EU Inches Toward Blockchain in Fight Against VAT Fraud

Europe is laying the groundwork for using blockchain—the record-keeping technology behind cryptocurrency—to fight the billions of euros lost in annual value-added tax fraud.

The technology already is on the near horizon for other purposes, including protecting personal data and streamlining tax information exchanges among countries.

European governments are under pressure to crack down on VAT evasion after a string of fraud scandals highlighted the vulnerability of the crucial revenue source. VAT is vulnerable to fraud because it relies on self-reporting and a disjointed system of rules and enforcement among European Union member countries.

Blockchain could solve many of the system’s weaknesses by creating a registry of digital invoices that would allow tax authorities across Europe to see and verify the taxes paid when a product changes hands, according to Richard Ainsworth, head of the tax program at Boston University School of Law.

“Blockchain closes the window for VAT fraud to occur,” said Ainsworth, whose research on potential uses of blockchain for tax collection has been cited by the European Parliament.

“It will go a long way to solving this problem because on the blockchain will be line-by-line individual transactions data. It will solve the trust problem, but first you’ve got to get the data in the blockchain,” he said.

No European country has yet moved its accounting systems for VAT transactions on to blockchain. Practitioners warn it will likely take years for such technology to be implemented. But early efforts are beginning to take hold.

A New System

Tax practitioners agree that blockchain is a promising tool for combating tax fraud, particularly in the EU’s VAT system, which is complicated by different tax rates as well as different rules.

With a blockchain system, a taxpayer could upload digital invoices into a country’s reporting system. The invoices would be verified and put onto a blockchain-based network accessible to participating tax administrations and auditors. Such a system could allow VAT payments to be automated and would also create a history of transactions that authorities across the EU could easily access if they suspect fraud or errors, according to Eelco van der Enden, a partner at PricewaterhouseCoopers in the Netherlands who advises tax administrations on compliance.

“You would close the loop and organize a system whereby real-time auditing of transactions is possible,” said van der Enden. ”The dissymmetry more or less goes away.”

The EU losses an average of 50 billion euros a year from “carousel fraud”, according to a 2018 report released by the European Parliament. Carousel fraud happens when a series of connected businesses exploit cross-border VAT rules and disappear before the authorities catch on. The European Parliament in February adopted an overhaul of the VAT system meant to stop fraud and reduce complexity for businesses.

EU Investment

The commission said last year it would pour 340 million euros up to 2020 into blockchain projects to reshape the way authorities collect cross-border taxes, manage health records, and protect personal data. Europe aims to have an infrastructure in place by next year to support these public services.

A tax information system could be part of that infrastructure, according to Spyridon Pilos, European Commission principal manager in the directorate for information, workplace, and innovation, speaking at the OECD’s blockchain forum.

“The EC’s director general for taxation is looking at the use of blockchain to facilitate the exchange of information between tax authorities. This is something that is being built as part of the European blockchain services infrastructure,” Pilos said.

Some European countries have already started experimenting with blockchain for tax collection and other government services.

In Finland, tax authorities began working with banks on a blockchain system to track taxes on real estate deals at the start of this year, said Timo Puiro, a senior adviser at the Finnish Tax Administration, at the OECD forum. Finland has also conducted a “proof-of-concept,” or pilot project evaluating efficacy, of a blockchain-based VAT system, Puiro said.

In Sweden, tax authorities are testing blockchain to digitize receipts, for income tax on non-residents, and customs duties. Estonia has moved a number of government services onto blockchain, including bank, health and business registers.

Netherlands-based startup Summitto, which received funding from the EU’s Horizon 2020 project, is working on a blockchain-based accounting system that tax administrations could use to combat VAT fraud. The company, started in 2017, has presented its program to four EU governments, said Lucas Mul, the company’s communications officer.

Other countries have been digitizing their tax accounting and auditing systems, a preliminary step toward blockchain technology, practitioners said. Hungary and Italy now have recently made digital invoicing mandatory for many taxpayers.

And in Germany, the government released a federal blockchain strategy Sept. 18 that addressed potential governmental uses.

“We are aiming to take advantage of the opportunities offered by blockchain technology and to mobilize its potential for digital transformation,” said a spokeswoman for the Federal Ministry of Finance, which drafted the strategy alongside the country’s economy ministry.

Lack of Harmony

Still, tax practitioners said it will likely be years before blockchain is widely used by EU for VAT reporting.

“Everybody could agree that VAT is a perfect use case, but the EU carousel fraud is such a complex problem,” Dennis Post, lead partner in blockchain and tax at EY, said at the OECD blockchain forum. “We need another couple of years for the technology to really mature.”

Tax practitioners cited a slew of obstacles to widespread adoption, including privacy concerns, the complexity of cross-border VAT rules that could hamstring automation attempts, and a lack of political consensus among member countries.

A blockchain-based system where tax data is widely accessible could ruffle privacy-conscious countries such as Germany, which has limited its participation in tax information sharing networks such as the EU’s Eurofisc system, and could also run afoul of the EU’s General Data Protection Regulation.

Van der Enden of PwC said he expects EU tax authorities will begin cross-border pilot projects in the next two or three years.

“Where many countries currently stand, moving from the current situation to blockchain would be too far, too fast. It’s like swallowing an elephant. ” said van der Enden. “First, there needs to be political goodwill for various countries to open their minds and make it work.”