How quantum computing will improve tax administration and compliance

Everything in real time – that’s the vision. But what is already within reach for the Head of Tax through the use of ERP systems (Enterprise Resource Planning Systems)- is still a distant dream for governments and the academics who advise them. This is because there is currently a lack of both available data and powerful computers to rapidly model global changes in regional or national tax decisions in combination with economic and social parameters. However, thanks to the rapid progress in the development of quantum computers, it seems possible that tax impact theory will also make a quantum leap here in the foreseeable future.

The benefits of power

Quantum computers are programmed to solve problems that conventional computers cannot due to the high number of variables involved.¹ In drug research, for example, it could enable a large number of combinations of different active substances to be tested faster.² Drivers would be able to calculate the best route in real time,³ which would be good for the flow of traffic and the climate. Essentially, quantum computers together with artificial intelligence could trigger many innovations and dramatically change the world of business and tax. After all, as more and more data become available, more and more computing power is required, while enabling much more detailed and forward-looking modeling of the impact of economic decisions.

Complexity of taxation effects

One of the necessary tasks of a government is to collect taxes to finance public spending. Meanwhile, taxpayers plan their affairs, by choosing where to operate from, and benefit from tax competition between regions and nations. Tax impact theory is at the heart of a scholarly approach to taxation and, in essence, the issue of how changes in tax systems affect the adjustments companies make in response. It is about how companies and other players react to the announcement or observation of changes in tax law. Based on this, tax impact theory can be used to address important aspects of taxation, such as fair taxation or international tax issues.

For example, it would be useful for further decision-making to examine the main variants of supranational models, such as the Common Consolidated Corporate Tax Base (CCCTB), which is being promoted at EU level.

Under this model, companies would be required to follow the rules of a single EU tax system and file only one tax return for all their income in the EU, instead of in each member state individually (“one stop shop”). This consolidated taxable profit would then be allocated on the basis of a formula between the member states in which the company operated. The tax authorities of the respective member states then only need to apply the respective national corporate income tax rate to the share of profit allocated to them. Since this approach would be mandatory for the largest corporate groups (in terms of revenue), the system is primarily intended to curb tax avoidance through profit shifting. However, political concerns about the preservation of tax sovereignty and practical implementation problems have held the project up for years and it has made only sporadic progress. In particular, the question of how to measure the amount of “activity” in the individual member states to use as a basis for allocating taxation rights remains unanswered.

Data gathering

Governments have a strong interest in being supplied with the necessary information that is relevant for taxation decisions. And as reporting requirements grow, the volume of data being generated increases as well. Since mutual administrative assistance was established in the EU in 2011, the exchange between member states of information of significance for applying and enforcing domestic tax laws has expanded apace. The data are either collected from the taxpayers themselves by means of imposed transparency obligations or obtained from tax audits that reveal information of cross-border tax relevance that may be unknown to the state in question. Exchange of available information has rapidly grown to include advance tax rulings with cross-border effect and advance transfer pricing agreements: country-by-country reporting for multinationals, beneficial ownership information, and the much discussed obligation to report cross-border tax arrangements (DAC6). The most recent pipeline project to broaden the exchange of information is a reporting requirement for platform operators that will require them to provide information on sales on their electronic platforms. While the collection, transmission and evaluation of data is still a complex process that is currently miles away from producing clear real-time information, newly defined interfaces and systems between taxpayers and tax administrators will help pick up the speed in the foreseeable future.

Greater public transparency

The public country-by-country reporting discussed in the EU, which is a further development of the BEPS project to combat base erosion and profit shifting, is also intended to increase tax transparency. This process will require all international corporations operating in the EU with annual revenue of EUR 750 million or more to disclose information on profit before tax and the amount of tax paid in every tax jurisdiction in which they operate. A draft on the country-by-country disclosure of companies’ tax payments has been submitted to the EU Council of Ministers and is due to be introduced to Parliament soon.

Redistribution

In addition, there are global approaches, for example, at the OECD level with Pillar 1 and 2 of the BEPS project, in which the community of states is striving to impose taxation on the digital economy and introduce minimum taxation and could be on the verge of reaching an agreement  until summer 2021. There is also the Common Reporting Standard (CRS), an international procedure for the exchange of financial account information, that will also play its part in ensuring that more and more data is available and that tax law will be fundamentally changed in the coming years.

