Blockchain and VAT: an Introduction

Blockchain and VAT: an Introduction

VAT fraud costs European Union (EU) Member States an estimated 50 billion euro on an annual basis. In total, the difference between the expected amount of VAT collected and the actually collected VAT (the VAT gap) is 137.5 billion euro .[1] Several Member States are considering disproportionate measures to fight this fraud. None of them seem just. That’s why we’ll discuss the potential of blockchain in fighting VAT fraud.

What is VAT fraud

First, let’s find out how VAT fraud works. VAT fraud is also known as carousel fraud. In a carousel fraud scheme fraudsters make use of the VAT exemption for intra-communitarian transactions. Here is a simplified example: German Company A sells goods to Dutch Company B. No VAT is paid because this is a transaction between companies from two different EU Member States. Afterwards Company B sells its goods to Company C, which is also located in the Netherlands. Company B receives VAT, but does not report this to the tax authority. At the same time, Company C asks for its VAT refund and sends the goods back to Germany or a different country to make it even more complicated to track but without paying VAT. This process can be repeated over and over again. That’s why it’s called carousel fraud. Although there are several ways to commit VAT fraud, the essence of all these types of VAT fraud is that fraudsters report an incorrect amount of VAT.

Carousel

To detect this type of crime, in many cases tax authorities perform checks on invoices. However, this is a very inefficient post-audit process. Often, these checks are done manually and randomly. Not only is this system prone to fraud, but it also results in unnecessarily high detection costs due to an inefficient detection process. Luckily innovative technologies offer a solution to these problems!

DLTs and blockchain

A good example of such a technology is the Distributed Ledger Technology (DLT), an umbrella term for several distributed technologies such as blockchain, enables you to generate mathematical proofs of your data and to store this data in a decentralised way. Data becomes, simultaneously, more transparent and more secure.

The first DLT was the public blockchain of the cryptocurrency Bitcoin. One of the strengths of Bitcoin is that anyone can validate the ledger. Currently, it is impossible for an ordinary citizens to check how much money is actually being printed by their central bank. Furthermore, it is a costly endeavour to check whether all of your banknotes are actually real banknotes. Bitcoin solves these issues. Instead of trusting what a central bank tells you, now anyone can check how many Bitcoins are in circulation. No longer do you need to blindly trust the bank. DLT allows for a more transparent system, as everyone (with the help of some serious computer skills) can verify the code and math involved. In other words, there are no more black boxes.

DLT is applicable in a setting where the cost of validating information is high, since this goes hand in hand with a high amount of fraud. DLT can be implemented to automate and standardise the validation process.

Using blockchain technology to fight VAT fraud

DLT can be used to develop a safe and confidential invoice registration system that brings an end to VAT fraud. The digital registration of invoices comes with tons of benefits as compared with the current way of reporting VAT. Within Europe, Italy and Spain recently moved to a centralised invoice registration system. All invoices are stored in a central database which is accessible by the government to perform audits. As recent and more frequent cases of data abuse and cyber attacks show, this is a dangerous situation. In these centralised systems, there is a high probability that sensitive company data falls in the wrong hands. The recent data leak of the Ecuadorian government in September 2019 demonstrated how this can go horribly wrong. In the event personal data of 20 million people was leaked, whilst Ecuador only has a population of 16 million people. Therefore, government officials think that data of people both dead and alive was leaked…

To solve this problem, summitto invented a modern confidential invoice registration system. In the development of this system, we are taking a ‘privacy-by-design’ approach. Privacy by design is an essential part of the GDPR. It prescribes that businesses should take privacy into account from the very start of a project. In other words, measures to ensure privacy will not be taken after a successful cyberattack has occurred, but these measures will already be introduced during the development stage of the project.

We apply this approach by using blockchain technology and modern cryptography to detect VAT fraud without storing any actual invoice data. In this way, businesses do not need to be afraid that their valuable data falls in the wrong hands, because the data is never collected in the first place. Still, by aggregating transactional data, tax administrations can automatically get a selective insight into who is not reporting correctly. On top of that, our solution comes with even more advantages for businesses. For example, businesses will be automatically compliant. This reduces audit costs for businesses and increases the trustworthiness of their financial data. That will allow them to gain easier access to loans, thus increasing their cash-flow.

DLT has shown the potential to help solve fraud problems that inflict an enormous damage on society. It offers public verifiability of data, and lowers the costs to generate verified financial data. Our solution is a good example of putting this theory into practice in order to return the 50 billion euro lost in VAT fraud each year to tax authorities all over the EU. Our efforts did not go unnoticed. We have been invited to discuss our solution with the European Commission in December during the “VAT in the Digital Age” event.[2] Let’s fight VAT fraud together!

Want to know more about summitto, see https://stopvatfraud.com/ and subscribe to our newsletter.

  1. Data from: https://ec.europa.eu/taxation_customs/sites/taxation/files/vat-gap-full-report-2019_en.pdf

  2. See: https://ec.europa.eu/taxation_customs/events/vat-digital-age_en