Virtual currencies are very topical at present, as the world waits with baited breath for a potential crash in the value of the main “currencies,” after a surge last year.
Virtual currencies are also appearing on the radars of national tax authorities. Many have issued notices recently reminding taxpayers that their activities in virtual currencies could have income tax and value-added tax consequences, including the United States Internal Revenue Service – despite the fact that there remain doubts over the legal and regulatory status of virtual currencies in many jurisdictions.
But could the technology that underpins bitcoin – Blockchain – become the tax man’s best friend?
What Is Blockchain?
In short, a blockchain is a decentralised digital ledger — a continuously growing list of records, or “blocks,” which are linked and secured using encryption. This Blockchain technology underpins the tracking of virtual currency transactions, enabling the compilation of a complete history of all the transactions that have occurred along the chain.
Blockchain is highly secure, and its decentralised nature is key to this. There is no central database within which records of transactions are held; instead, each “node,” or computer on the network, receives a copy of the blockchain. Therefore, tampering with the information held on Blockchain would be very difficult, if not impossible.
Anonymity Versus Transparency
As things stand, personal information about the individuals transacting in the most popular virtual currencies is not included in these blocks, and this is what enables transactions to be conducted anonymously. This is an aspect of virtual currency technology that deeply concerns the world’s financial regulation and law enforcement authorities. However, this was a choice made when establishing virtual currencies, rather than being a framework limitation; there is no reason why blockchains cannot include such information where the technology is applied elsewhere.
Indeed, Blockchain has the potential to be used for a range of purposes, from financial services – for instance, the settlement of financial trades – to cross-border transactions, public administration, and even elections.
With its inherent incorruptibility, Blockchain is now being talked about as a panacea for the administration of value-added tax. This is because Blockchain would, theoretically, hold not only all the data about transactions between buyers and vendors, but also establish a record of taxes. And it is entirely plausible that any VAT blockchain could be designed so that VAT due on a transaction is also automatically transferred to the tax authority. As such, Blockchain has the potential to dramatically reduce rates of VAT fraud and error.
The Next Logical Step?
It is now commonplace for tax compliance procedures, such as the completion and filing of tax returns, to be completed in a digitized format to increase the speed and efficiency of tax administration, and to reduce levels of error and the loss of data. Blockchain, therefore, appears to be the next logical step for tax administrators.
Indeed, China is already actively studying the potential of Blockchain for tax administration, and is collaborating with Miaocai Network, an electronic invoice and taxation operator licensed by China's State Administration of Taxation, to launch a Blockchain-based system for collecting tax and issuing electronic invoices.
It is not too far-fetched to believe that if China makes a success of this project, other countries will soon follow.