Fear and Loathing by Banks

Clash of the Titans

Information from the banking system plays an important role in tax authorities’ efforts to close the tax gap. By analyzing bank account transactions, it is possible to form a tax base and compare it with the data declared by the taxpayer.

Banks are categorically opposed to tax authorities’ interest in their clients’ financial activities and do everything they can to prevent access to this information. Next, we will analyze this conflict to understand why it occurs, and how to find a compromise solution.

What Information do the Tax Authorities Need?

For tax administration purposes, tax authorities require the following information from banks:

• Account opening and account termination by businesses and individuals.
• Transactions on current accounts and the purpose of operations, to understand if they affect the tax base.

Tax authorities often only want to know the turnover on the account. This information shows whether the taxpayer had account activity, but it does not help calculate the tax base or verify full compliance. Transactions through payment terminals (acquiring) are also of interest. They reflect non-cash revenue from bank card payments to business accounts.

How to Get Banking Data?

Banking data is collected manually and automatically. The manual method involves sending an official request from tax authorities and receiving paper responses from banks. The automatic method involves sending a request and receiving a response in electronic machine-readable form.

In terms of legislation, banks transfer data to tax authorities in two scenarios:

1. Unconditionally, whenever specific events happen, for example, when an account is opened or funds are transferred.
2. At the conditions of the tax authority’s request.

Different countries use various forms of data exchange, including hybrid methods. For example, information about the opening and closing of accounts may be provided unconditionally, while the remaining information is provided at the request of tax authorities.

Tax authorities’ requests often encounter legislative barriers:

• Court decisions.
• Decisions of the prosecutor’s office or other supervisory bodies.
• Decisions by the head of the tax authority.
• Authorization to request data only as part of public tax control measures.

These barriers make it impossible to get full data about taxpayers’ account transactions. This makes it difficult for tax authorities to identify violators systematically. If they could get complete and reliable financial data, then a real-time comprehensive assessment of tax risks is possible. Otherwise, the tax authority is only occasionally able to use this data as evidence of violations identified by other means.

From a tax administration perspective, the ideal situation would be if banks compulsorily, unconditionally, and automatically transfer all account and transaction data of their clients in real-time. On all other issues, tax authorities are ready for compromises that can eliminate discrepancies and build effective digital audit controls.

Digital Tax Auditing System

The digital tax audit pursues the following objectives:

• Creating a scalable data warehouse for information on taxpayers’ accounts and transactions. We are talking about hundreds of millions and billions of records.
• Building a data collection and quality control system that meets the following criteria.
  • Completeness. Contains data about all taxpayers.
  • Continuity and promptness. Data for all tax periods are available without significant delays.
  • Reliability and accuracy. By comparing debits and credits and reconciling accounts with transaction data, the system can check the correctness of information provided by banks and find violations.
• Implementing a data processing system to:
  • Calculate the tax base using transaction data.
  • Calculate the tax payable for the period.
  • Perform comparisons with tax returns.
  • Send to the digital desk audit the findings and create claims for taxpayers to remedy violations.

A digital tax audit system can boost tax revenues from organizations and sole proprietors by up to 30% (over current tax collections), and from individuals — by up to 100%.

The system’s effectiveness largely depends on the volume and share of non-cash payments in daily business activities. It becomes expedient if non-cash payments in the country account for over 50% of total payments. The government must encourage the development of convenient payment solutions while also restricting the use of cash payments.

Causes of Banks’ Resistance

In almost every country, banks are independent entities that are subordinate to the country’s Central or National Bank. The Central Bank itself is not subordinate to the government and conducts its activities independently. In other words, tax authorities lack the authority to compel banks to give the required data.

Most often, banks are concerned about the following risks:

• Fearing that their information will be disclosed, clients will switch to paying in cash or transferring funds to foreign banks, resulting in lower profits.
• Clients will switch to other banks that avoid disclosures to tax authorities and can ensure that information about accounts and transfers remains confidential.

The first risk is mitigated by the popularity and convenience of non-cash payments in everyday life. Experience shows that consumers react negatively in countries where merchants do not accept cards and instead require payment in cash. Such a requirement is inconvenient for many customers and tourists. They just stop visiting these establishments. Here, the fear of the tax authorities is overshadowed by the fear of losing customers and business.

The second risk is eliminated only by the state when it imposes equally stringent requirements on all banks, without exception.

It is also necessary to keep in mind that setting up and automating data exchange with tax authorities entails additional costs for banks. That is true even considering that the basic capability should be already present in every automated banking information system. Otherwise, it would be impossible to provide financial services and conduct banking business.

Banks also justify their reluctance to share financial information by citing regulations on banking or commercial secrecy. It prohibits the transfer of such information to third parties. However, data disclosed to tax authorities are immediately subject to tax secrecy. Penalties for violating tax secrecy are more serious than for violations of banking secrecy.

In conclusion, we can say that the success of this initiative requires the state to plan and organize a massive PR campaign. That campaign should make the public aware that banks are transferring data to the tax authorities. This will boost voluntary tax compliance and increase tax collections by an average of 15-20%.