Taxation for Blockchain

March 18, 2018

Jaime Fernandez-Pontes

Taxation and Blockchain, two concepts that although may seem relatively strange when put together, we believe in their synergy to unfold the full potential of distributed ledger technology to gradually improve the current taxation system by boosting the capabilities of governments to revolutionise tax compliance and collection and monitoring tax fraud. This article will touch upon the possibility of implementing blockchain technology to ameliorate the current taxation system, which in many regions the fraudulent and corrupted collection of taxes deprives the possibilities for an efficient and regular functioning of public finances, thus hindering the region’s growth and the prospects of better living conditions for its people. The question we would like to pose is, aside from the hype of blockchain in banking and finance, why not blockchain applied also in taxation?

On the potential benefits of blockchain technology for tracking down tax evasion, through distributed ledger technology governments could benefit from a trace of transactions as a tool to avoid tax fraud and fraudulent tax collections. Recent scandals like the Panama Papers, the Falciani list or the Paradise Papers could somewhat be avoided through blockchain technology as it would permit the tax authorities to trace payments to and from accounts abroad, thus allowing to solve tax evasion to a large extent. Digitalisation of tax is gaining speed, mostly in western countries where they are adopting numerous digitalised tax system, but no so much is changing in developing economies. As for developing countries, we believe this transition to a digital taxation system would allow them to contest tax evasion which in turn would allow for a better management of finances within the country. Adding to this, one of the benefits of blockchain for taxation in developing countries would be the ability to tax foreign companies operating in the country, thus permitting to monitor and spot corporate tax evasion. As a result of the high level of security blockchain technology provides, as digital ledgers cannot be altered or tampered, we find it a more sophisticated and efficient tool for the authorities to spot anomalous behaviour on transactions and thus track down tax fraud. A further strength we found refers to the real-time information blockchain provides, as information is constantly updated for everyone in the network at the same time, real time changes could take place concerning tax collection, such are big movements of currency in and out of the country.

We have seen bitcoin and other cryptocurrencies being used as a rather effective way to evade taxes, yet until very recently, most tax authorities went unnoticed of the potential of blockchain technology to tackle the problem of tax evasion. In one of their last reports, PWC spoke extensively on tax collection and the IOT (PWC Report 2017). We found particularly interesting the fact that these days many payments are done with devices connected to the IOT, so there is the potential for tax agencies to pursue anti-tax fraud policies through the IOT, as the majority of our daily tasks and activities are carried out partially or fully though a device which is most cases is connected to the IOT. By this we mean that most VAT invoices could be uploaded to the chain regardless of the size of the purchase, for instance, last year the UK lost up to £1.5bn from VAT evasion by foreign online retailers, we propose that instead of having to account all invoices, a system where the government could see transnational invoices and the number of payments would allow for an easy track down on VAT tax evasion and also smoother tax checks.

Concerning tax collection, we find the transparency blockchain technology provides a key determinant in the potential implementation of the technology. This transparency could be materialised in the form of provenance of payments, traceability of tax payments as well as transparency on transactions. We propose that, following the example PWC developed, a blockchain-based transaction using “smart contracts could be used to automatically pay transaction-based taxes such as VAT to HMRC on a real-time basis”. Ultimately, the implementation of blockchain technology for tax collection could allow for a reduction or partial dismissal of tax advisers to produce tax returns.

Regarding the potential benefit of blockchain technology for tax compliance, blockchain could change the behaviour of taxpayers because of the dangers and consequences of non-compliance with tax collection. The chance of getting caught and excluded from the blockchain network for non-compliance would be high. As a result, it is likely blockchain could help reduce the tax gap to some extent, thus reducing to some extent tax fraud (PWC Report 2017).

Concerning the future of tax payments, the scenario whereby salary payments are tied to self-executing smart contracts, taxes will be automatically extracted upon payment when due by the smart contract, time stamped and remitted to authorities. This payment information will be permanently stored on the blockchain leading to error reduction and permanent proof of tax payments. Likewise, tax authorities will also have an audit trail of where VAT has been paid and the time of payment, so the authorities will also have the technological aid to prove by means of cryptography if someone has paid their taxes or not (PWC Report 2017)

The proposal of PWC also refers to the trace of the tax payments after they have been deposited in the governments accounts, as the remittance process will not stop there as taxpayers will also have the chance to keep an eye on what their taxes are used for, thus reducing citizens mistrust over tax money usage. Likewise, tax authorities will also have an audit trail of where VAT has been paid and the time of payment. (PWC Report 2017). For example, we find practical examples of blockchain development in tax collection, for instance China just announced that it will use blockchain technology for social taxation and issuing electronic invoices. This is just the latest example of the far-reaching array of applications possible for the technology.

We however found examples of blockchain technology applications to taxation which are not applicable to certain scenarios. It is true that the majority of people use a device that participates in the IOT network, but there is a significant number of people who don’t. Moreover, blockchain technology would allow for certain tax collections, such as corporate tax or income tax, or mostly those concerning certain levels of currency movement, but there are many situations where blockchain technology would not be able to solve mismanagement of taxes, such are cash payments, or exchanges. This way, we found that blockchain would mostly be beneficial on the corporate side of taxation, yet many small transactions and small taxes would still need to be collected the way there are collected today. We believe that blockchain may not be the cure for all the flaws in the tax system, yet it could be applied in a number of areas to reduce the administrative burden and collect tax at a lower cost and act as a government tool to check on fraudulent tax payments.

We have seen how in Arizona the house of representatives has been pushing for tax payments using bitcoin, and other states like Illinois and Georgia are willing to follow, here we see that aside from the hype and speculation of cryptocurrencies and blockchain for banking and finance, the prospects of implementing blockchain technology for taxation are on the rise. It is essential for governments to increase their levels of understanding through research and the implementation of proofs of concept in order to be aware of the benefits that can be derived from the blockchain in the tax world. Amongst the benefits include a reduction of the administrative burden and the cost of tax collection and compliance (PWC Report 2017). We however believe that the transition to a digital tax system should be treated with a certain level of scepticism, as there are many segments of public policy involved on the legal facet of blockchain. Modifications in the legal side of smart contracts, identity protection and fraudulent use of the network should take place before we adventure further in a technology which is evolving and changing on a daily basis, we therefore support the view that the certain aspects revolving around blockchain would need to be modified to allow a simple, smooth and efficient implementation of the technology to the tax system for this transition to be effective and reciprocally beneficial for both tax payers and tax collectors .

References: PWC Report 2017:

  1. https://www.pwc.co.uk/issues/futuretax/how-blockchain-technologycould-improve-tax-system.html
  2. PWC Report 2016: https://www.pwc.com/gx/en/services/tax/tax-policyadministration/future-of-tax.html
  3. Note: For further reading on the application of blockchain to technology follow this link: https://www.wu.ac.at/fileadmin/wu/d/i/taxlaw/institute/WU_Global_Tax_Policy_Center/Tax___Technology/Backgrd_note_Blockchain_Technology_and_Taxation_03032017.pdf