EU blockchain to solve VAT fraud?
This blog first appeared in International Tax Review
Should we ignore the bitcoin speculative bubble and hacking scare stories as the fireflies before the technological storm? Could blockchain solve the EU’s €50billion VAT fraud menace, and revolutionise tax reporting?
Or is blockchain’s hype overblown and optimism misplaced? Are the considerable concerns about its electricity-guzzling dependency and slow speeds likely to mean it cannot solve the bitcoin micro-payment challenge let alone global tax reporting needs? And perhaps the real blocker on even the existing technologies is that countries have poor form on agreeing or even sticking to data standards that blockchain would require to succeed.
Blockchain – integrity through public participation
Blockchain is a public electronic ledger of transactions between different parties of any sort, held on a chain of internet-linked computers. Each computer holds an identical copy of the ledger, and they all change simultaneously with each new transaction. If anyone enters into a transaction (buys, sells, transfers etc), all copies are updated instantly. This means everyone in the network has a real-time record of all transactions since the start, and can easily spot and trace if a bad actor is making fraudulently changes.
Its most popular use at present is the recording of ownership and sales of digital currencies, like bitcoin. Blockchain’s huge attraction is that its structure makes it near impossible to hack and forge transactional data stored on it. The hacks on digital currencies’ exchanges that you have heard about are just that: hacks of the exchanges’ own systems, and not of the bitcoin blockchain itself.
As a side note, each change creates a new block of data, hence the name, blockchain.
Could it be adapted to impede €50bn in VAT fraud
The question tax authorities are now exploring is could blockchain be modified to help monitor and block the extensive problem of cross-border VAT fraud occurring in the EU’s Single Market economic bloc.
The type of transactional information blockchain captures and holds for digital currencies (a record of the parties to a sale and exchange prices of each transaction) would need to be extended. This would include adding VAT invoice data – shipping information, goods descriptions, costs, prices, VAT calculations etc. This information could be placed in cloud-based blockchain, with secure access for all players in the supply chain.
From this, it is easy to project a blockchain general ledger, holding accounting transactions that approved suppliers and customers can report and monitor in real-time. This would also provide tax authorities perfect transparancy on taxable supplies, which, through powerful analytical software, could easily be monitored in real-time to calculate tax liabilities and spot attempted frauds.
If adapted to European cross-border trading, this could tackle the biggest obstacle to eliminating an estimated €50billion in missing trader VAT fraud. All parties in a transaction could see, and have to approve simultaneously any transaction. This would severely limit criminal gangs’ opportunities to report a cross-border, zero-rated VAT transaction with one party, but actually carry out a standard VAT-rated domestic transaction with another. These non-validated transactions, at the heart of the multi-billion VAT fraud issue, would not be copied across the blockchain, so could be instantly spotted by the tax authorities. This compares with the existing, historically VAT return reporting system which can take months to unearth such fraudulent transactions.
Fiscally flawed fantasy?
But blockchain has some severe design flaws which could undermine this tax tracking proposal. These include:
- Very slow processing speeds – blockchain can typically process just 10’s of transactions a second whereas international payment companies processing taxable transactions must operate hundreds of times faster
- Mining in bitcoin, the process of creating new bitcoins, requires hours of computer processing time and expensive electricity consumption. It is not yet clear if this problem would transfer to tax transaction efforts
- Digital ledger technologies are already well established elsewhere, and untested blockchain does not appear to add much new
- Fears of fraud as blockchain is anonymous. This is probably urban myth: the FBI tracked down all the parties in the 2014 $473mMt. Gox exchange fraud via their bitcoin keys, which uniquely identify all parties. So this is unlikely to block a tax adaptation; and
- What data would a tax blockchain capture? Possibly the real problem with EU VAT fraud, and other tax data exchanges, is that governments have been slow and reluctant to agree on shared data requirements and formats. Witness the diverging standards on the OECD-agreed SAF-T reporting, or the failure to agree on a standard VAT return.
Blockchain the tax technology of the future?
Blockchain looks like a boundless, white-heat technological agent of change to solve the seemingly immovable EU VAT fraud problem. However, it’s worth being sceptical. With its faults, blockchain is increasingly looking like an invention for a problem that doesn’t exist. Even putting fraud aside, bitcoin is failing in its original mission to replace expensive mirco-payments. So why would it work for VAT and other tax reporting?
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