What is the potential of using blockchain technology in tax administration? The Bavarian State Tax Office has explored this question in a research project together with the Fraunhofer FIT Business Informatics Project Group as well as the Friedrich Alexander University of Erlangen-Nuremberg and mgm. The project is part of the blockchain strategy of the Bavarian state government and was supported by the Bavarian State Ministry for Digital Affairs. The focus is on a blockchain-based approach for better tax registration and verification of traders on online marketplaces. The results are promising – especially due to the use of a Self-Sovereign Identity (SSI) system.

Kurz & knapp

  • Research project tests blockchain-based system to combat sales tax defaults on online marketplaces
  • Prototype based on widely used solution modules demonstrates general feasibility of an SSI solution

The fight against tax fraud on online marketplaces is in full swing. In Germany, the legislator has reacted and introduced recording obligations for marketplace operators in 2019. However, the current procedure is based on paper certificates and is thus associated with high expenses, characterised by media disruptions and remains susceptible to forgery.

How a more reliable and efficient digital alternative based on blockchain could look like was investigated by the Bavarian State Office for Taxes (BayLfSt) together with the project group Business Informatics of Fraunhofer FIT, the Friedrich-Alexander University Erlangen-Nuremberg and mgm. The research project included the conception, prototypical implementation and evaluation of a blockchain-based system for combating tax losses on online marketplaces. The experience gained was also intended to enable well-founded statements about possible uses of blockchain technology in other areas of taxation and administrative procedures.

The consortium has described the results of the project in the 50-page white paper “SSI@LfSt – Einsatz der Blockchain-Technologie in der Steuerverwaltung” (German language only).

SSI-based solution concept promises greatest potential

At the beginning of the project, the project partners first analysed the existing paper-based processes and collected the legal, technical and organisational requirements. They then explored three possible solutions: a blockchain-based tax token, a blockchain-based validity register and an SSI-based solution. The latter emerged as the most promising approach and was further explored and evaluated in the form of a prototype. The core idea of Self-Sovereign Identity is that users retain control over their digital identities and manage them independently. When using the technology in the considered use case, the traders’ tax records take over the role of the identities.

The general procedure with the SSI system is similar to the previous process:

  • The tax authority issues traders with proof of tax registration.
  • The traders thus confirm their tax registration to the marketplaces.

With the SSI system, however, the process can now be mapped digitally, and it also becomes verifiable and forgery-proof. The issued proof is a so-called “Verifiable Credential”, which traders can store in a kind of digital wallet. The marketplace can use cryptographic procedures to check whether a trader’s credential is valid and in turn transmit proof to the financial authority. The status of the validity of a registration is stored on a public blockchain.

Prototype demonstrates technical feasibility

The evaluation of the developed concept considers economic, technical and legal aspects. One identified legal hurdle lies, for example, in legal framework conditions that are designed for other technologies. The study therefore recommends that legislators also take new technology concepts into account in the future in order to facilitate the legally compliant design of blockchain-based solutions. In terms of data protection, certain risks arise due to central characteristics of blockchain technology – past entries are permanently recorded and publicly viewable. However, the authors of the legal opinion are optimistic about the possibility of implementing an SSI solution that complies with data protection law.

From a technical point of view, the solution approach can be implemented – even with existing infrastructure and prefabricated components. The prototype developed demonstrates all process flows for all parties involved, from the issuing of tax certificates to verification by the marketplaces. A number of technical challenges remain. These include scalability, the currently limited functionalities of current proof management infrastructures and the small number of technical providers. However, the authors of the study are confident that these aspects can be solved through ongoing developments in the field of SSI.

SSI solution approach can be used multifunctionally

Since the solution concept is designed as a generic SSI system, it can be transferred to other procedures with reference to tax data. It is predestined for cases in which a taxpayer needs proof from the tax authority and must present it to a third party. This is the case with BAFöG, for example. Applicants must submit proof of assets from their parents or spouse. Currently, this is usually done by submitting the income tax assessment notice. However, this contains much more information than is needed for the proof. Based on an SSI solution, applicants could even provide the proof more selectively and with less data than today.

Project partner together with mgm: