Blockchain and VAT Taxation – some thoughts

Let me go on a limb and say that except for cryptocurrencies, blockchain is still a tool (hammer) looking for areas it may be applied to meaningfully (nails). 

Many Proof of Concept (POCs) doing the rounds within companies, industries and consortia are unfortunately a play on what looks like the current fad – Blockchain.  Many are in areas that work quite well under current database structures, thank you.  But fear-of-being-left-behind is forcing companies and industries to try and run pilots to stay at the cutting edge.  There are POCs galore, but there are no new “killer apps” for blockchains.

What is it that makes Bitcoin Blockchain the wonderous invention it is with its promise to disrupt entire industries and possibly economies?  Some important features in the crypto currency environment that make Bitcoin Blockchain a success is:

a.     Multi party involvement

b.     Multi party engagement

c.     Mutual Trust elimination

d.     Trusted authority elimination

e.     Transaction dependency /chain

f.      Embedded rules within the system on data updation and consensus generation

In this environment, would GST – the Goods and Services Tax in India be a candidate use case for blockchain.  GST is a destination based tax on “value-addition” across the chain in manufacturing and services sector.  The broad principle is that the more value that is added, the higher the rate of tax.  Also, in order to avoid incidence of multiple taxation on a particular good or service, the manufacturer/service provider gets credit for input taxes paid lower down the chain.  The intent here is to trace a particular “raw” good at source and trace repeated value-addition to it along the chain before it is finally consumed by an “end-consumer”.  Every raw/intermediate good or service could possibly be tokenized and consumed once and once only.  End consumer here is just the poor fellow who cannot further sell it post-addition to someone else down the chain.

Transaction chaining is an important element of GST and could be of financial and academic interest to see how different raw goods/services take increased value across a chain before being finally consumed

In the GST use-case, we have most of the important features defined above that helped Bitcoin Blockchain be the success it is currently viz – multiple parties transacting, multiple strangers interacting, need for trustless collaboration, transaction dependency and chaining, traceability of transactions etc.  However, an important missing element is that the rules defining the system are exogenous to the system i.e. they are defined by a government that has the ability to define, refine and completely overhaul the rules defined thus far.   In some sense, the government plays the role of a Centralized Miner that does the rule setting, enforces consensus and collects all the “transaction fees” in the form of GST.  Given this exalted status of the government, the blockchain naturally collapses to a permissioned RDMS run and controlled by the government.

However, if the good/service transaction payload is segregated from other data like identifiers, it may be possible to forensically examine the database and hunt for clues to VAT-fraud, tax avoidance and evasion.  A blockchain enables the analyst to assume non-repudiation of data (as it would be cryptographically secured by the parties), single use of raw/intermediate good/service, speed (can be mandated via periodic updation of invoice data), immutability (as future consumer could act on the previous good/service and transform it via value-addition/ consumption). 

In tax collection circles, there is reference to VAT-Gap or the gap between government estimate of VAT revenues and actual revenues.  This was estimated to be about Euro 160 billion in EU in 2014.  VAT is susceptible to fraud like missing/unregistered vendors.  It is believed that using blockchain may permit a deeper forensic analysis of this VAT-Gap and ability to catch fraudsters in quick time.  It was also enable procurement analysis to identify under/over invoicing, mispricing transfers and other evils.

Precursor to a blockchain type solution was the experiment by Revenue Quebec, mandating the use of 33,000 Sales Recording Modules (SRMs) in 20,000 establishments in its restaurant industry at a cost of under $90 million netted revenue gains of $940 millions in 2015 which is anticipated to reach $2.1 billion by 2018/19.  Better forensic analysis and improved incentives for compliance may result in improved domestic enforcement

This article is a thought-experiment intended to induce further discussions and critique.  Currently there are no blockchain based VAT systems in operation anywhere in the world.  Also, there are not many references to governmental efforts towards building a blockchain based system either.  Some references to deeper analyses involved include the proposal for VatCoin for GCC countries, Kazakhstan, blockchain based DICE (Digital Invoices Custom Exchange) adoption in Rwanda/Nigeria and suggestions for VAT-gap reduction in EU.  However, this author has not been able to identify any major ongoing effort to adopt Blockchain in VAT administration so far.

4 July, 2017

References

1.     Blockchain solves VAT fraud – Richard T Ainsworth (Prof. NYU Graduate Tax Program), Andrew Shact (VP Tax and Treasury, Mimecast) – June 2016

2.       Francois Badenhorst – Blockchain Pegged as UK’s Tax Future – Accounting Web (Jan 27, 2016)

3.     Blockchain, Bitcoin and VAT in the GCC: The Missing Trader Example – Boston University School of Law, Richard T Ainsworth (Boston University School of Law), Musaad Alwohaibi (University of Florida, Fredric G Levin College of Law)

4.     Kazakhstan to move VAT reporting to Blockchain – www.forklog.net - April 20, 2017

5.     Is Blockchain the future of taxation? Aleksandra Bal – International Bureau for Fiscal Documentation – April 2016