A new threat to the TAX freedom of Europeans
In 2021, the European Commission proposed a legal framework establishing a European Digital Identity (“EDI”). The EDI will be available to all businesses, residents, and citizens of the EU. Such legal and natural persons will be able to quickly prove their identity and share electronic documents from their EDI wallets. This can be done simply by clicking on a button on their mobile phone. Companies will be able to use the EDI to verify the age of their customers.
The proposal for the EDI invites the EU countries to create a common EDI-related toolbox by September 2022 and start preparing for the implementation of a new EDI regulation as soon as possible. The toolbox needs to include standards, technical infrastructure, and best practice guidelines. The EDI proposal aims to address the current legislative gap pertaining to the lack of laws requiring the EU countries to create national IDs that are interoperable with the national IDs of the other EU countries.
The purpose of this article is to discuss the threats which the proposal poses to the tax freedom of EU residents. More particularly, the article will examine the possibility to track the location of the users of the EDI without their permission and use the collected information to wrongly accuse them of tax crimes.
Tracking the location of EDI users
The European Commission states that “the new European Digital Identity Wallets will enable all Europeans to access services online without having to use private identification methods or unnecessarily sharing personal data. With this solution they will have full control of the data they share.” Although it may be true that EDI users will have some control over the data they will share, EDI wallets may include information about the location of their users. Even if EDI users choose not to share such personal data with third parties, many provisions of the EU General Data Protection Regulation (GDPR) may be restricted by EU countries in cases related to “budgetary and taxation matters”. This means that some EU countries may use information in EDI wallets, without the permission of the owners of those wallets, to investigate suspected tax evasion.
If an EDI user is suspected of tax evasion, the data in the individuals’ EDI wallet can be examined in detail. For example, the tax authorities can check whether the user used the EDI to purchase any goods/services requiring age verification in a given EU country and whether the user used the EDI to purchase flight tickets to certain EU countries. The tax authorities may combine the collected data with other materials in their possession and use the findings to argue that the EDI user concerned is a tax resident of a given country because the person in question lived in that country for 183 days or more. In this regard, it is worth mentioning that most EU countries apply the so-called 183 days’ rule, i.e., a rule stating that, if an individual resides in a given jurisdiction for 183 days or more, therefore is regarded as a tax resident of that jurisdiction and is liable for paying taxes there.
The EDI poses a significant threat to the tax freedom of Europeans because the information collected from EDI wallets can be combined with other data in such a way as to wrongly indicate that EDI users were tax residents of certain EU countries. For example, imagine that the EDI of an individual is stolen and used by criminals in another EU country. The EDI user concerned may not know that her EDI wallet was stolen and the criminals can use it to purchase services requiring age verification. The tax authorities may use the data from the EDI wallet to argue that the user was actually residing in the country where the verifications were made. It will be challenging for the EDI user to prove that a third party used her EDI wallet. As a result, an EDI user living in a low-tax jurisdiction may be required to pay taxes in a high-tax jurisdiction.
Even if an EDI wallet is not stolen, the data stored in the wallet can be used by the tax authorities to wrongly accuse the owner of the wallet of tax evasion. To illustrate, imagine that an EDI user lives in Bulgaria (a low-tax country) and goes to France from time to time for up to one week per month. Normally, she should be regarded as a Bulgarian tax resident and should pay taxes in Bulgaria. However, if the EDI user concerned uses the EDI wallet exclusively in France, the French tax authorities may use the data in the EDI wallet to argue that the EDI user is a tax resident of France and should pay (i) the French personal income tax of up to 45%, (ii) plus a surtax of 3% on the portion of income that exceeds EUR 250,000, (iii) plus a wealth tax of up to 1,5%. In comparison, Bulgaria charges a fixed personal income tax of just 10%, without any surcharges and wealth taxes. Thus, as a result of the data in the EDI wallet, the individual concerned may pay an additional tax amounting to 40% of her income.
This article has clearly shown that, although the EDI may facilitate the ID verification processes throughout the EU, it may be used by tax authorities to wrongly accuse EDI users of tax evasion. This puts the tax freedom of Europeans at risk. The storage of data that can be used to prove tax residence in a single wallet and making that wallet accessible to the tax authorities of the EU countries allows those authorities to monitor the activities of individuals suspected of tax evasion and selectively use the data to support their allegations.
Every year numerous individuals are wrongly accused of tax evasion. Defending a legal case against the tax authorities may require a lot of time and financial resources. Defendants having low income may not be able to afford hiring a litigator at all. Those who can afford to hire a litigator may need to pay hundreds of thousands of euros in legal fees. Even if they win the case, they may not be fully reimbursed for their legal fees as courts usually use their own parameters when awarding legal costs to the winning party. Furthermore, if the tax authority knows that its claims are unsubstantiated, it may not wish to settle the case quickly because it does not have an economic interest in doing so. Tax authorities do not like to spend their hard earned money. They spend the money of the taxpayers and need to prove to the taxpayers that they do their very best to enforce the applicable tax laws. Thus, the battle between the wrongly accused in tax evasion and the tax authorities can be compared to the battle between David and Goliath, a situation where a weaker and less powerful individual faces a much stronger opponent. The EDI seems to be the ticket to this battle and the EDI user will play the role of David. Although the EDI user may win the case, the question is whether it is worth engaging in a fight with the tax authorities.