New tax transparency framework for crypto-assets

New tax transparency framework for crypto-assets

On 10 November 2023, 48 members of the OECD agreed to implement the Crypto-Asset Reporting Framework (CARF) to increase global tax transparency and tax reporting in the crypto markets.

All 48 countries have pledged to implement the CARF into local law and adopt information exchange agreements by 2027. Those countries that are also signatories to the Common Reporting Standard (CRS) will also implement the proposed changes to include ‘digital financial products’.

While the list of 48 countries includes the US, UK, Brazil and many EU countries, there is a noticeable absence of key countries in the crypto markets such as China, India, Turkey or any African countries.

Why is this happening?

Tax authorities around the world began automatic exchange of individuals’ financial account information in 2017. Most crypto-assets can be transferred and held without the involvement of traditional financial institutions that have to report under the CRS, and growth in the use of crypto-assets by individuals and some businesses since 2017 has been rapid. This means that tax authorities get little information about crypto-asset transactions or holdings – a growing part of the world economy.  

The G20 governments are concerned that crypto-assets might be used to undermine existing international tax transparency initiatives like CRS, thus facilitating tax evasion and other criminal activity. So the G20 has asked the OECD to develop a framework for automatic global information exchange for crypto-assets (including non-fungible tokens (NFTs)), to bring them within the CRS.

How will it work?

The proposed Crypto-Asset Reporting Framework (CARF) involves revenue authorities (e.g. HMRC) collecting data from resident crypto-asset intermediaries and exchanges that effect transactions for or on behalf of their customers. The data will provide details of the intermediaries’ customers (individuals and entities) and their aggregate investments and crypto-asset transactions. The data will then be exchanged between national tax administrations so that each administration will receive data about the crypto-assets of taxpayers resident in their country.

The proposals would make four types of transactions reportable under the CARF:

  • An exchange between a crypto-asset and fiat currency
  • Exchanges between crypto-assets
  • A transfer of crypto-assets (broadly a transfer between different crypto-asset user’s accounts or address)
  • Crypto-assets used as payment for goods and/or services exceeding $50,000.

Broadly, the value of the crypto-assets at acquisition and gross proceeds for disposals will need to be reported to the relevant tax authority. Such transactions will be reported as an aggregate per each type of crypto-asset, but grouped into different categories such as crypto-to-crypto and crypto-to-fiat transactions.

Where a user transfers crypto-assets to wallets outside of a Reporting Crypto-Asset Service Provider, the number of units and total value of crypto will be required to be reported. This requirement is designed to increase transparency and allow tax authorities to enquire into transfers where they may view the transfer as tax avoidance or evasion.

The final framework for the CARF has a wide definition of crypto-asset covering digital representations of value that rely on cryptographically secured distributed ledger (or similar technologies) to validate/ secure a transaction. In practice, the wide definition will capture not just typical crypto-assets such as Bitcoin, but also stablecoins and some non-fungible assets, alongside certain crypto-derivatives.

As part of the future-proofing of the CARF, the mention of similar technologies is designed to encompass emerging technologies that effectively operate in a similar fashion to existing crypto-assets and would give rise to similar tax issues.

However, there is a welcome exclusion for low-risk assets such as cryptoassets that aren’t used for payment or investment purposes, Central Bank Digital Currencies, and Specified Electronic Money Products (the latter two are reportable under the amended CRS). Broadly, the definitions of a crypto-asset mirror the recommendations by the Financial Action Task Force which advises on money laundering matters, meaning the tax reporting and AML reporting obligations should be similar.

Who will have to report?

Broadly, financial intermediaries, crypto-exchanges, and any service providers which facilitate an exchange of crypto-assets on behalf of customers with a nexus in one of the 48 signatory countries (termed Reporting Crypto-Asset Service Provider under the CARF). Note that the reporting obligation can extend to individuals providing business services.

