In a world full of asymmetric information, imperfect data and growing information needs of the tax administration, a single incorruptible database recording all transactions is an appealing idea. With blockchain serving as a single source of truth, all parties (suppliers, consumers, tax administrations) would have the same information in real-time and there would be no need for time-consuming reconciliations. Blockchain would solve problems related to fragmented information systems, limited visibility of supply chains and real-time data traceability that are commonly encountered in the VAT system. However, there are still serious limitations to the widespread adoption of the blockchain technology in the VAT sector.
First, the existing regulatory framework (especially, privacy and data localization laws) presents some obstacles to the adoption of blockchain-based VAT solutions. Blockchain is an append only ledger, which means that data that has been recorded cannot be deleted. This seems to contradict the “right to be forgotten” that is embedded in the GDPR (which is the legislation governing data protection in the European Union). Article 17 of the GDPR gives individuals the right to ask organizations to delete their personal data and the data controller must erase this data without undue delay (i.e. within a month).
Second, to be widely adopted, blockchain-based solutions would need to communicate and share data with the off-chain world. As data should not be locked within a specific blockchain, there must be possibilities to extract the data and move it to a different database if a need arises. Another key consideration is the relationship between blockchain solutions and ERP systems. It would be highly inefficient to record the same data in two systems so both systems should be linked to enable smooth data flow. Thus, interoperability still remains a key technological challenge in the blockchain world at the moment.
If a blockchain-based solution is to be used for VAT purposes, it must be highly scalable as the number of transactions and the volume of data will significantly grow over time. Blockchain-based solutions will always be slower than traditional databases. Whereas in traditional databases transactions are processed once, in blockchain networks they must be processed independently by each node, meaning that a lot more work is done for the same result. Slow performance and limited scalability cannot be avoided, at least in permissionless public blockchains, as they are part of the price to guarantee the security of the network.
This article has provided a brief summary of the limitations of blockchain technology that prevent its widespread adoption in the VAT area. If you are interested in this topic, please take a look at my article Between Hype and Disillusionment: will a VAT blockchain be ever possible? (Tax Notes International, vol. 97 no. 8, 24 Feb. 2020).