Technology uses grow to tackle tax fraud across the sharing economy

Research by PwC estimates that the sharing economy generates $15 billion in global revenue, which could grow to $335 billion by 2025.

Tax authorities are now investigating the risks of tax evasion and fraud posed by the sharing economy. However, this emerging sector poses a challenge to tax authorities that are more accustomed to detecting tax fraud using traditional business models. This is particularly true where the individual is not registered as conducting a business or is in a foreign jurisdiction. However, the online nature of these platforms also presents an opportunity to deploy technology to tackle this.

The OECD has put together a report, studying the experiences of 21 jurisdictions to determine the challenges and benefits of digital tools that can increase the potential for sharing knowledge on the solutions available to tackle such tax crime. It is now calling on other countries to adopt similar systems to enable a global attack on tax fraud.

Grace Perez-Navarro, deputy director of the OECD’s Centre for Tax Policy and Administration, said the report’s findings indicated how economies have been able to harness technology to combat basic tax fraud techniques.

Tax authorities are using analytics, regulatory and policy considerations, legislative solutions and international cooperation among tax authorities to efficiently target tax evaders, particularly where online platforms are located in jurisdictions other than the location of the customer. The OECD’s report cites Argentina, Australia, Austria, Belgium, Finland, Japan and the UK as some examples of where such activities have had some success.

With an increasing number of tax authorities implementing technology solutions to help combat tax evasion and tax fraud, there is now a case to encourage other tax administrations to consider whether the same approach is effective in their jurisdiction.

When it comes to sophisticated technology tools, the UK tax authority, HMRC, uses a data analysis system called Connect. 

It works by sending numerous diverse pieces of information to a supercomputer, Connect, from bank interest and property transaction details to the much anticipated offshore financial information being passed between jurisdictions in accordance with the Common Reporting Standard. Connect is essentially a powerful tool that enables HMRC to mitigate the relative risk of a taxpayer before deciding to launch an investigation.

However, Mike Down, partner at RSM in the UK, said that HMRC is strangely coy about revealing how much it knows.

“Earlier this year – by means of a Freedom of Information (FOI) request – we sought to obtain an overview of the various sorts of data which HMRC is collecting. We asked the department to list ‘all the sources of information that HMRC draws on for use in its Connect system’,” Down said. HMRC rejected the FOI request by stating it is exempted from disclosure because it “could harm our ability to carry out our functions needs” as criminals might apprise the information to plan further crimes.

The UK tax authority’s hesitance to share the information has certainly raised interest in their Connect system and the amount of information being collected. Unfortunately, it was not included as a case study in the OECD’s report. 

Notably, the UK’s tax gap statistics reveal that although over a six-year period the department had achieved notable success in clamping down on tax avoidance, the outcome of its efforts in tackling tax evasion has been less successful. “Simply put, as a constituent of the total tax gap, £36 billion [$44.2 billion], the monetary amount being lost through evasion and the hidden economy (£11.4 billion) is still considerable,” Down said.

By employing cost effective technology, tax administrations have raised a substantial amount of tax revenue and been able to use the tools to deter further fraud, which has increased the overall compliance of taxpayers.

Although the sharing economy poses a great threat to tax revenues for all countries, other businesses – such as those in the retail sector – are still a challenge.

While tax authorities get better at detecting tax fraud, the fraudsters also find new ways to remain under the radar.

The two main technologies used by taxpayers to supress electronic sales and pay less tax are known as phantomware and zappers.

Phantomware is a software that is installed in electronic cash registers or other electronic points of sale that allows the operator to alter the data that has been recorded to “suppress” sales so that when the auditor checks the registers or the records produced by the register, there is less income shown and reported to the tax authorities. The program can only be accessed through a hidden menu, which allows the business owner to “cook the books” at the press of a button, Perez-Navarro explains.

Zappers are an external device or program accessed online that does the same thing as phantomware . “The latest techniques involve using foreign zappers to provide certain services (e.g. deletion, alteration and replacement of sales data or remote crashing of the hard drive) that make it very difficult to detect,” Perez Navarro said.

Another rising concern is false invoicing, which occurs when a business fabricates or inflates invoices that name the business as the debtor, allowing it to claim expenses for tax purposes that have not been incurred. By requiring electronic invoicing, tax administrations were able to address this problem as it involves standardising the requirements of electronic invoices, a digital signature of receipt, connecting electronic invoicing to sales recording devices, and the provision of invoice information to the tax authority.

For example, Mexico lost about €3 billion ($3.2 billion) between 2007 and 2009 in tax revenue due to forged invoices, according to the OECD’s report.

“This type of ‘everyday evasion’ has been tough to tackle in the past, not so much because of its complexity but rather because it is impossible for tax authorities to audit every single restaurant, bar, souvenir shop or construction business,” Perez-Navarro said. “This challenge was heightened by the introduction of ‘electronic sales suppression’, which essentially consists of technological tools that facilitate the under-reporting of income by making sales ‘disappear’ from cash registers and the businesses’ books and records.”

When finding solutions to these issues, a key factor for the government is ensuring the technology is affordable, effective and easy to implement.

To combat these schemes, some countries are requiring businesses to use data recording technology to record the sales data of a transaction immediately and store the information in a tamper proof system to ensure it cannot be manipulated by phantomware or zappers , or at least if it is tampered with, it will be detectable.

For instance, in Hungary, electronic cash registers were installed with a fiscal control unit to combat under-reporting income in consumer businesses like restaurants. After only a year in operation, VAT revenue increased by 15% in the affected sectors. By introducing the new systems, the rise in VAT revenues exceeded the overall costs of the project.

“This kind of technology can be used in any kind of cash register, computer-based point of sales systems, or those that are tablet or smart-phone-based,” Perez-Navarro said. “These types of solutions also are being used to send data automatically to the tax authority in real time or at regular intervals.”

To implement these type of technologies the legal framework has to support it. Legislation, consultation, collaboration, incentives, compliance, monitoring and enforcement are key building blocks to implementing digital solutions.

The results of utilising technology to prevent, detect and tackle tax fraud and evasion speak for themselves. Although it is not a single fix to the problem, technology does have the capabilities.

“I expect there to be an expansion of the types of technological tools that allow for direct transfers of data from the taxpayers’ business systems to the tax authority. Why? Because there are benefits to both tax authorities and to the taxpayers,” Perez-Navarro said. “For example, in the province of Quebec, the use of this type of technology has reduced the audit time for a restaurant from 70 hours to three hours, and this may mean that the audit can be conducted electronically and remotely. The results from these types of solutions have been impressive.”