Whether tax programmable elements built into CBDC enhance efficiency in tax assessment and collection?

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Whether tax programmable elements built into CBDC enhance efficiency in tax assessment and collection?

Adv LLM thesis submitted by Sreema Seeram

in fulfilment of the requirements of the 'Advanced Master of Laws in International Tax Law'

degree at the University of Amsterdam

supervised by Dr Dennis Post co-supervised by Dr Claudio Cipollini



Regarding the Adv LLM Thesis submitted to satisfy the requirements of the 'Advanced Master of Laws in International Tax Law' degree:

1. I hereby certify (a) that this is an original work that has been entirely prepared and written by myself without any assistance, (b) that this thesis does not contain any materials from other sources unless these sources have been clearly identified in footnotes, and (c) that all quotations and paraphrases have been properly marked as such while full attribution has been made to the authors thereof. I accept that any violation of this certification will result in my expulsion from the Adv LLM Program or in a revocation of my Adv LLM degree. I also accept that in case of such a violation professional organizations in my home country and in countries where I may work as a tax professional, are informed of this violation.

2. I hereby authorize the University of Amsterdam and IBFD to place my thesis, of which I retain the copyright, in its library or other repository for the use of visitors to and/or staff of said library or other repository. Access shall include, but not be limited to, the hard copy of the thesis and its digital format.

3. In articles that I may publish on the basis of my Adv LLM Thesis, I will include the following statement in a footnote to the article’s title or to the author’s name:

“This article is based on the Adv LLM thesis the author submitted in fulfilment of the requirements of the 'Advanced Master of Laws in International Tax Law' degree at the University of Amsterdam.”

4. I hereby certify that any material in this thesis which has been accepted for a degree or diploma by any other university or institution is identified in the text. I accept that any violation of this certification will result in my expulsion from the Adv LLM Program or in a revocation of my Adv LLM degree.

signature: name: SREEMA SEERAM date:30 June 2022

5. free m a


Table of Contents

Table of Contents ... III Table of Figures... V List of Abbreviations used... VI Executive Summary ... VII Main Findings... VIII

1. Introduction. ... 1

2. Overview of digital currency, CBDC and its technology ... 3

2.1. Is digital currency a currency? ... 3

2.2. What is CBDC?... 4

2.3. The technology design of CBDC ... 5

2.3.1. Blockchain technology ... 6 Cryptography ... 6 Consensus Mechanism ... 7 Transactions and ledgers ... 8 Network design and Users rights ... 9

2.3.2 Centralised architecture ... 10

2.3.3 Smart Contracts ... 11

3. Programmable tax elements that can be built into CBDC ... 12

3.1. VAT ... 13

3.1.1. Registration ... 13

3.1.2. Invoicing ... 15

3.1.3. Tax collection through split payments ... 18

3.1.4. Deduction or refund of Input VAT ... 20

3.1.5. Tax Reporting ... 20

3.1.6. Tax Audit and Assessment ... 21

3.2. Withholding taxes ... 21

3.2.1. Domestic withholding taxes ... 21

3.2.2. Cross-border withholding taxes ... 22 Current issues in claiming tax relief ... 22 Using cross border CBDC ... 23

3.3. Exchange of Information ... 24

3.3.1. DAC 7 ... 24 Obligations on reportable platform operators... 26 Existing scenario ... 27 CBDC scenario ... 27

3.3.2. Cross border reporting requirements ... 29 Existing scenario ... 29 CBDC scenario ...29

4. Potential tax challenges from CBDC ... 30

4.1. Transparency and taxpayers rights ... 30


4.1.1. GDPR ... 31

4.1.2. Principle of Proportionality ... 32

4.2. Public criticism and no wide adoption ... 32

4.3. Increase in administrative costs to business and tax authorities ... 33

4.4. Smart contracts are immutable ... 34

4.5. Single Point of Failure ... 34

5. Conclusion ... 35

Bibliography ... IX


Table of Figures

Table of Figures... V

Fig 1: UTXO Model ... 8

Fig 2: Purchase and sale transactions through CBDC wallet ... 20

Fig 3: Split payments through CBDC ... 22

Fig 4: Cross-border withholding relief under CBDC ... 24

Fig 5: Reporting and tax collection through CBDC under online platform sales ... 28


List of Abbreviations used

AML Anti Money Laundering

API Application Programming Interface B2B Business to Business

CBDC Central Bank Digital Currency CRS Common Reporting Standard

DAC Council Directive 2011/16/EU of 15 February 2011 on administrative cooperation in the field of taxation

DLT Distributed Ledger Technology ECB European Central Bank

EU European Union

FATCA Foreign Account Tax Compliance Act GDPR General Data Protection Regulation

IBFD International Bureau of Fiscal Documentation ID Identification Number

KYC Know Your Customer

MIT Massachusetts Institute of Technology MTIC Missing Trader Intra Community

OECD Organizsation for Economic Cooperation and Development PE Permanent Establishment

PoS Proof of Stake PoW Proof of Work

SME Small and Medium Enterprise TIN Tax Identification Number UHS Unspent funds Hash Set UPI Unified Payments Interface USA United States of America UTXO Unspent Transaction Output VAT Value Added Tax

WEF World Economic Forum WHT Withholding Tax


Executive Summary

Efficiency in tax administration is a policy aim for decades. Legislators amend the laws to tackle tax fraud and design new mechanisms for better transparency and assessment. This thesis aims to study whether such efficiency can be attained through programming tax elements into CBDC.

Chapter 2 of the thesis introduces the concept of digital currency and whether it is actually a fiat currency. Then it analyses what is a CBDC. The chapter discusses in detail the

technology underlying the CBDC, both blockchain-based and centralised architectures.

Chapter 3 of the thesis discusses the tax programmable elements in VAT, withholding taxes and exchange of information. In VAT, the thesis covers the areas of registration, invoicing, collection, refund or deduction of input VAT, reporting and audit. It primarily focuses on CBDC’s ability to track and access information. The programmability of split payments is discussed to increase tax revenue. Further, the thesis proceeds with the same focus on split payment mechanism in withholding taxes and the ability to obtain taxpayers’ information for smooth and effortless refunds of taxes in a cross-border scenario. Lastly, the efficiency of CBDC to eliminate or reduce complex reporting obligations on the intermediaries is discussed.

Chapter 4 examines the critical view of the challenges faced due to the adoption of CBDC as an alternative tax assessment and collection mechanism. It primarily focuses on taxpayers’

rights and the tax authorities’ obligations of transparency towards them. It criticises the technical problems of smart contracts and their adverse effects on businesses.

