India loses ₹75,000 crore in taxes annually due to individual and MNC tax avoidance. The United States is no stranger to this either, losing a whopping $188.8 billion every year. Even in China and Japan, the losses stack up to a combined $113.7 billion annually.
Have you noticed how technology is advancing by leaps and bounds these days? Well, it’s no wonder that governments and companies are looking towards digital solutions to prevent tax evasion and fraud. However, with the rise of digital transformation, a solution could be within grasp.
In this blog, we’ll look at how digital transformation is contributing to the prevention of tax evasion and fraud, as well as why it’s a game changer for the future of tax enforcement.
What is Tax Evasion?
Tax evasion refers to the illegal act of avoiding the payment of taxes owed to the government. This can involve deliberately misreporting income, inflating deductions, or hiding money and its interest in offshore accounts. It’s important to differentiate tax evasion from tax avoidance, which is the use of legal methods to minimize tax liability.
5 Common Types of Tax Evasion
Tax evasion refers to the intentional avoidance of paying the full amount of taxes owed or paying taxes past the deadline.
Taxpayers employ various tactics to evade taxes. Some of these common methods of tax evasion are as follows:
- Misrepresenting Information on Tax Returns: Intentionally filing incorrect tax returns results in lower taxes paid.
- Hiding Income through Cash Transactions: Taxpayers may use cash transactions to conceal the source of their income.
- Using Forged Documents: Providing false receipts or other fabricated documentation to increase expenses and lower taxable income.
- Utilizing Offshore Bank Accounts: Keeping bank accounts in foreign countries allows taxpayers to hide financial info from the tax authorities.
5 Ways to Prevent Tax Evasion Through Digital Transformation
The integration of technology can facilitate effective and long-lasting tax reforms, tax the digital economy appropriately, and minimize the difficulties in compliance.
Electronic Cash Register Data Recording
Granting the tax administration access to sales data at any time acts as a deterrent for taxpayers altering records. Encouraging and regulating auditability raises awareness of the risks of tax evasion and fraud through misused receipts and encourages the public to support compliance efforts.
Electronic Tax Invoicing
GSTN authenticates electronic tax invoices and can be used on the common GST portal. Every invoice will be assigned an identification number by the Invoice Registration Portal (IRP) managed by GST Network (GSTN).
Automatic exchange of information involves the periodic transmission of bulk taxpayer information by the source country to the residence country regarding various types of income. This provides timely information on any non-compliance, including tax evasion on investment returns or the underlying capital sum.
Access to Encrypted, Distributed Ledgers
Encrypted, distributed ledgers make it easier for accountants to track financial information, reducing the risk of fraud in financial statements. Tax administrations will have access to real-time information instead of storing vast amounts of taxpayer data.
Streamlined Tax Administration
A well-organized tax administration structure can prevent tax fraud. Connecting corporate accounting systems with the tax administration’s e-filing and e-payment platforms can improve the system and make it more user-friendly. Services may include pre-filled tax returns, taxpayer access to their own filing information, data sharing with banks for faster credit approval, and privacy-preserving queries by researchers and local communities.
6-Step Guide to Implement Digital Solutions to Prevent Tax Evasion
With the rise of digital transformation, implementing solutions to combat tax evasion has never been easier. This 6-step guide will show you how to harness the power of technology to avoid tax evasion.
Step 1: Define Objective
As there are a variety of solutions available for any given problem, the tax administration must clearly define its objective. This entails:
- carefully identifying the issue that needs to be solved
- contrasting the answers that are accessible
- looking into technological alternatives
- creating an execution strategy that is clear to taxpayers
It may also be helpful to seek the input of a range of government stakeholders, including policy, budgetary, tax, technical, and legislative functions.
Step 2: Consult Taxpayers
Engagement and consultation with the taxpayers can equip the tax administration with insights into the most cost-effective solutions. Such solutions would:
- be appropriate for various business types, sizes, and stages of development
- offer the chance to address issues
- offer direction
- find additional supporting measures (such as incentives or enforcement measures).
Positively framing this dialogue can be particularly effective, as although there may be costs for taxpayers, there is an opportunity to present the benefits for taxpayers.
This includes the importance of ensuring a level playing field between competitors, the ability to streamline other tax reporting obligations, and the ability to guard against reputational damage that arises from tax crimes.
Step 3: Collaborate With Private Sector
Collaboration with the private sector providers of the solutions from an early stage can be helpful. Early engagement with the private sector can also assist the tax administration in learning the technical terminology and equipping it to describe the required specifications accurately.
Testing prototypes of technology tests or practical proof of concept evaluations can further support the development of relevant technology requirements and specifications, which ultimately facilitates efficient implementation.
Step 4: Adopt a Pilot Project Approach
Adopting a pilot project approach can introduce the solution for an initial test period in a particular business sector at high risk of tax fraud and evasion.
This can be helpful in identifying any implementation problems or unforeseen practical questions. Once any implementation problems have been resolved, the solution can be implemented more widely in industry sectors or locations, which are the next priority in terms of risk.
Step 5: Raise Public Awareness
Campaigns can be continued over time to publicize the results of technology solutions in recovering public revenue because of these:
- boost taxpayer morale
- reinforce the deterrent effect of these solutions
- lend support to further expansion of the use of technology tools
The public is an important advocate of change. This can be particularly helpful if legislative changes will be used to introduce a technology solution.
Step 6: Enforce
Enforcement efforts are also necessary to ensure the effective use of technology solutions. These act as a deterrent for businesses in avoiding or misusing the required technology solution as well as penalizing any offenders. In addition to monetary penalties, other examples of penalties that are used include:
- the suspension of a business license
- imposing a period of enhanced supervision by the tax authority
- public “naming and shaming” of non-compliant taxpayers
The public can also be encouraged to act as an enforcement mechanism where there is a whistleblowing mechanism, allowing employees or customers to inform the tax authority of suspected violations of tax obligations and possibly offering a reward for doing so.
Finally, tax administrations should continue to engage with taxpayers, the private sector, and each other in order to stay abreast of new risks and share the gains made in implementing new solutions.
The Key Takeaway
As technology races forward at breakneck speed, it’s up to tax authorities to stay one step ahead and be ready to adapt.
Tax authorities should continue to share their experiences and insight in utilizing technology to combat and deter tax evasion and tax fraud, as well as provide feedback on the broader reform efforts across the tax administration to improve tax compliance.
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