Distributed ledger technology
In the early days of blockchain technology, there was a lot of excitement about its potential to transform the tax system and the way taxes were collected. In a 2015 survey conducted by the world economic forum73% of respondents (800+ business leaders) predicted that governments would collect taxes via blockchain by 2023.
Well, that year has come and the prediction hasn’t come to pass. Although there have been several successful blockchain projects in the tax arena, the technology has yet to gain significant market acceptance. The 2020 OECD Discussion Paper Tax Administration 3.0 The Digital Transformation of the Tax Administrationwhich sets out a vision for the digital transformation of the tax administration for the coming years, barely mentions blockchain among the tools that will contribute to a smooth and frictionless tax collection process in the future.
Is blockchain for taxes another example of the Segway curse? When the Segway, a self-balancing, two-wheeled electric vehicle, was launched, it was hailed as a society-changing invention. The product worked well, but the world was not ready for it, as potential users were faced with many practical questions (Where can you park? How do you charge? Is it used on roads or sidewalks?). Although the Segway novelty fascinated many people, there was no compelling need for anyone to buy it and it remains a marginal invention today. Blockchain for taxes may be headed for the same fate.
big vision
Blockchain was hailed as the cure for almost all problems plaguing the European Union’s value added tax (VAT) system. Every year, EU countries lose billions in VAT revenue due to tax fraud and inadequate tax collection systems. In 2020, the VAT gap (ie the difference between expected tax revenue and actually collected) was estimated at €93 billion. Governments have been implementing various compliance obligations, such as installment payment, real-time reporting and mandatory electronic invoicing, which improve tax collection but at the same time contribute to the fragmentation of the EU single market and increase the cost to do business.
Another issue that can create tax risks for companies is the increasing complexity of supply chains. Businesses that do not have sufficient visibility into all their procurement and distribution networks may be exposed to additional VAT liabilities if fraud is committed by another party in the chain and they cannot demonstrate that they did not know and could not have known.
Various ways of incorporating blockchain into the VAT system have been proposed in the academic literature. The most advanced use case would be to use a distributed ledger to record all VAT-relevant transactions between companies. These transactions would be validated by the tax administration in real time, which would allow rapid detection of irregularities and fraudulent activities. Other more limited use cases include the use of distributed ledger technology to track documentary evidence of intra-EU supplies of goods or to record intra-company transactions. In a world filled with asymmetric information, imperfect data, and growing information needs of the tax administration, a single, incorruptible ledger that records and validates transactions seemed like a very attractive idea. So why hasn’t the tax sector embraced blockchain solutions on a large scale?
Innovation your ecosystem needs
Breakthrough innovations don’t happen in isolation, they need complementary products to take hold. Sometimes a product fails not because of an intrinsic defect, but because the community can’t adequately support it by the time it hits the market. Just as an electric car would be useless if there were no charging stations available, a blockchain-based VAT system would require some add-on components and integrations to operate successfully.
Blockchains were originally designed as independent systems with a specific purpose. But any blockchain-based tax solution would need to be deeply integrated and share data with various business applications that organizations commonly use to manage their activities. While it is possible to integrate blockchain into a company’s enterprise resource planning (ERP) system to create an immutable platform for storing an organization’s data, such integration is very challenging given the multitude of different ERP systems on the market and the limited amount of middleware. technologies that can connect ERP systems to different blockchain networks. The integration effort can become even more complex if a company uses more than one system.
If blockchain were to be used for actual tax collection (as the World Economic Forum survey predicted), instead of just being a big data repository, it would have to support money transfers. Currently, distributed ledgers can only transfer cryptocurrency and tokenized assets, but fiat currency payments (including tax remittances) still rely on the traditional financial system. Therefore, a proper integration of payment facilities would be a prerequisite for any blockchain-based tax collection system.
scaled value
From a tax administration perspective, blockchain-based VAT solutions would generate more benefits if used for both domestic and cross-border trade. This means that a VAT blockchain project would have to be developed and managed by more than one country. Participating countries would have to agree on decision-making procedures, technology standards, service level agreements, system audits, and dispute resolution mechanisms.
Several collaborative projects in the area of indirect taxation involving multiple countries have shown that achieving international consensus is a difficult task. While countries are generally willing to agree to non-binding recommendations and guidelines, the idea of enacting binding laws is far less appealing. EU countries have failed to reach agreement on many reform proposals that sought to harmonize the EU’s VAT system. Even something relatively simple like the concept of a single EU-wide VAT return was abandoned due to divergent views. Since blockchain-based solutions would require consensus on matters beyond tax, the difficulty of aligning the interests of various stakeholders would be compounded.
A solution that needs a problem
While the creation of a blockchain-based tax reporting or collection infrastructure may never materialize due to a lack of political consensus and high implementation costs, blockchain technology has also seen very slow acceptance among tax departments. taxes. Although a real-time updated shared ledger may seem like a good tool for administratively complex management of transactional tax data, tax departments are not keen on adopting blockchain to streamline and transform their processes. By contrast, other technologies, such as robotic process automation, are gaining ground in the tax arena.
The main reason for the relatively low interest in blockchain among tax departments is that the use of distributed ledger technology is generally reasonable when various external parties want to interact and keep track of the data they exchange. Blockchain-based systems are not suitable for supporting individual tasks from a single department; they are designed to provide traceable documentation of data exchanges across organizational boundaries in a way that neither party can unilaterally manipulate. Blockchain use cases in a single department are not very clear. A tax department might consider using blockchain for document management, but existing tools are already adequate to support this task. Similarly, most of the existing database management systems have an audit trail and advanced user management systems, which prevents data tampering risks.
Although blockchain applications use validation mechanisms and rely on consensus, they may not always record the correct data. Like any software application, blockchain faces the inherent problem of the interface between the digital and physical worlds: someone has to program the distributed ledger and make sure the proper entries are made. Since the information must be provided by people, what enters the blockchain may be subject to manipulation or error. For example, two related parties may agree to include fictitious transactions or fictitious prices in the general ledger. If these inputs are validated by the network, the blockchain is technically correct but not legally correct.
Finally, there is the element of risk. Since the purpose of tax departments is to ensure compliance and protect the company from tax liability risks, most companies would not consider them the right place to experiment with new technology. Before implementing any new technology solution, tax administrators typically want to know how many other companies have tested the innovation and successfully adopted it. Since tax departments consume data from many different systems, compatibility and interoperability considerations are important when selecting any new technology tool.
Conclusion
While tax administration has become more digital and automated, it is still based on “traditional” technologies and a blockchain-based VAT system is not likely to appear in the near or distant future. Although blockchain technology has the potential to solve problems related to fragmented information systems, limited visibility into supply chains, and real-time data traceability commonly found in VAT systems, its widespread adoption in the tax sector is seen hampered by interoperability challenges. standardization and the lack of the necessary ecosystem. Before embarking on blockchain projects, one should consider what added value a blockchain solution will provide and whether there are alternative solutions that could achieve the same result in a more efficient way.
The opinions expressed in this article are those of the author and do not necessarily reflect the views of any organization with which he is affiliated.