Chapter 5 concludes the research question by answering that tax programmable elements in CBDC would be effective if adopted as a targeted measure.


Main findings

Programmability in CBDC is ongoing research. Although few papers focus the on tax implications of CBDC, there is no published literature on tax programming in CBDC. But it is seen as a great potential to address tax challenges. Almost all central banks are looking at the pros and cons of issuing CBDC. Even though CBDC is inspired by blockchain

technology, a few countries are researching centralised architecture to achieve the benefits of blockchain. The primary goals include payment efficiency, safety, transparency, stability and financial inclusion. Programmability can be achieved in both blockchain and centralised architecture.

This study evaluates whether the programmable elements increase tax revenue and reduce the cost of compliance. The author found that two programming areas must be focused on

achieving this. Firstly, the ability to store and track the relevant financial information for tax assessment and split payment mechanism for tax collection. The author found that tapping the informal sector to register and issue invoices under VAT will increase tax revenue. It is also found that a split payment system can significantly reduce the VAT gap up to 56%. The tax audit costs by the inspectors can be reduced due to the pre-filling of the data from the transactions which are non-malleable.

The EU commission studies report high compliance costs on refunds of withholding taxes.

The author finds that recent developments in cross-border CBDC can increase tax inspectors’

transparency of the investor’s information.

The author finds that the tax administrations require transparency in assessment. This is evident from forums on the exchange of information, multilateral conventions etc. These impose high standards of transparency on the intermediaries. The author finds that there is a duplication of reporting obligations under different rules. The author asserts that these obligations can be eliminated with high transparency through CBDC.

This study evaluates the challenges in operation through CBDC. It is found that the public give utmost priority to privacy. It is found that the split payment mechanism adopted on a broader scale may be inefficient and uncertain. The author also considers the practical challenges in smart contracts and concerns about its wide adoption.

The author, therefore, concludes that tax elements in CBDC increases efficiency in tax assessment and collection if adopted as a targeted measure within a limited scope.


1. Introduction

Tax authorities face challenges in tax assessment and collection across the globe, particularly in the light of the digitalisation of the economy.1 The lack of information to the tax

authorities and aggressive tax planning by the entities is eroding the tax base of the nations and making it difficult to assess the taxable income.2 In addition to the lower assessed income, a gap is created when the taxes collected are less than what is imposed.3 It is very challenging to enforce such tax claims if it is extraterritorial.4 International organisations such as OECD focus on enhancing transparency through forums on exchanging information and multilateral conventions.5 Anti-avoidance measures, information exchange agreements, reporting standards and alternative collection systems have been introduced, but still, there is continuing tax gap.6

Tax assessment is becoming critical in the tax budget.7 Taxpayers underreport their taxable income to avoid being taxed.8 Tax authorities face difficulties tracing the unreported income and verifying the accuracy of the reported income.9

Yet another concern is that the assessed tax is to be collected. “A tax system couldn’t be considered fair if it does not guarantee that the assessed tax is collected”.10 In the EU alone, the VAT gap in 2019 was 134 billion euros, equating to a total revenue loss of 10.3% across the EU.11

Hence, tax assessment and collection are one of the significant issues any tax administration worldwide is facing.

1 OECD, ‘Technology Tools to Tackle Tax Evasion and Tax Fraud’ (OECD 2017)

<https://www.oecd.org/tax/crime/technology-tools-to-tackle-tax-evasion-and-tax-fraud.htm> accessed 22 June 2022.

2 ibid.

3 Mark J Mazur and Alan H Plumley, ‘Understanding the Tax Gap’ (2007) 60 National Tax Journal 569

<https://www.journals.uchicago.edu/doi/abs/10.17310/ntj.2007.3.14> accessed 28 June 2022.

4 Aleksandra Bal, ‘Extraterritorial Enforcement of Tax Claims’ (2011) 65 Bull. Intl. Taxn. 10 IBFD Journals 1

<https://research.ibfd.org/#/doc?url=/collections/bit/html/bit_2011_10_int_2.html> accessed 29 June 2022.

5 OECD, ‘Tax Transparency - OECD BEPS’ (OECD) <https://www.oecd.org/tax/beps/tax-transparency/>

accessed 29 June 2022.

6 European Commission and others, ‘VAT Gap in the EU: Report 2021’ (Publications Office of the European Union 2021) <https://data.europa.eu/doi/10.2778/447556> accessed 29 June 2022.

7 OECD, ‘Technology Tools to Tackle Tax Evasion and Tax Fraud’ (n 1).

8 ibid.

9 ibid.

10 Aleksandra Bal (n 4) 1.

11 European Commission and others (n 6).


This paper focuses on addressing these issues by enhancing tax efficiency in tax assessment and collection through programmable tax elements in CBDC. CBDC is explored by central governments as a step forward towards a cashless economy.12

CBDCs have great potential to have programmable elements.13 This paper focuses on exploring the programmable tax elements in CBDC. As per BIS Report, “More than half of the world’s central banks are now developing digital currencies or running concrete

experiments on them”.14 Various projects on CBDC are being carried out: Digital Euro, Digital Rupee, Project Jura, Project Hamilton, and Project Jasper.15 But the programmability for tax purposes is still an area not thoroughly researched. This paper aims to focus on the programmable features to trace the financial transactions to access information for tax assessment and split payments to enhance tax collection.

To evaluate this question on tax efficiency through programmable features in CBDC, a review of published projects and pilot research papers on CBDC have been conducted. The author has reviewed existing articles on tax issues in evasion, fraud and collection in VAT, withholding taxes and exchange of information. The author searched multiple law and tax databases such as IBFD, OECD, TaxNotes, UvA Library, IEEE Xplore, and Google scholar for papers on CBDC, smart contracts, blockchain, VAT invoicing, exchange of information standards and withholding taxes. Additionally, a simplistic google search is made to identify information that could not be found directly through the websites mentioned above. The selected papers were reviewed to perform an analysis on the research question. Although there are multiple hits on the term CBDC from the websites, the author selected 10 articles and reports that exclusively focus on evaluating CBDC technology and its implications.

Although the literature involves programmability of payments, auditing and privacy, none of

12 Luisa Scarcella, ‘The Implications of Adopting a European Central Bank Digital Currency: A Tax Policy Perspective’ [2021] SSRN Electronic Journal <https://www.ssrn.com/abstract=4013013> accessed 13 May 2022.

13 Ashley Lannquist, Sheila Warren, and Richard Samans, ‘Central Bank Digital Currency Policy-Maker Toolkit’

(World Economic Forum 2020) <https://www.weforum.org/whitepapers/central-bank-digital-currency-policy- maker-toolkit/> accessed 27 April 2022.