Whether a Reporting Crypto-Asset Service Provider has a reporting obligation will depend on its nexus. A nexus is created where the provider is:

  • Tax resident
  • Incorporated, or organised, under the laws of a jurisdiction, provided it has legal personality or is subject to tax reporting.
  • Managed from the jurisdiction
  • Has a regular place of business in the jurisdiction, or
  • Has a branch which effects the transaction in a reportable jurisdiction

Where multiple nexus is created, a hierarchy applies to reduce the administrative burden.

The end of crypto anonymity

The CARF proposals also aim to ensure that individuals and entities providing business services to exchange crypto-assets (for other crypto-assets or for national currencies) apply standard due-diligence procedures to:

  • Identify their customers (as well as the natural persons controlling certain Entity Crypto-Asset Users)
  • Determine their tax jurisdiction, and
  • Collect the information needed to enable them to comply with the CARF’s reporting requirements.

Updating the CRS

The proposals extend the CRS’s scope to cover electronic money products, Central Bank Digital Currencies and indirect investments in crypto-assets through investment entities and derivatives, thus enabling countries to automatically exchange crypto-asset trading information.

To help integrate CARF data into the CRS, the OCED is also proposing a number of amendments to its CRS model (eg to ensure there is no duplicated reporting). Newly proposed provisions also focus on updating the CRS to make the data more usable by tax administrations and limiting burdens on Financial Institutions. The changes are intended to ensure administrations have visibility of:

  • The type of controlling persons of the entity holding the account, to help tax authorities distinguish between ownership and control structures and the management team, as well as checking if taxable income or wealth should be allocated to the controlling person
  • Whether the account is new or pre-existing
  • Whether the account is a joint account (and how many joint holders there are)
  • All the countries in which an account holder is tax resident.

Impact on crypto-asset providers

The obligation to carry out due diligence would bring crypto-asset providers into line with mainstream financial service providers and impose significant administrative burdens – a major change to some established business models.

As with FATCA and CRS, implementing robust due diligence processes are key to creating a smooth and efficient reporting system. For existing financial institutions or service providers that are covered by CRS, reliance can be placed on their existing processes and, similarly, where an entity is reportable under FATCA, provided the existing processes cover the requirements of the CARF, reliance can be placed on the existing processes.

Where a service provider is not already reporting under CRS or FATCA, it will firstly need to implement a process to determine whether the end user is a reportable user or an excluded person/active entity by means of a self-certification by the user that determines their tax residence(s).

If a service user is reportable, a due diligence process will need to be set up to collate certain information, such as first and last name, address, tax jurisdiction, date of birth, and tax identification numbers for individuals. Additional information is required for entities, and separate rules apply where an individual is a tax nomad.

What does this mean for crypto-asset holders?

The CRS is helpful for HMRC. It compares the information reported annually on taxpayers’ bank accounts and income to data from tax returns and other information held in HMRC’s Connect databank. Where discrepancies are identified, it can take action in a number of ways.

The CARF would give HMRC additional information on the crypto-asset transactions of taxpayers, and can be expected to lead to more compliance and enforcement activities in the future. For example, HMRC is likely to issue ‘nudge letters’ to prompt taxpayers to check to see if they need to correct their position for past years. In other cases, HMRC may open detailed investigations into taxpayers’ UK tax affairs (as in most cases taxpayers should declare worldwide income and gains in the UK). These can be both time-consuming and expensive, as HMRC can charge tax-geared penalties for careless or deliberate mistakes.

Any taxpayers who think they may need to correct errors or omissions in past years’ tax returns (in relation to cryptos or any other assets or income) should consider taking specialist advice on making an unprompted disclosure to HMRC to bring their tax affairs up to date before the new rules take effect. Making disclosures before HMRC starts any sort of compliance check usually results in lower penalties on top of the peace of mind of drawing a line under problematic historic issues. 

Read more on the UK tax treatment of crypto-assets