Taxation and financial reporting
The market for crypto assets (including cryptocurrencies as well as crypto-based tokens) is growing rapidly. It also affects the tax authorities, who must adapt just as quickly.
The reliance of crypto assets on cryptography and distributed ledger technology, in particular blockchain technology, means that they can be issued, recorded, transferred and stored in a decentralized manner, without having to rely on traditional financial intermediaries or central administrators.
In addition, the crypto asset market has spawned a new set of intermediaries such as crypto exchanges and wallet providers, which may currently be subject to only limited regulatory oversight. Both types of services in the field of crypto business are relevant for the tax authorities.
The crypto asset market is characterized by a shift from traditional financial intermediaries, the typical providers of information in third-party tax reporting regimes such as the Common Reporting Standard (CRS), to a new set of intermediaries that have only recently come under financial regulation and are often not subject to tax reporting requirements regarding their clients.
The CRS, published by the Organization for Economic Co-operation and Development (OECD) in 2014, is a key tool for ensuring transparency in cross-border financial investment and combating tax evasion abroad. The CRS has improved international tax transparency by requiring jurisdictions to obtain information about offshore assets held by financial institutions and automatically share that information with taxpayer residence jurisdictions on an annual basis. However, crypto assets in most cases are not subject to the CRS, which applies to traditional financial assets and fiat currencies.
Recognizing the importance of addressing the aforementioned crypto asset tax compliance risks, the OECD is developing a Crypto Asset Reporting Framework (CARF) designed to enable the collection and exchange of transaction information.
CARF consists of three building blocks:
- CARF rules and comments, which may be transposed into domestic law to collect information from resident intermediaries;
- The framework of bilateral or multilateral agreements or arrangements of competent authorities for the automatic exchange of information collected under CARF with the jurisdiction(s) of residence of Users of cryptoassets based on the relevant tax treaties, agreements on the exchange of tax information or the Convention on Mutual Administrative Assistance in Tax Matters; and
- Technical solutions to support information exchange.
Rules and comments of the crypto assets reporting system
The CARF rules and commentaries have been developed around four key questions:
- volume of covered crypto assets;
- intermediaries subject to data collection and reporting requirements;
- transactions to be reported, as well as information to be reported in relation to such transactions;
- due diligence procedures to identify users of crypto assets and relevant tax jurisdictions for reporting purposes.
Amount of crypto assets covered
The proposed definition of crypto assets under CARF focuses on the use of cryptographically secure distributed ledger technology, as this is the distinguishing factor underlying the creation, ownership, and transferability of crypto assets. The definition also includes a reference to “similar technology” to ensure that it can include new asset classes that will emerge in the future that are functionally similar. Thus, the definition of cryptoassets is aimed at those assets that can be stored and transferred in a decentralized manner without the intervention of traditional financial intermediaries, including stablecoins, derivatives issued in the form of cryptoassets, and some non-fungible tokens (NFTs).
The definition of crypto assets is intended to ensure that all assets covered by the new tax reporting system are also subject to the FATF Recommendations, ensuring that intermediary due diligence requirements can build on existing AML/KYC obligations.
The term “Relevant Crypto Assets” (i.e., the crypto assets that give rise to the reporting of Relevant Transactions) excludes from the reporting requirements two categories of crypto assets that pose limited tax compliance risks. The first category is closed-loop crypto assets intended to be exchanged for goods or services under well-defined, limited conditions. The second category is central bank digital currencies, which are fiat currency claims on an issuing central bank or monetary authority that function similarly to money held in a traditional bank account. Thus, the reporting of central bank digital currencies will be included in the scope of the CRS.
Intermediary in the field of crypto assets
Intermediaries that facilitate the exchange between crypto assets, as well as between crypto assets and fiat currencies, play a central role in the crypto asset market. Thus, it is proposed that those intermediaries that, as a business, provide services that carry out exchange transactions in the relevant crypto assets, for or on behalf of clients, are considered to be reporting service providers in accordance with CARF.
These intermediaries are also the responsibility of entities for FATF purposes (i.e. virtual asset service providers). Thus, they can collect and verify the necessary documentation of their clients, including those based on AML/KYC documentation.
The above functional definition will cover not only exchanges but also other intermediaries providing exchange services such as crypto asset brokers and dealers and crypto asset ATM operators.
In relation to reporting, reporting crypto asset service providers will, in principle, be subject to the rules if they (i) are tax residents, (ii) are both registered or organized under the law and are legal entities or subject to tax reporting (iii) are managed, (iv) disposed of with a fixed place of business, or (v) carrying out related operations through a branch located in the jurisdiction adopting the rules. CARF also contains rules to avoid duplication of reporting in the event that a reporting crypto asset service provider has references to more than one jurisdiction.
The following four types of transactions are subject to reporting under CARF:
- exchanges between crypto assets and fiat currencies;
- exchanges between one or more forms of crypto assets;
- reporting retail payment transactions; and
- transfers of crypto assets.
CARF stipulates that for Crypto-Asset-to-Fiat transactions, the amount paid or received in fiat is reported as the purchase amount or gross proceeds. For Crypto-to-Crypto transactions, it is proposed that the value of the crypto asset (when acquired) and gross proceeds (when sold) should (also) be in fiat currency. Under this approach, in relation to crypto-to-crypto transactions, the transaction will be divided into two reportable elements, i.e.: (i) the sale of a crypto asset (reported gross proceeds based on the market value at the disposal date); and (ii) the acquisition of a crypto asset (the reported value of the acquisition is based on the market value at the time of acquisition).
CARF also allows the tax authorities to subscribe to receive reports on a list of external wallet addresses to which the reporting crypto asset service provider transfers the relevant crypto assets for the user.
Finally, CARF also applies to certain cases where a Reportable Crypto Asset Service Provider processes payments on behalf of a merchant accepting crypto assets in payment for goods or services (i.e. Reportable Retail Payment Transactions). In such cases, the reporting crypto asset service provider must also treat the seller’s customer as their customer and report the value of the transaction on that basis.
CARF contains the due diligence procedures that reporting crypto asset service providers must follow when identifying their users, identifying relevant tax jurisdictions for reporting purposes, and collecting relevant information necessary to comply with reporting requirements under CARF. The requirements are designed to allow Reporting Crypto Asset Service Providers to efficiently and securely determine the identity and tax residence of their Users, whether they are natural or legal persons, or individuals who control certain Legal Entity Crypto Asset Users.
The due diligence procedures are based on the CRS self-certification process as well as the existing AML/KYC obligations outlined in the 2012 FATF Recommendations, including updates in June 2019 on obligations applicable to VASPs.
The preparation of tax reporting for companies that conduct transactions with crypto assets has its own characteristics, due to the constantly changing tax regimes of various jurisdictions. The Finance Business Service team of lawyers monitors on a weekly basis the innovations in the tax legislation of each of the jurisdictions we serve, which allows us to keep abreast of changes and offer our clients the best solutions. A team of our specialists will accompany you at every stage from the preparation of tax documentation, filing, parallel consultations with the tax authorities to the complete closure of the issue with the regulatory authorities.