14 Anneke Kosse and Ilaria Mattei, ‘Gaining Momentum – Results of the 2021 BIS Survey on Central Bank Digital Currencies’ (BIS 2022) BIS Papers 125 3 <https://www.bis.org/publ/bppdf/bispap125.htm> accessed 29 June 2022.

15 ‘Central Bank Digital Currency (CBDC) Tracker’ (Central Bank Digital Currency (CBDC) Tracker)

<https://cbdctracker.org/> accessed 24 May 2022.


them specifically analyses tax programming elements. One paper16 focuses on the tax policy perspective, which provides useful insights into tax implications of CBDC.

To address this literature gap, this thesis studies building and integrating tax concepts and elements into CBDC technology. The thesis focuses on analysing whether these elements increase efficiency in tax assessment and collection. To answer this question, this paper begins with an overview of digital currencies, CBDC and its technology (Chapter 2). Chapter 3 focuses on how programmable tax elements can be built into CBDC in areas of VAT, withholding and exchange of information. It mainly focuses on split payments and tracking financial information. Chapter 4 discusses the challenges and drawbacks from legal, tax and technical perspectives, which might adversely affect the tax efficiency goals of CBDC. The issues primarily concern transparency and taxpayer’s rights, public goals from CBDC and programming difficulties are mainly discussed. Chapter 5 concludes the paper by discussing the main points found in the research and answering the research question.

2 – Overview of digital currency, CBDC and its technology 2.1. Is Digital currency a currency?

Currency is money issued by a government and recognised as a legal tender.17 Money is a verifiable record18 that fulfils three main functions: a medium of exchange, a unit of account and a store of value.19 If a digital currency meets this definition, it can be called a currency for legal and economic purposes.

Crypto asset is a comprehensive term for all digital financial assets based on DLT, which includes digital currencies.20 There is no unique and widely accepted definition of digital or virtual currency in a regulatory framework.21 As per the ECB report (2015), virtual currency is defined as “a digital representation of value, not issued by a central bank, credit institution

16 Scarcella (n 12).

17 Jake Frankenfield, ‘What Is Currency?’ (Investopedia, 2020)

<https://www.investopedia.com/terms/c/currency.asp> accessed 22 April 2022.

18 ‘Money’, , Wikipedia (2022) <https://en.wikipedia.org/w/index.php?title=Money&oldid=1084842202>

accessed 27 April 2022.

19 William Stanley Jevons, Money and the Mechanism of Exchange (D Appleton 1876) 14–16.

20 OECD, ‘Taxing Virtual Currencies: An Overview of Tax Treatments and Emerging Tax Policy Issues’ (OECD, Paris) 10 <https://www.oecd.org/tax/tax-policy/taxing-virtual-currencies-an-overview-of-tax-treatments-and- emerging-tax-policy-issues.htm> accessed 14 March 2022.

21 Lorenzo Aquaro, ‘Taxation of Virtual Currencies from an Italian Perspective’ (2021) 23 Fin. & Cap. Mkts 1, Journal Articles & Opinion Pieces IBFD 2

<https://research.ibfd.org/#/doc?url=/collections/dfi/html/dfi_2021_01_it_1.html> accessed 30 April 2021.


or e-money institution, which, in some circumstances, can be used as an alternative to money”.22

To be defined as a currency, it must be recognised as a legal tender in at least one jurisdiction.23 El Salvador and the Central African Republic adopted bitcoin as a legal tender.24 However, it is not issued by the central authority. Regarding the functions of money, digital currency does not fulfil all of them.

Medium of exchange: It is accepted as a method of payment but is limited compared to fiat currency25

Unit of Account: Digital currency does not have independent value but is measured in an equivalent value in fiat currency.26

Store of Value: Digital currencies are highly volatile and are not a reliable store of value.27 Due to the lack of the above functionality, digital currency cannot be called an actual currency.

2.2 What is CBDC?

“Blockchain is here to stay, but so too are central authorities”.28 To curb the decentralisation of monetary power among the general public, many central public authorities have started pilot projects and trials on CBDC.29 “CBDCs represent central bank liability and are

denominated in an existing unit of account, serving as a medium of exchange and a store of value”.30 It is similar to digital currency but issued by a central public authority and is recognised as legal tender. It is denominated in the currency of the country issuing it.31

22 European Central Bank., Virtual Currency Schemes: A Further Analysis. (Publications Office 2015) ch 2.1 and 2.2 <https://data.europa.eu/doi/10.2866/662172> accessed 6 April 2022.

23 OECD (n 20) 19.

24 Oliver Knight, ‘Central African Republic Adopts Bitcoin as Legal Tender’ (27 April 2022)


accessed 27 April 2022.

25 OECD (n 20) 20.

26 ibid.

27 ibid.

28 Michael del Castillo, ‘Enterprises Building Blockchain Confront Early Tech Limitations’ (23 March 2018)

<https://www.coindesk.com/markets/2018/03/23/enterprises-building-blockchain-confront-early-tech- limitations/> accessed 28 April 2022.

29 Kosse and Mattei (n 14).

30 CPMI, Markets Committee, ‘Central Bank Digital Currencies’ (Bank for International Settlements 2018) 174

<https://www.bis.org/cpmi/publ/d174.pdf> accessed 27 April 2022.

31 OECD (n 20) 47.


CBDC is the fiat currency of the country but in a digital form.32 Therefore, it is considered a currency for economic and legal purposes. The objectives of CBDC are to increase

accessibility and safety; to provide robust and convenient payment infrastructure with lower costs.33

CBDC can be issued in two forms: Wholesale or Retail CBDC. Wholesale CBDC is primarily issued to financial institutions for use in interbank payments and securities

transactions.34 It already exists today in the form of reserves.35 The real innovation can be in retail CBDC. Today, the public hold fiat currency in physical form and retail CBDC would allow them to use digitised central bank money.36

Ongoing research is being carried out to analyse the benefits of CBDC, designed through DLT, in finance, payments and supply chain management but a few in taxation.37 This paper aims to focus on its implications for taxation. It elaborates on enhancing tax assessment and collection by incorporating programmable tax elements into CBDC. For this, it is essential to understand the basics of the technology design of the CBDC.

2.3 The technology design of CBDC

With respect to technology design, a country can choose between DLT-based or conventional central bank infrastructure.38 The transaction validation in the DLT can be distributed across the nodes in the network, which can be financial institutions, intermediaries, or third parties.

However, the central bank can also choose to be the only validator node. A country can choose the design based on its considerations of resources, scalability, interoperability, privacy and security concerns.39 Research is carried out to achieve the goals of CBDC without DLT-based infrastructure.40 Project Hamilton Phase 1 report provides a new design

32 ibid.

