The global tokenization market is worth billions today, and predictions call for tokenization to become a trillion-dollar sector in the next decade or so.
Tokenization can make illiquid assets liquid, opaque processes transparent, and siloed markets into global, 24*7 online spaces.
Throughout our discussions on this medium channel, we read about the tokenization of art, real estate, securities, treasury bills, carbon credits, music, and whatnot. We saw tokenization truly mobilizing sectors such as healthcare, supply chain, education, financial services, etc.
However, we should have considered the idea of VAT (Value added tax) being tokenized.
Recently, Fireblocks, an enterprise-grade provider of tokenization services, collaborated with South Korea’s leading Bank, NongHyup (NH) Bank, to explore the potential of tokenization in tax refunds.
Fireblocks and NongHyup (NH) Bank signed a MoU (Memorandum of Understanding), which both will work on as a prototype system. This system will integrate ‘digital assets into value-added tax (VAT) and goods and services tax (GST) refund processes for eligible retail purchases.’
This information may seem daunting initially, but let’s break down the concept of VAT tokenization and how it will benefit users and tax authorities.
How Do VAT and Other Indirect Taxes Work?
Indirect taxes like VAT apply to the supply of movable assets and services, including imports.
Indirect taxes are regressive, i.e., applied as a fixed percentage, unlike direct taxes, which have different tax slabs for various income groups.
Manufacturers and sellers collect VAT or indirect taxes like GST from the consumer. These taxes are often embedded in the price of goods and services. The manufacturer collects indirect taxes and sends them to the government.
Where Does Tokenization Come In?
Tokenization involves representing assets as tokens on a blockchain. In this case, the tokenized assets would be goods and services. These tokens do not fall under the category of taxable assets, but the goods and services they represent carry indirect taxes, such as VAT.
The tokens here carry information or economic facts (related to the good or service) that can be taxable. Different goods and services may have different GST or VAT rates depending on the territory or how they are legally defined.
For instance, essential commodities may be subject to a lower GST (Goods and Services Tax), while luxury items may be subject to a higher GST. The tokens representing the goods and services may be embedded with information about the object’s legal definition, source, and applicable tax.
The tokens representing the goods and services represent their real-time movement within the supply chain, from the origin to the end user, along with the accruing taxes. In the case of services, the laws of the territory where the services have been performed would apply.
Smart contracts can execute tax collection commands by moving the share of tax accruing at each phase of the product’s life cycle to a designated wallet or account. They are programmed to react automatically to a set of conditions.
When programmed to trigger a tax refund, smart contracts initiate a refund to the manufacturer or seller every time a set of rules or conditions are met.
This refund initiation would be automatically achievable and traceable to the manufacturer or seller.
That way, the tax refund process will become more aligned, secure, and transparent, and tokenization will reduce wait time. In general case scenarios, sellers and manufacturers must wait months and more than a year to get their tax refunds back.
Note: The hypothesis discussed above may diverge from the original application.
How Does Tokenization Help Optimize Tax Refund Processes?
In the case of Fireblocks and NH Bank, the pilot project for a refund of VAT and GST would apply to purchases at retail outlets. Fireblocks’ co-founder and CEO Michael Shaulov said:
“Through tokenization, we can assign unique digital identifiers to assets, allowing for real-time tracking across their lifecycle — from issuance to settlement — without the risk of manual error or fraud. This not only reduces operational costs but also ensures a secure, immutable record that strengthens trust between banks and their clients.”
Shaulav summarizes the utility of tokenization in the tax collection and refund process well. Tokenization can help streamline the entire collection process, reduce fraud, and add security. It can also reduce the number of manufacturers trying to escape tax payments via manipulation. Manufacturers and sellers can expect faster refund delivery, allowing for additional working capital.
Since smart contracts can be programmed differently for different kinds of tokens, different products carrying exemptions or specific tax rates can have differently programmed tokens.
For instance, South Korea charges a flat 10% VAT, but certain products, such as medical and unprocessed foods, are exempt. All this information can easily be embedded in tokens, and tax collection can be automated. Similarly, tax records on the blockchain can become accessible to all the stakeholders, and instances of errors can be eliminated.
Will The Prototype Be Viable in the Long Term?
Integrating tokenization in tax refunds may sound like a radical move. However, tax refunds are a part of the larger initiative where banks like NH Bank are attempting to leverage blockchain and tokenization to enhance their digital service offerings and soak in consumer demand.
The tokenized tax refund initiative is still in its prototype stage. NH Banks and Fireblocks have collaborated first to assess the feasibility of the idea and its potential to be incorporated into routine financial processes. It will be some time before we see a full-fledged product or platform powered by tokenization getting rolled out.
The move, however, affirms that banks and institutions are no longer wary of blockchain or related technologies like tokenization. Many are testing the waters and have already initiated tokenized funds and services.
The best is yet to be seen.
At TokenFi, we are making your tokenization journey simpler and smoother with our extensive line of products. TokenFi’s upcoming RWA tokenization module is powered by Chainlink’s proof of reserves and can help you tokenize any asset, except securities, without writing a single line of code.
