doing minimal tax ID length checks, or performing actual tax authority database checks in real-time. As we have pointed out above, the risk can be more than ~20% of your revenue.
Optionality: Make Tax ID optional and only ask for what is needed, when is needed
Clear labelling: Simply and clearly explaining that “having a valid tax ID is mandatory for B2B transactions because it impacts taxes” drives a better understanding and customer experience.
Timing: Ask for this information early on in the funnel so your backend processes can run the actual validation (some countries take a few seconds) without impacting the customer experience. This means asking if your customer is a business as one of the first questions and prompting them to provide their VAT/GST number as early as possible (i.e. making the tax ID input field one of the top fields so it is populated first, thus while the customer fills in all other details the real-time government database validation has the few seconds latency it needs).
Ask it once: Work with profiles and processes that store customer and other business information so a customer never has to fill it in twice. It is hard enough to look for all the necessary information, don’t make them repeat it. However, allow for a guest checkout as well.
Check it periodically: Once the customer data is in your database, an automated solution like Fonoa Lookup can help you validate your entire database periodically, making sure that your customer data is always up to date.
Clear format requirements: Being clear on format expectations and providing clear and understandable real-time validation feedback if the provided data is incorrect or inaccurate improves the customer experience (e.g., explain how long the number should be and what it is called locally, and provide easy-to-read feedback that differentiates between the number being the wrong format, not found in the database, not registered for tax or the name or address not matching). Adding a support touchpoint after failure equally helps optimize for conversion.
Real-time not desirable: If real-time tax ID validation is not desirable for latency reasons (i.e., the time it takes to complete), at least embed a tax ID country syntax and format check. This helps avoid obvious errors and allows you to run the actual database validation in the background. Should the info come back as incorrect, this may prompt a customer reach-out process to collect, complete, and address the situation further without directly impacting your checkout process.
A/B testing: If your product team is unconvinced or uncertain about changing the checkout process across the board, ask them to collaborate on a partial rollout or A/B test. Getting a proof of concept will help your teams analyze the impact of collecting data during checkout. This can be done through choosing a specific business market to test in, or through real A/B testing with different checkout flows for similar customers. This will allow you to measure important metrics like cart abandonment and conversion rates, checkout duration, step completion rates, error rates, etc.. Tax teams have to make sure that they also provide the relevant data in terms of (latent) compliance costs, audit risks, customer support ticket volumes and costs, etc,. in order to compare apples to apples.
E-invoicing and Digital Reporting countries: It is critical to inform your business teams that in more and more countries, e-invoicing and digital reporting rules that require (near) real-time electronic reporting of transactional data (e.g. sales transactions) are coming into force. To do so, you will need fully accurate tax ID information of your business (B2B) customers. Without this, you cannot report these transactions compliantly and will be subject to instant tax authority scrutiny.
Use dedicated tax technology: Solutions like Fonoa’s Lookup tool are built specifically for e-commerce and the digital economy. By using the right 3rd party dedicated technology you can rely on validation accuracy, coverage, speed and performance which are all critical components in the checkout process. Trying to build a tax ID validation tool yourself is risky and can consume an entire team of professionals from tax, engineering and project management. It requires niche expertise, maintenance is time-consuming and ‘getting it wrong’ during checkout results in direct revenue loss.

How Fonoa Can Help

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.

Avoid Tax Liabilities: Determine exact tax treatment upfront.
Time Savings: Eliminate transaction and invoice corrections.
Improve Customer Experience: Prevent errors in tax calculations.

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.

Real Global Coverage: Instantly validate tax IDs in 110+ countries.
Automatically clean your data: Rely on advanced auto-formatting to clean your data and save time solving for errors.
Process validations in bulk: Perform validations with up to 50,000 numbers in a single batch.
Search by name: Search by name and find tax IDs you are missing.
Comprehensive results: Retrieve the most comprehensive information related to tax IDs directly from government sources.
Simple access and flexible usability: Monitor and review validations from a simple, intuitive user interface or integrate directly through our API.

To discover how we can support you and your business, speak to our teams today.

Why Tax ID Validation at Checkout Matters (and How to Implement It)

Table of contents

Intro

Checkout 101