33 CPMI, Markets Committee (n 30).

34 Ashley Lannquist, Sheila Warren, and Richard Samans (n 13).

35 ibid.

36 ibid.

37 Kosse and Mattei (n 14).

38 Raphael Auer and Rainer Boehme, ‘The Technology of Retail Central Bank Digital Currency’ (BIS 2020) BIS Quarterly Review <https://www.bis.org/publ/qtrpdf/r_qt2003j.htm> accessed 18 April 2022.

39 Ashley Lannquist, Sheila Warren, and Richard Samans (n 13).

40 Federal Reserve Bank of Boston and Massachusetts Institute of Technology Digital Currency Initiative,

‘Project-Hamilton-Phase-1-Whitepaper’ (2022) <https://www.bostonfed.org/publications/one-time- pubs/project-hamilton-phase-1-executive-summary.aspx> accessed 29 June 2022.


to meet the goals of performance, scalability and privacy without distributed technology.41 Phase 2 focuses on adding privacy-preserving designs for auditability.42

The following sections explain blockchain-based technology and then the centralised CBDC designs.

2.3.1 Blockchain technology

Blockchain technology combines components of peer-to-peer networking, distributed data storage, cryptography with an auditable database and consensus protocol.43 The main aspects involve Cryptography, Consensus Mechanism and Transactions.44 Cryptography

Blockchain uses cryptographic hash functions to encrypt the operations on the ledger.45 Hash functions convert data of any arbitrary length to a uniquely fixed-size output.46 It would be computationally infeasible to determine the input for a given output.47 This makes the blockchain immutable and less prone to fraud as it is impracticable to alter the data. This makes blockchain a reliable and immutable ledger.

It also uses asymmetric key cryptography to sign and verify transactions.48 It includes a private key used by a participant to sign a transaction and transfer the asset.49 Other

participants in the network can verify the transaction by using the transferor's public key to validate the ledger entry's authenticity.50 This makes the blockchain verifiable and provides an auditable database.

41 ibid.

42 ibid.

43 Dylan Yaga and others, ‘Blockchain Technology Overview’ (National Institute of Standards and Technology 2018) NISTIR 8202 <https://www.nist.gov/publications/blockchain-technology-overview> accessed 17 April 2022.

44 David Mills and others, ‘Distributed Ledger Technology in Payments, Clearing, and Settlement’ (Washington:

Board of Governors of the Federal Reserve System 2016) 2016–095

<https://doi.org/10.17016/FEDS.2016.095> accessed 17 April 2022.

45 Yaga and others (n 43) s 2.1.

46 ibid.

47 ibid.

48 ibid 2.3.

49 Mills and others (n 44) s 3.4.

50 ibid.

(15) Consensus Mechanism

It is a mechanism to get a consensus, among the participants in the peer-to-peer network, on the validation of the new block of data in the ledger.51 There are various types of consensus mechanisms.

PoW: Blocks in which the highest amount of computational work is put are accepted as a valid data chain on the ledger.52 The participant gets a certain amount of native currency, fixed by the protocol of the blockchain system, as a reward for the efforts.53

However, there is no need for such a complex consensus mechanism in CBDCs as there will be one or a few governance nodes performing transaction validation.

PoS: Consensus is reached based on the validation by a node with a certain amount of stake in the native currency of the blockchain.54 The blockchain system can use various methods to select the nodes.55 There is no competition among nodes to perform intense computations, and hence does not require significant energy and time consumption as in PoW.56 Some blockchains removed the reward system for mining in PoS as it requires fewer resources to create a block.57

Round Robin: Here, “each node takes turns creating blocks”.58 This can be adopted in a permissioned blockchain as it requires trust among the parties to the network.59

Proof of Authority: There will be specific nodes designated as “authorities” which are

authorised to validate transactions.60 This kind of consensus is to be adopted for CBDC-based blockchain since it is the authorised departments and officials who have to validate and audit the transactions.

51 Yaga and others (n 43) s 4.

52 Yaga and others (n 43).

53 ibid.

54 ibid.

55 ibid.

56 ibid.

57 ibid.

58 ibid.

59 ibid.

60 Sascha Jafari, ‘Combining Modern Technology and Real-Time Invoice Reporting to Combat VAT Fraud: No Revolution, but a Technological Evolution’ (2020) 31 Intl. VAT Monitor 3 Journal Articles & Opinion Pieces IBFD

<https://research.ibfd.org/#/doc?url=/document/ivm_2020_03_e2_2> accessed 29 June 2022.

(16) Transactions and Ledger

A transaction records a transfer of assets between parties, and a ledger is a collection of transactions.61 Bitcoin uses the UTXO Model, whereas Ethereum uses the Account model to record transactions.62

In UTXO Model, a transaction takes in one or several unspent transaction outputs as its inputs and creates new outputs.63

5 Euro

Fig 1: UTXO model

For example, in fig 1 above, Gary has five euros which are unspent transaction output. He uses this to pay 3 euros to Nick. It is not possible to take 3 euros as input and make the payment; instead, the whole of the 5-euro output is to be taken as a whole as an input for another transaction. He pays 3 euros to Nick and 2 euros to his address. 1 euro is the new unspent transaction output that can be used for further transactions. The balance of 1 euro is the transaction fee (reward) for the block miner.

This model can be used in making split payments. Split payments can split the transaction amount and direct the payment to tax authorities and the vendor. Split payments can be an alternate tax collection system for withholding taxes and VAT payments to the tax

authorities. This is discussed in detail in the following chapter.

In the Account-based Model, a transaction is based on a money transfer between different accounts.64 Unlike UTXO Model, it is possible to spend partial balances.65 In this, each

61 Yaga and others (n 43).

62 Yizhong Liu and others, ‘Cross-Shard Transaction Processing in Sharding Blockchains’ in Meikang Qiu (ed), Algorithms and Architectures for Parallel Processing, vol 12454 (Springer International Publishing 2020)

<http://link.springer.com/10.1007/978-3-030-60248-2_22> accessed 17 April 2022.

63 ibid.

64 ibid.

65 Vitalik Buterin, ‘A Next-Generation Smart Contract and Decentralized Application Platform.’ (2014)

<https://ethereum.org/en/whitepaper/> accessed 29 June 2022.

