Luxembourg: How Blockchain Could Help Fight—Or Even End—VAT Fraud

Last Updated: 28 September 2017
Article by Georges Bock

Most Popular Article in Luxembourg, October 2017

A common mugger might snatch an iPhone from your hand, or swindle you out of the cash in your wallet. But all the muggers in Europe probably couldn't steal the value that EU countries lose to VAT fraud, and that's because that number is estimated to be a staggering €40-100 billion per year.

Estimates say that 9% of VAT owed in Spain never makes it to the Spanish government. In Greece, it's as high as 28%.[1] This is no small problem, obviously, and in the current age of tax transparency and digital power, percentages like these seem embarrassingly anachronistic.

Like many of my colleagues I'm a FinTech and RegTech fanatic, and as such have been following (and, where possible, using and helping develop) the newest technologies of this exciting epoch in which we're living. More officially, I'm a tax expert who's been in the business for over 25 years. These interests combined, I can't help but notice when technology poses an elegant solution to a significant tax problem, and that brings me to blockchain and VAT fraud.

A huge use-case for blockchain

It seems that every use-case for blockchain or digital ledger technology (DLT), is huge, and all that huge potential can be overwhelming, but in the area of VAT the elements involved are simple. DLT exists, has been tested, and works. It is essentially a permanent and immutable record of transactions—in real time—within a network. What mostly remains is a shift in mindset, to such a degree that institutions as large as multinational companies and European governments must feel confident about putting real money towards a real blockchain product.

Before we get that far, however, it's worth discussing exactly how a blockchain could plug the leaks in the system that fraudsters currently exploit. Every sale implicates a number of players: the buyer, the seller, a bank, maybe multiple banks, and tax authorities, to name a non-exhaustive list. Let's imagine that, to each good or service which is subject to consecutive sales transactions, a ledger is associated. At every step of the chain, each player or "node", including the tax authorities, would have to confirm the transaction. Each validated transaction would then add a block to the ledger. Before a transaction would be authorised and carried out, and the related invoice issued, it would have been validated by the tax authorities who would have all the information needed to detect and eliminate any risk of irregular transaction, such as missing trader intra-Community fraud (also known as "carousel" fraud). VAT could even be charged and deducted in real-time, under the immediate scrutiny of the tax authorities. The current messy system built on discrete players, outdated information systems, and errors being retrospectively righted (i.e. overpaying or underpaying) would be replaced by an effective, decentralised solution.

A distributed ledger would secure and simplify the process by providing a platform where the many players—companies and governments alike—share a master source of truth. Blockchains provide for complete transparency and searchability, meaning that a government could easily consult the blockchain to see who sold goods and services to whom, moved money to whom, on whose behalf, and extract the appropriate VAT, once and finally. It would also help in cross-border situations: if Italian computers spoke to Luxembourgish ones and vice versa, it would help governments treat VAT in cross-border situations and international businesspeople avoid being involved as innocent parties in fraudulent transactions.

Action plans

Some countries have recently introduced new anti-VAT-fraud systems, though none use blockchain technology. For example, a new Spanish system flags transactions carried out by businesses who meet a certain threshold, at which point they must fill out the invoice information with the VAT authorities. Validation lies with the government, rather than being decentralised, and can take up to four days. The Chinese authorities have a centralised validation system as well, where information must be validated before transactions can take place.

These systems make sense, but why not go a step further and make a properly transparent and fast-validating blockchain? In a European context, a major obstacle is, of course, the coordination of many governments, which is why a directive from the EU would be invaluable in kickstarting an industry-wide, Europe-wide effort at a platform that would hugely prevent fraud while remaining extremely fast and competitive for businesses on a European scale. I wouldn't mention it if it weren't for the exciting fact that, as I said above, the technology exists today. All that's left is the mobilisation of all the big players.

As an afterthought, too: VAT as an "indirect" tax is itself already levied in a decentralised manner, so a decentralised method of securing its collection seems to make sense, at least as a philosophically elegant solution. Keep an eye out on our blog for my next article, about blockchain and funds.


[1] Study and Reports on the VAT Gap in the EU-28 Member States: 2016 Final Report // Ref: TAXUD/2015/CC/131 // Author: IHS, Institute for Advanced Studies for the Directorate General Taxation and Customs Union // 23 August 2016

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