In essence, however, the problem remains the same. These systems will only function as intended if, in addition to the government regulations, the necessary technology is available to ensure transparency and fairness. The technology must also enable companies to effect such notifications without system breaks and with as little effort as possible. The potential computing power of a quantum computer could play a central role here, particularly when it comes to conducting advance simulations of possible consequences for the distribution of the tax base.

Tax impact analyses are also on the agenda as public debt skyrockets in all countries in the wake of the pandemic, and sociopolitical challenges such as climate change and the demographic trend spill over into the tax world. The need for data and reliable impact analyses is enormous.

ADIMA⁴

Recently, the OECD itself has been trying to identify and analyze such data. This is precisely the goal of the ADIMA initiative. The acronym ADIMA stands for Analytical Database on Individual Multinationals and Affiliates. It has taken on the task of examining 500 multinational companies in order to understand where they and their value chains are located in the world, how they operate and where they pay taxes. To this end, the Paris-based organization brought together its data analysts, statisticians, computer scientists and programmers in a project group and, two years ago, installed a database. The reason given for this approach is that, up to now, only scant official statistics have been available on individual multinational companies, and their behavior is becoming increasingly important for some countries. The OECD plans to greatly expand the database and include information not usually found in company reports by evaluating open big data sources, such as news outlets, websites and Wikidata. In the first published reports, which initially looked only at the top 100 ADIMA companies, found through data analysis in open sources that 85 out of 100 companies had active operations, but official financial statements showed only 75 companies.

The examples provide an insight into government efforts to collect reliable data to secure their share of the tax base and be able to continue to fund public spending in the future. But if all this data were available today, would there be sufficient computing capacity to process it? Can today’s computers perform comprehensive impact analyses that illuminate every nook and cranny of entrepreneurial activity all over the world?

Vision for 2050

Let’s assume that quantum computers will be universally deployable in the future. Given the diverse environmental, social and economic challenges around the world, as well as competition for government revenue sources, supercomputers could also be used to find a global approach to all business-related taxes that create economic fairness. In theory, combining powerful quantum computing with complicated international tax rules would be possible, even if in practice the political compromise required would be a hurdle at least as high as applying the technology.  

In my opinion, however, visions are not a crime and should be encouraged. By around 2050, for example, the equalization and steering functions of national taxation systems could be extended to create a single global system encompassing all business-related taxes. Currently, such a system is barely feasible from a technical perspective. Today’s computers are not fast enough to identify the tax effects in real time, worldwide and country-by-country on the basis of changes in laws, and to track the enforcement of the regulations. Several very powerful quantum computers, on the other hand, could analyze and evaluate large volumes of data much faster.

Here is a concrete example: municipalities finance their budgets largely from trade tax revenues, which fluctuate depending on the state of the economy. With the help of quantum computers, the expected revenues of the companies and therefore of the municipalities could be forecast using a multitude of variables and levied by means of a surcharge on the income taxes. This could help avoid year-long delays in necessary renovations of public facilities, for example. Calculation models could form the basis for allocating funds between the municipalities. In the current pandemic, no major retail chain will want to think about redistributing resources from rich to poor municipalities, but in the future they will regain their interest in breathing life into high streets and marketplaces.

Data on real estate and land is also urgently needed for the upcoming real estate tax reform in Germany. The escape clause allows federal states to initiate real estate tax reforms that deviate from federal law and some federal states are already publishing their first draft laws. However, all sides would stand to benefit if real estate data were available and the states did not have to employ different models to generate future value-driving attributes for their revenues to assess tax.

From a political perspective, a global tax governance system would be a monumental task. New national and international standards would have to be set, assessment bases defined and control bodies convened. However, the BEPS project shows that closer cooperation on sensitive tax issues that deeply encroach on national sovereignty is possible and that anonymized data could be made available to decision-makers in real time.

The use of new technologies would make a positive ecological, economic and social contribution to the world of tax. A few years ago, no one would have thought it possible for artificial intelligence to play a role in corporate decision-making. We therefore need to remain open to the possibilities of new technologies, even if their usefulness still seems a long way off.