Input Output

(3 Euro) s

Output (2 Euro)


account contains balance, contract code and storage.66 This can build smart contracts into the account to execute automated transactions.67 Network design and Users rights in blockchain

The blockchain network was introduced as an open-source and to have no trusted third party to validate the transactions.68 It is permissionless and public,69 which means anyone can access and validate the blocks of data on the network. There is no centralised governance, and anyone can act as a node.70 Typically, full nodes store the entire blockchain data and perform validation functions, whereas lightweight nodes have limited storage capabilities.71 Although this system is a pioneer in decentralised payment systems with no issue of double- spending, it has scalability, privacy and security concerns.72

A permissioned blockchain is created to address these needs. It restricts the number of users and their rights which enhances scalability and security.73 It is typically controlled by a few authorities or organisations who are called “validators or governance nodes”.74 They require participants to register on the network and get an identity.75 The validators grant a varying level of access to transact and operate on the network to each participant depending on the criterion and requirement.76 Only limited nodes may be granted to have access and validation rights to create, amend or delete the protocol and the data on the network. This helps in utilising blockchain technology without compromising privacy and security concerns. CBDC can efficiently be deployed on permissioned blockchain rather than on public blockchain for privacy and security concerns.

66 ibid.

67 ibid.

68 Satoshi Nakamoto, ‘Bitcoin: A Peer-to-Peer Electronic Cash System’ (2008) <https://bitcoin.org/bitcoin.pdf>

accessed 29 June 2022.

69 ibid.

70 ibid.

71 Yaga and others (n 43).

72 ibid.

73 micobo GmbH, ‘Technical Difference between Ethereum, Hyperledger Fabric and R3 Corda’ (Medium, 16 November 2018) <https://micobo.medium.com/technical-difference-between-ethereum-hyperledger-fabric- and-r3-corda-5a58d0a6e347> accessed 28 April 2022.

74 ibid.

75 ibid.

76 ibid.


2.3.2 Centralised infrastructure

Even though most of the central banks are working on the use cases of blockchain-based CBDC, most of the functionality goals such as scalability, flexibility, resiliency, speed, privacy etc. can be achieved without DLT.77 Project Hamilton by MIT and Boston Fed works on a design where users interact with a central transaction processor. The central bank or a central trusted operator runs the transaction processor.78 This section explains the features of this design and the central transaction processor presented in the Project Hamilton


The design involved decoupling transaction validation from the transaction execution to minimise data storage in the core. The transaction format and protocol will be secure and provide flexibility for potential functionality like self-custody and programmability. It aims to develop a system design and commit protocol that efficiently executes transactions.

Users’ funds in Hamilton are represented through the UTXO model. UTXOs are compatible with privacy extensions in the future. It offers parallelism in transaction execution. It also supports arbitrary programmability. But the user interface abstraction can be an account- based model.

The adopted system design and data representation eliminates double spend, and replay attacks, and transactions are non-malleable.

The transaction design involves complete visibility of the transactions, public keys, and values by the processor, and it stores the entire UTXO set. To avoid data retention and user privacy challenges, an alternative design is explored where data is stored as a set of opaque 32-byte cryptographic hashes of UTXOs. This is called UHS.

This kind of transaction design enhances storage function. Despite the input size, the hash set is fixed 32 bytes. This helps build programmable features with large storage space. The UHS can be applied to different transaction formats or scripting languages. The transaction

processor does not store the balance or account information. This protects privacy. However, this also raises concerns about audibility, programmability and transaction protocols.

Implementing complex smart contracting language is difficult since the programming is restricted to only transaction local state. More research on cryptographic designs for privacy

77 Federal Reserve Bank of Boston and Massachusetts Institute of Technology Digital Currency Initiative (n 40).

78 ibid.


and auditability, programmability and smart contracts79, and use cases would be expected to be explored in Phase 2 of the project.

Auditing the total amount of unspent funds in UHS is limited but can be enhanced by logging into data outside UHS or storing values in homomorphic commitments that can be confirmed using additional cryptography techniques.

2.3.3 Smart Contracts

A smart contract is a computerised protocol that executes the terms of an agreement.80 Once the conditions built in the protocol are satisfied, the contract is self-executed.81 This reduces the verification and transaction costs significantly. This system automatically moves digital assets according to arbitrary pre-specified rules.82 The UTXO script in Bitcoin allows for smart contracts but is limited in its capability. In contrast, the account model in Ethereum allows for multi-stage and complex contracts by building Turing complete programming language on its blockchain.83

A hybrid design model is proposed where both the UTXO and account models are built in the DLT of the CBDC.84 This captures the benefits of both the models, which prove to augment the processing speed, although the effect of the implementation of smart contracts is not yet researched.85

Research also provides that centralised infrastructure which supports UTXO or account based model can also support programming of smart contracts without the need of blockchain.86 The Life cycle of smart contracts involves four phases: Creation, Deployment, Execution and Completion.87 The first stage is the coding stage which requires the efforts and coordination

79 See 2.3.3

80 Zibin Zheng and others, ‘An Overview on Smart Contracts: Challenges, Advances and Platforms’ (2020) 105 Future Generation Computer Systems 475 <https://linkinghub.elsevier.com/retrieve/pii/S0167739X19316280>

accessed 29 June 2022.

81 ibid.

82 Buterin (n 65).

83 ibid.

84 Jinnan Zhang and others, ‘A Hybrid Model for Central Bank Digital Currency Based on Blockchain’ (2021) 9 IEEE Access 53589 <https://ieeexplore.ieee.org/abstract/document/9395116> accessed 29 June 2022.

85 ibid.

86 Federal Reserve Bank of Boston and Massachusetts Institute of Technology Digital Currency Initiative (n 40).

87 Zheng and others (n 80).


of lawyers and software engineers.88 Lawyers help parties to draft the contract, and then engineers will convert this into a programmable code to be built into the DLT.89 The deployment stage involves implementing the code on the network.90 In a permissioned blockchain, validating nodes would be authorised to code it to the network. In the execution stage, the smart contract executes the contracts automatically when the conditions coded into the contract are fulfilled.91 This also involves transaction validation.92 The last stage consists of an update on the states of the parties engaged in the contract.93

There is a global need for a digitalised financial and tax system that enhances taxation of transactions and automates tax processes, reducing administrative burden.94 The following chapter studies how the CBDC and smart contract technology can cater to these needs by increasing tax revenue and reducing efforts and costs involved in tax assessment and collection, particularly in the VAT, withholding taxes and exchange of information.

3. Overview of tax programmable elements

This chapter focuses on the elements in taxation which can be automated through

programming in CBDC. It particularly focuses on current elements of tax assessment and collection in VAT, Withholding and Exchange of Information. An analysis is made on how tax programmable elements in CBDC can promote tax efficiency by increasing tax revenue and reducing the administrative burden on tax authorities and compliance costs on taxpayers.

