The OECD Wants More Visibility Into Your Cryptocurrency Activity - Forbes

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What Happened

Pseudonymity and decentralization are two great benefits offered by the crypto industry. However, these features can be exploited by illicit actors for various purposes, including tax evasion. Roughly 46 million Americans own a share of bitcoin. However, the number of tax returns the IRS receives with cryptocurrency transactions are nowhere near that number. This trend continues around the world.

In response, last week the Organization for Economic Co-operation and Development (OECD proposed a framework called the Crypto-Assets Reporting Framework (CARF) to improve cryptocurrency tax transparency between countries. CARF intends to strengthen the OECD's existing Common Reporting Standards (CRS) that require financial institutions to report certain non-crypto financial transactions to tax regulators to improve the integrity of the global tax compliance system.

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Key Concepts

What are the Common Reporting Standards (CRS)?

The CRS were established by the OECD back in 2014 to combat offshore tax evasion. Under the CRS, financial institutions like banks are required to identify non-resident account holders and report certain financial information such as balances, interest, dividends, investments, and proceeds from sales of financial assets related to those accounts to local tax regulators. Local tax regulators are then required to share this information with the tax regulator of the country where the account holder resides.

This information transfer occurs automatically in a streamlined fashion between more than 100 participating OECD countries today. Tax regulators can rely on this continuous information sharing between countries to uncover bad actors who use offshore strategies to evade taxes.

Challenges with the crypto economy

The CRS do not fully address the intricacies associated with cryptocurrency at the moment. This allows bad actors to use cryptocurrency to evade taxes using offshore tax strategies.

According to OECD, the adoption of cryptocurrency is posing challenges to global tax administration in two important ways.

First, many cryptocurrency transactions happen in a decentralized manner without going through any traditional financial intermediaries like a bank or a brokerage that is required to follow the CRS. "Crypto-Assets’ reliance on cryptography and distributed ledger technology, in particular blockchain technology, means they can be issued, recorded, transferred and stored in a decentralized manner, without the need to rely on traditional financial intermediaries or central administrators"

Second, the crypto industry has given rise to new financial intermediaries such as cryptocurrency exchanges and wallet providers that are only subject to limited OECD reporting right now. The limited disclosures are not enough to robustly capture all aspects of crypto.

Solution: Crypto-Assets Reporting Framework (CARF)

The OECD proposed the CARF to capture cryptocurrency into OECD reporting standards.

Recently released, the OECD's paper describes the scope of the crypto assets, intermediaries & transactions subject to proposed reporting along with the due-diligence intermediaries must perform when collecting user information.

Crypto-Assets covered

CARF subjects a wide variety of digital assets to new reporting requirements. The definition of crypto assets includes "those assets that can be held and transferred in a decentralized manner, without the intervention of traditional financial intermediaries, including stablecoins, derivatives issued in the form of a Crypto-Asset and certain non-fungible tokens (NFTs)."

The interpretation also captures new asset classes that can emerge in the future and will operate similar to the crypto assets we see today.

Intermediaries subject to the CARF

Intermediaries facilitate crypto transactions between two parties. The CARF targets centralized cryptocurrency exchanges, decentralized cryptocurrency exchanges, broker dealers and even ATMs.

Transactions in scope

Crypto related transactions subject to the CARF include crypto-to-fiat trades, crypto-to-crypto trades, transfers of crypto assets & retail payments.

Due diligence requirement

Under the due diligence requirement, intermediaries facilitating crypto transactions are required to collect identity information of the users along with information about their tax residence.

If the CARF is adopted as it is proposed, the intermediary cryptocurrency exchanges will be required to gather personal identification information about non-resident users and report transactions in scope (see above) to local tax regulators.

It's worth noting that the CARF is similar to the Travel Rule imposed by the Financial Action Task Force (FATF). However, the CRS has no minimum threshold for individual accounts. So, they are all reportable. Additionally, while the FATCA focuses only on tax evasion by US persons, the CRS targets offshore tax evasion based on an account holder’s country (or countries) of tax residence.

Implications

It will be interesting to see how the crypto industry responds to the proposed reporting standards. Although the intentions are good, it will be an onerous task to comply with all the data collection & due diligence requirements. This will add to the administrative burden that US crypto exchanges are already going through to comply with third-party information reporting requirements mandated by the Infrastructure Bill.

When it comes to decentralized intermediaries, it is unclear who will bear the burden of implementing CARF or if there's any "intermediary" to begin with in a peer-to-peer transaction. Even if there's a centralized entity associated with decentralized protocols, collecting personal identification data may be detrimental to the business model. The process will also raise data privacy concerns.

The industry has until April 29, 2022, to comment on the CARF proposal and raise any concerns.