A Growing Interest in Blockchain Use by Tax Authorities

The Big Question: Can blockchain reduce the tax gap and tax administration costs, thereby making the tax system fairer, safer and simpler? Let’s have a look at the current problems, the status quo and blockchain’s potential role in the tax system.

A shortage of tax revenue has been one of the most relevant issues in European politics over the last decade. Since 2010, many EU member states have run budget deficits. Traditionally, states could either cut spending or raise taxes to balance the books again. However, there is also a third option: try to reduce the so-called tax gap.

The tax gap is the gap between the total amount of taxes owed to the government and the taxes actually recouped each year. Tax gaps arise, for example, due to simple calculation errors or oversights by the taxpayer when submitting returns. Other causes include illegal tax evasion, whereby money is concealed to minimise tax liability, and legal tax avoidance, whereby financial and accounting techniques are used to avoid liability. Of course, it’s not possible to collect all taxes — some businesses become insolvent, for example, and are unable to settle their liability. The European Tax Gap Report 2019 suggests that EU member states have a total tax gap of no less than €750 billion, which is likely to be an underestimate.

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Where do we stand today?

Tax evasion and avoidance raise fundamental questions about the fairness of our tax systems. In addition, tax processes tend to be bureaucratic and labor-intensive, costing a lot of money and time. This has led to hopes that digitization could improve the current system. The potential benefits of digitalised tax systems have been recognized by many countries, such as France, which have already implemented digital tax services or are considering it. So how much progress has been made and could blockchain technology be used to implement such a system?

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What does blockchain / DLT mean for the future of taxation?

There is increasing interest in using blockchain to improve tax compliance, reduce auditing costs and simplify tax returns. The cost of tax compliance can be reduced by using smart contracts to automate transactions, allowing businesses to claim VAT refunds faster and authorities to conduct tax audits more efficiently. Blockchain could complement the existing system by building a single, transparent shared database. In this way, blockchain could be used by governments to build trust in tax institutions by making VAT infrastructure more transparent. For example, people could use a smartphone app to track exactly how their tax contribution is spent, increasing transparency and trust between governments and the public.

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In addition, blockchain could allow real-time taxation, whereby deductions are automatically carried out on each ingoing and outgoing transactions. This would speed up the tax refund process while helping to gather information to prevent tax evasion. In theory, this could make the entire system faster, fairer, safer and simpler, while reducing tax gaps.

However, it is important to acknowledge that the economic environments in which tax agencies operate are highly complex. Thus extensive planning and testing would be required to ensure that blockchain-based tax solutions function as intended.

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Projects and pilots are emerging

A number of promising systems have been piloted by both businesses and government agencies. Chinese tech giant Tencent received the go ahead from the country’s tax officials to build a blockchain-based invoice standard. This General Framework of DLT-Based Invoices is also being supported by other countries including Switzerland, the UK, Sweden and Brazil. Recently, China’s Taxation Bureau issued over 10 million blockchain invoices. More than 7,600 companies have accessed Shenzhen’s blockchain electronic invoice system to date, with an aggregate invoice amount of more than $1 billion.

In addition, several companies are seeking to develop blockchain-powered software solutions to improve accounting processes. An example is Armanino, which has recently introduced blockchain-based auditing software. The accounting and business consulting company aims to be the first real-world application of real-time attestation. “We have this digital ledger that becomes the single point in truth capturing all these transactions. You open up the possibility of real-time audit and being able to provide transparency.” Armanino partner Andries Verschelden said to Coindesk.

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The way forward

The use of blockchain in the taxation system is no longer merely hypothetical — a range of government pilot projects coupled with common international standards and blockchain-based software tools show that it will soon be a practical option. In the best case scenario, blockchain will help to construct a transparent ecosystem in which the trust of taxpayers can be rebuilt. If this vision is to come to fruition, however, transparency will be crucial. Thus, educating taxpayers about the system and its benefits will be key.

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Photo credits:

Photo 1 by Leeloo Thefirst on Pexels
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