This is done by aiming to reduce tax fraud and tax gap and collect more tax revenue at lower costs without increasing the tax burden on the taxpayers. Tax processes need to be converted into algorithms to make a use case on the CBDC. The possible elements which can be coded into CBDC are explained below.

88 Claudio Cipollini, ‘Blockchain and Smart Contracts: A Look at the Future of Transfer Pricing Control’ (2021) 49 Intertax 4 315 <https://kluwerlawonline.com/journalarticle/Intertax/49.4/TAXI2021030> accessed 18 April 2022.

89 Zheng and others (n 80).

90 Cipollini (n 88).

91 ibid.

92 ibid.

93 ibid.

94 Antonio Lanotte, ‘Blockchain and Smart Contracts in Tax’ [2021] Tax Notes International

<https://www.taxnotes.com/tax-notes-international/tax-technology/blockchain-and-smart-contracts- tax/2021/10/18/79g2g> accessed 29 June 2022.


3.1 Value Added Tax

Value Added Tax is one of the primary sources of revenue for countries’ budgets.9596It is the largest source of tax revenue on average in Latin America and the Caribbean, at 27.7% of the total tax revenue in 2019.97 Whereas, in the Asia Pacific, it represents over one-fifth of the region’s total tax revenue on average, ahead of other sources of income tax in 2019. In the EU, taxes on goods and services form 33.5% of the total revenue in 2019.98 Hence, it is essential to protect these revenues from fraud and evasion. Tax authorities worldwide are facing two main types of tax evasion: “under-reporting of income through electronic sales suppression and over-reporting of deductions through false invoicing”.99 This is further increased by the cash and sharing economy.100 The following elements aim to resolve these issues through programming in CBDC.

3.1.1 Registration

Taxpayers may intentionally abstain from registering under VAT to avoid compliance obligations.101 In Account-based CBDC,102 tax authorities can track the information on the sales payments received by the entities and can conduct initial audits to ensure their registration.

One of the reasons tax authorities were not able to detect cross-border frauds such as carousel frauds is due to lack of information and delay in exchange of information.103 A single VAT registration across the EU can be made possible through KYC information from CBDC. With this, tax authorities can access the taxpayer’s sales across the EU. Also, for taxpayers

(resident and non-resident), single VAT registration eases the compliance burden. A single

95 OECD/WBG/ADB, ‘VAT Digital Toolkit for Asia-Pacific’ (OECD, Paris 2022) <https://www.oecd.org/tax/vat- digital-toolkit-for-asia-pacific.htm> accessed 29 June 2022.

96 OECD/WBG/CIAT/IDB, ‘VAT Digital Toolkit for Latin America and the Caribbean’ (OECD, Paris 2021)


accessed 29 June 2022.

97 ibid.

98 International Montary Fund, Government Finance Statistics Yearbook and datafiles, ‘Taxes on Goods and Services (% of Revenue) - European Union | Data’ (Worldbank)

<https://data.worldbank.org/indicator/GC.TAX.GSRV.RV.ZS?locations=EU> accessed 27 June 2022.

99 OECD, ‘Technology Tools to Tackle Tax Evasion and Tax Fraud’ (n 1).

100 ibid.

101 ibid.

102 Explained in the following paragraphs

103 Marie Lamensch and Emanuele Ceci, ‘Vat Fraud: Economic Impact, Challenges and Policy Issues’ [2018]

EPRS: European Parliamentary Research Service. <https://policycommons.net/artifacts/1335646/vat- fraud/1942306/> accessed 29 June 2022.


registration procedure with a digital euro provides seamless transaction payments and auditing across the EU.

CBDC can reduce any delay in the process of registration. For example, Article 214 of the Directive 2006/112104 (hereinafter “VAT Directive”) provides an obligation on the Member States of the EU to ensure the registration of taxable and non-taxable persons making the supply of goods or services with a unique number. Usually, registration under VAT involves providing information and documents about i) legal name of the entity ii) date and place of establishment or incorporation iii) place of business iv) contact details v) type of entity vi) type of taxes liable vii) type of business activity.105 Also, information on expected turnover and import of goods or services is asked to determine the classification of the taxpayer as SME106 or not. This is the usual information under registration under any law. A business typically needs to get registered under multiple laws and regulations such as Company Law, Business administrations and Chambers, Employer regulations etc. It is a duplication of the process for the entity.

This can be eliminated with a CBDC account-based system. Any user of CBDC must register on the network, whether blockchain-based or otherwise, and will be required to fill out a KYC form. This information is available on the network and can be accessed by various authorities in the government. Based on the veracity of the information and the applicable laws, registration can be provided or denied. Under domestic VAT legislation, tax authorities may verify whether he is carrying out an economic activity under the VAT directive,

determine whether he is a taxable person, and then provide the registration with a unique ID.

CBDC can be issued in two types:

Account-based: Central bank directly or indirectly holds the accounts of the customers.107 The central bank can also outsource the task to financial institutions. This requires obtaining the identity of the participant through KYC procedures. This is similar to the existing bank deposit system.

104 Council Directive 2006/112/EC of 28 November 2006 on the common system of value added tax

105 Jeffrey Owens and Robert Risse (eds), Tax Law and Digitalization: The New Frontier for Government and Business: Principles, Use Cases and Outlook (Kluwer Law International BV 2021) ch 6

<https://wkldigitalbooks.integra.co.in/Customer/Home/BookDetails?TitleGUID=D8621800-935B-4A71-9FA7- 17005E3F672B> accessed 29 June 2022.

106 A taxpayer below certain threshold of aggregate annual turnover in the Member State is classified as SME

107 Ashley Lannquist, Sheila Warren, and Richard Samans (n 13).


Token-based: CBDC will be held in the digital wallets by the holder in the form of a digital token.108 This is similar to physical cash since the money holder is anonymous. The

transactions can be made in anonymity without any identification requirement of the holder.

It may provide privacy and accessibility but can lead to the funding of illicit activities.

Business entities can be identified and verified for information in Account-based CBDC.

However, this programmability may not be possible in a token-based system since the user remains anonymous. Existing taxpayers registered under the VAT can update their VAT ID on their KYC form. It can be updated manually by the user. In the case of blockchain-based CBDC, offline data can be exported to the CBDC network through Oracle.109 CBDC can be made interoperable with other blockchain and non-blockchain platforms through three approaches.110

i) Cross Authentication (for data exchange between compatible blockchain platforms) ii) Oracle (for data exchange from the non-blockchain platform)

iii) API gateway (for data exchange between compatible and non-compatible blockchain platforms)

With specific designs of CBDC, there would be no breach of privacy or security regarding KYC information. This is because the data would be stored in the user’s wallet.111 The central processor would only access the transaction data for its execution and validation.112 The taxpayer can transfer the information to the authorities through secured transmission by encryption.

