European Union: Solving VAT Fraud, Once And For All, With Blockchain

Last Updated: 25 September 2018
Article by Quentin Warscotte

Most Read Contributor in Luxembourg, July 2019

1954 marked a milestone in the history when, in Edina, Minnesota, construction began on the first-ever modern-era shopping mall. The "Southdale Center", which still exists, was the first fully enclosed, climate-controlled shopping centre in the world, boasting space for 70 shops.

The same year, in France, tax authority director Maurice Lauré introduced an equally significant invention: Value Added Tax. VAT is remarkable for two main reasons: firstly, it is assessed and levied incrementally, based on the increase in value of a product or service at each stage of its production or subsequent distribution; and secondly, as an indirect tax, VAT is not collected by the state directly but through a network of intermediaries, the taxable persons, who are in charge of collecting the tax from the consumers (who bear the economic cost linked with the VAT) and remitting it to the state.

Simple and cheap to administer, VAT spread over Europe and the world over time, growing in importance to become one of the main sources of income for each country of the European Union.

Much has changed since 1954: shopping and VAT, like other things, have become far more sophisticated. With rules becoming more numerous and detailed (the European VAT directive alone now contains more than 400 articles) and collections being based on constellations of taxable persons, some of whom are unreliable, VAT has become increasingly susceptible to fraud.

Every year, a sum equivalent to €100 from each EU citizen is stolen by crooks committing cross-border VAT fraud (one of the most common types). That makes €50 billion in Europe annually that go missing from, for example, healthcare and education. Such a sum is three times the annual budget of a state Luxembourg's size!

However, as VAT grows in complexity, so has technology grown in power: it is time, now, to apply new but tested digital methods to secure indirect taxes and to make VAT fraud obsolete.

Distributed ledgers and digital thinking

E-commerce has utterly revolutionised shopping—so why shouldn't blockchain, i.e. digital ledger technology (DLT), revolutionise VAT collection?

As my colleague Georges concluded in this article, VAT is similar to DLT in that it relies on a decentralised network of individuals or "nodes": where VAT is about collecting tax, DLT is about validating transactions. The similarity lends some logic and consistency to the idea of combining the two networks: using blockchain, taxable persons and tax authorities alike can interact securely and in an auditable way, which would ensure efficient and correct VAT collection.

The idea of preventing fraud by validating transactions prior to their occurrence, which is inherent to the concept proposed above, is not new. But the centralised systems currently used often fail in terms of agility and are usually limited to a single tax authority, whereas fraud, and especially VAT fraud, often occurs on a cross-border basis.

Blockchain, in contrast to these centralised systems, enables the labelling and tracing of flows of money (such as VAT amounts) from a taxpayer up to a tax authority. This record, together with the immediacy and decentralised nature of the validation, which is characteristic of the technology, makes stealing the money impossible. Thus, setting up a private blockchain for the taxpayers, banks, and tax authorities in a given transaction could make VAT collection truly safe and secure.

For instance

Imagine a transaction taking place between two parties. Instead of having the money flow directly and entirely from the buyer to the seller, and then the VAT amount transferred (hopefully) by the seller to the tax authorities, the part of the price paid corresponding to the VAT could be transformed, by an intermediary (the cash clearer), into a virtual currency. These "VAT coins" would come into existence directly when the buyer gives its payment instructions, and would only be exchangeable against money with the tax authorities, by taxable persons having a right to claim that VAT back.

By carrying out this "tokenisation", it would be ensured that VAT is effectively paid to the tax authorities and does not disappear. This concept is further explained on our dedicated webpage.

Blockchain has come a long way in the last few years: no longer a bombshell concept, it has proven itself workable and is already in use for securing transactions on securities, exchanging money, voting, confirming supply chains, and many other cases. Preventing VAT fraud should be its next application.

Of course, it will not be an easy job: practical challenges could lie in getting taxpayers' systems to interact efficiently with the DLT network, or in dealing with the existing complexities of the VAT system. It could be the biggest change in the way taxes are collected in decades, but the rewards could be just as huge.

Europe was the birthplace of a revolutionary tax: VAT. Could it be the one of an equally revolutionary method of its collection?

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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