3.1.2 Invoicing

Another aspect of tax evasion is false invoices to over-report deductions.113 The fraudulent invoices are not only used for tax evasion but also payment for unlawful or illegal activities such as bribes, terrorist financing etc.114 A business, under this fraud, claims fictitious expenses which are not incurred or incurred in personal nature that are not deductible.

108 ibid.

109 See 3.1.2 for more details on Oracle

110 World Economic Forum, ‘Interoperability’ (WEF 2020) <https://widgets.weforum.org/blockchain- toolkit/interoperability/index.html> accessed 6 May 2022.

111 Federal Reserve Bank of Boston and Massachusetts Institute of Technology Digital Currency Initiative (n 40).

112 ibid.

113 OECD, ‘Technology Tools to Tackle Tax Evasion and Tax Fraud’ (n 1).

114 Alfredo Collosa, ‘False Invoices and Tax Fraud’ (CIAT, 21 March 2019) <https://www.ciat.org/false-invoices- and-tax-fraud/?lang=en> accessed 23 June 2022.


States introduced various invoice reporting systems to tackle this fraud.115 In these reporting requirements, businesses should report their invoices to the tax authorities.116 OECD 2017 report on technology tools to tackle tax fraud proposed “electronic invoicing” as an effective solution.117 Most Latin American countries have successfully implemented mandatory e- invoicing requirements, which helped address fake invoicing issues.118 The tax authorities of these countries have seen remarkable results in increased tax revenue and reduced the VAT gap.119

However, this reporting system is vulnerable to data exposure and complicates the business’s operations.120 There are papers focusing on integrating VAT and blockchain.121 Since CBDC can also be issued on DLT, electronic invoicing can be programmable into it.

Research has been carried out to issue electronic invoices on the blockchain.122 It can be implemented in the CBDC by designing an “electronic invoice blockchain protocol”.123 Further, it can have standardised protocols and data structures to provide multiple-party participation and access.124 It also adopts a modular design125 to achieve the scalability of the system.126

Invoice is considered to be the most crucial document for VAT as it is the source document based on which payments are made, deductions are claimed, and audits are performed.127 Any false or incorrect data in the invoice affects the entire chain. Since the blockchain is

115 Jafari (n 60).

116 ibid.

117 OECD, ‘Technology Tools to Tackle Tax Evasion and Tax Fraud’ (n 1).

118 ibid.

119 Bruno Koch, ‘The E-Invoicing Journey 2019-2025’ (2019) 22 <https://compacer.com/wp-

content/uploads/2019/05/Billentis_Report_compacer_single-sponsor.pdf> accessed 29 June 2022.

120 Jafari (n 60).

121 Madeleine Merkx, ‘VAT and Blockchain: Challenges and Opportunities Ahead’ (2019) 28 EC Tax Review 83

<https://kluwerlawonline.com/journalarticle/EC+Tax+Review/28.2/ECTA2019011> accessed 29 June 2022.

122 Xidong Liu, ‘Research and Application of Electronic Invoice Based on Blockchain’ (2018) 232 04012 MATEC Web Conference <https://www.matec-


html> accessed 29 June 2022.

123 ibid.

124 ibid.

125 Modular programming can be defined as a technique “separating the functionality of a program into independent, interchangeable modules, such that each contains everything necessary to execute only one aspect of the desired functionality”. ‘Modular Programming’, , Wikipedia (2022)

<https://en.wikipedia.org/w/index.php?title=Modular_programming&oldid=1078083576> accessed 5 May 2022.

126 Liu (n 121).

127 Jafari (n 60).


immutable, the terms in the invoice cannot be altered and provide an auditable ledger to the tax authorities for inspection. It provides a “single source of truth for invoices”.128

Article 220 of the VAT directive imposes an obligation on the taxable person to ensure that invoice is issued concerning the supply of goods or services or advance payments received.

Each Member State specifies its own rules regarding the invoicing for VAT.129 The EU VAT directive specifies certain rules and content requirements of the invoices.130 Invoicing process can be automated entirely through CBDC, and it would eliminate the compliance burden on the taxpayers.

The privacy issue would not be a concern since the invoices are encrypted using

cryptography,131 and only parties to the transaction can access the information. Hashing the invoices would address existing fears of privacy, and fraud.

Article 244 of the VAT directive requires the taxpayers to store the invoices properly. Since the data on the blockchain cannot be tampered with, the taxpayers need not worry about the damage to the storage.

The contents of the invoice can be linked to offline data for accuracy and automation. For example, Article 230 of the VAT directive requires the VAT payable amount to be expressed in the national currency of the Member State. In the case of cross-border transactions, the taxable amount may be expressed in a currency other than the national currency. Paragraph 2 of Article 91 provides that the “…exchange rate applicable shall be the latest selling rate recorded, at the time VAT becomes chargeable, on the most representative exchange market or markets of the Member State concerned…”. Not every account and tax invoice preparer is familiar with this rule, and most often, enterprises apply their own chosen exchange rate.132 Through CBDC, the exchange rate can be linked to the exchange markets’ websites, and the latest rate shall be applied automatically. This is done with oracles which connect the smart contracts to the real or offline world data.133 Invoicing requires references to external data

128 ibid.

129 Paragraph 1 of Article 219a of the VAT directive

130 Article 226 of the VAT directive

131 See

132 Alex Baulf, ‘Top 10 Tax Invoicing Issues and Pitfalls’ (VATlive, 23 February 2022)

<https://www.avalara.com/vatlive/en/vat-news/top-10-tax-invoicing-issues-and-pitfalls.html> accessed 6 May 2022.

133 Giulio Caldarelli, ‘Understanding the Blockchain Oracle Problem: A Call for Action’ (2020) 11 Information 509 <http://dx.doi.org/10.3390/info11110509> accessed 28 June 2022.


such as exchange rates, so a gateway from the external world is needed.134 Oracle is such a gateway, and it gathers and stores data from offline sources.135 The smart contract code calls for the correct information from a trusted oracle.136 This increases the accuracy of the

invoicing and VAT amounts, thereby reducing the risk of penalties.

3.1.3 Tax collection through split payments

Once the invoice is generated as prescribed in Section 3.1.2, a smart contract can be designed to incorporate the terms of the invoice. When the conditions are triggered, the contract will be executed, i.e., the payment is made to the seller. Split payments can be automated through smart contracts, where a code can be written to split the payment to the vendor and the government for tax payments. CBDC transaction design can be formatted through the UTXO set, which allows split payments. CBDC allows complex transfers to or from multiple sources of funds which is not possible either through cash or bank accounts.137 In the 2PC

architecture articulated in the Project Hamilton paper138, transactions using different funds can execute in parallel, and once funds are confirmed to be unspent, the transaction always proceeds further. The payment of tax will automatically be credited to the treasury account.

The split payment mechanism may violate Articles 206 and 226 of the VAT directive, which provides that the VAT shall be paid when submitting the return. Member States may need to get the approval of the Council of the EU for such derogation. Currently, three Member states139 in the EU got approval and adopted a split payment system for tax collection.140 The MTIC and carousel frauds can be prevented through these automated split payments.

These are frauds where the supplier (“the missing trader”) disappears with the VAT amount collected from the customer.141 The fraudsters often take advantage of zero rates on exports and deferred VAT payments on imports (“Intra-community supply”).142 The fraud typically involves

134 ibid.

135 ibid.

136 ibid.

137 Federal Reserve Bank of Boston and Massachusetts Institute of Technology Digital Currency Initiative (n 40).

138 ibid.

139 Italy, Poland and Romania

140 Fabiola Annacondia, EU VAT Compass 2021/2022 (2021/2022 edn, IBFD 2021) 976

<https://www.ibfd.org/shop/book/eu-vat-compass-20212022> accessed 6 May 2022.

141 Lamensch and Ceci (n 103) 15.

142 Lamensch and Ceci (n 103).


a) Registration with the tax authorities – An entity (say A) gets registered under VAT which is often a shell entity with no substance or real economic activities.143

b) Zero rating for VAT – The VAT on intracommunity supplies is zero-rated in the EU.

So, A would not be charged any VAT from the seller. When he imports the goods, he sells them to a customer (say B), collects VAT and disappears.144 The importer has to pay tax at the time of submission of VAT returns. This deferral allows A to commit the fraud.

c) Input deduction or refund – If the chain continues, B can sell to another trader in another EU State (say C) and claim a refund of input VAT on the export made. This trade can be repeated among the parties several times, thus creating a circular chain.

Hence, it is called “carousel fraud”.145 The entire chain runs very quickly, and the fraudsters escape before the government realises illicit activity. There would be no one left to be held liable and collect the VAT due.

This fraud can be eliminated in two ways:

i) Real-time VAT collection: With split payments, there is no gap between the levy and the collection of the VAT. This eliminates the possibility of any fraud completely.

The money never goes into the hands of the missing trader.

ii) Real-time VAT invoicing: The moment the invoice is generated, it is recorded on the ledger and is available for the tax authorities to inspect. Hence, they can match the supplier and buyers’ invoices and VAT amounts in real-time.

The exempt and zero-rated transactions would be excluded from the split payment mechanism.146 The list of exemptions and reduced rates which are published on offline websites can be connected through oracles to smart contracts. However, this can be applied to a defined set of transactions as smart contracts cannot be used to perform legal analysis to determine the nature of the transaction and the applicable rate.147

143 Owens and Risse (n 104) ch 6.

144 ibid.

145 Lamensch and Ceci (n 103) 16.

146 Fabiola Annacondia (n 139).

147 Merkx (n 120).


3.1.4 Deduction or Refund of Input VAT

The supplier most probably gets the refund of the input VAT since output VAT would be paid through split payments. The refunds can be automatically initiated periodically through a dedicated wallet for each taxable person.

VAT on purchases

VAT on sales

Fig 2: Purchase and sale transactions through CBDC wallet

In Fig 2 above, the taxable person pays the VAT on his purchases directly to a designated government wallet allocated to him/her. The output VAT collected on the sales would be tracked. At periodical intervals, the input VAT paid to the government wallet would be refunded after deducting any output VAT not paid on the sales.

The government can increase the frequency of periodical payments of refunds to the taxpayers to reduce the financial burden on the entities. Since the transactions are non- malleable, the tax authorities can perform a seamless audit of the business records of transactions.

3.1.5 Tax reporting

VAT returns shall be submitted periodically, with all the information required to calculate the chargeable tax and the deductions.148 A typical VAT return includes the total value of

supplies made and the total value of acquisitions for the business. In the CBDC, the return can be pre-filled based on the transactional information located in the user’s wallet. In the UHS model of Project Hamilton, the transaction processor will access the data only for transaction execution.149 The data is stored in a hash, i.e., encrypted form. The data can be retained in the user’s wallet, which can be used for prefilling the returns. The same can be automatically filed with the tax authorities before the deadline. The taxpayer may typically

148 Article 250 of the VAT directive

149 Federal Reserve Bank of Boston and Massachusetts Institute of Technology Digital Currency Initiative (n 40).

Taxable Person




claim a refund of input tax since the output VAT is automatically paid through split payments.150

The return can automatically be pre-filled under existing real-time reporting systems as well.

However, the taxpayer’s information is available in the centralised database of the authorities in an unencrypted form and can be easily retrieved when hacked. CBDC uses an encrypted form of transaction storage, which makes it impracticable to hack the data.

3.1.6 Tax audit and assessment

As discussed in Sections 3.1.2 and 3.1.3, the tax authorities can verify the transactions instantly when the invoice is generated. Tax audits involve a costly and time-consuming process. It is not possible to detect every fraud during the audit due to the lack of information to the authorities. Since the returns would be pre-filled based on the taxpayer’s transactions and the transactions cannot be tampered with, there is high accuracy in the tax assessment.

This reduces the time to audit each and every return. Tax authorities can also have real-time access to the information on the network. CBDC promotes a real-time audit of each sale made by the supplier.

3.2 Withholding Taxes

It is a deduction withheld by the payor on the payments made. The deducted amounts are paid to the government.151 It can be domestic or cross-border withholding.

3.2.1 Domestic withholding taxes

In domestic withholding, the payor and the payee reside in the same country, and the withheld amount is paid to the country’s tax authorities. There are typically no complex issues in this scenario. The payor has the burden of filing a return and paying the withheld amount to the government on due dates. However, with the automated split payment system in CBDC, this administrative burden can be completely wiped out. The payments can be split to the government instantly, as depicted in Fig 2 below.

150 See 3.1.3

151 EY and others, ‘What Happens When Government, Industry and Investors Seek Common Digital Ground?’

(EY) Withholding tax distributed ledger report <https://assets.ey.com/content/dam/ey-sites/ey-

com/en_gl/topics/tax/tax-pdfs/ey-withholding-tax-distributed-ledger-report.pdf> accessed 29 June 2022.




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