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What can Tax Administrations do in the face of the cryptocurrency boom?

Alfredo CollosaAlfredo Collosa    08 August 2021
What can Tax Administrations do in the face of the cryptocurrency boom?

Today, we are witnessing a boom in the use of cryptocurrencies as means of payment and as forms of savings and investment (at the end of 2020 they already exceeded 6,500 in circulation).

In general, they are currencies based on advanced cryptographic technologies that allow their issuance, validation, and registration in a decentralized manner[1].

Their acquisition, sale, use, or possession have an undeniable tax significance, however, in many countries, their tax treatment has not yet been clearly specified.

Therefore, the objective of this comment is to try to provide some ideas of what actions the Tax Administrations should promote as a control strategy for these operations.

1. WHAT ARE THE CHALLENGES FACING THE TAX ADMINISTRATIONS?

In the first place, there is no uniform tax treatment in the different countries, as the OECD warns in its report “Taxing Virtual Currencies[2]“, where it says that the lack of comprehensive guidance or a framework for tax treatment, which is partly due to the complexity of defining the treatment applicable to these assets in a way that covers their different facets, as well as their complex and rapidly changing nature.

Regulations are also important to protect consumers, in this regard Spain recently approved that the National Securities Market Commission can regulate the advertising of crypto assets.

In addition, for countries in general and for Tax Administrations (TAs) in particular, the following difficulties arise

  • Lack of centralized control over crypto assets.
  • The pseudo-anonymity, with difficulties related to obtaining the information of the operations, lie particularly in the identification of the corresponding intermediary, the reportable event, the available reportable information, and the valuation of the assets.
  • Valuation difficulties resulting mainly from sometimes high volatility, lack of a uniform database, and often inadequate documentation.
  • Hybrid features, which refer to difficulties in classifying a financial instrument or an intangible asset.
  • The rapid development of the underlying technology (blockchain).

Likewise, as the FATF (Financial Action Task Force) permanently alerts[3] , crimes such as money laundering and financing of terrorism, drug trafficking, illegal arms smuggling, fraud, tax evasion, cyberattacks, evasion of sanctions, child exploitation, and human trafficking could be committed through the use of cryptocurrencies.

The agency recognizes that virtual assets are an innovative technology to transfer value globally, such as sending payments and reducing commissions.

For this reason, they recently published a report aimed at combating money laundering and terrorist financing, which points out, among others, the following difficulties in its control:

  • Technology features that increase anonymity, such as the use of peer-to-peer exchange websites, mixing or flipping services, or anonymity-enhanced cryptocurrencies.
  • Geographical risks: Criminals can exploit countries with weak or non-existent national measures for virtual assets.
  • The structure of crypto-asset transactions, that is, the amounts that are made in small amounts or in amounts below the amounts that institutions must report when they encounter an alert (similar to the case of cash transactions).
  • Carrying out multiple high-value transactions, or in short succession: there is a regular and staggered pattern.
  • Sender or recipient profiles – Unusual behavior may suggest criminal activity.
  • Source of funds or wealth, which may be related to criminal activities.

As we can see, the challenges faced by the Tax Administrations are many and go beyond the strictly fiscal issue.

2. WHAT CAN TAX ADMINISTRATIONS DO?

In the first place, I believe that the TAs cannot remain inactive on this issue while waiting for multilateral solutions where a consensus is reached on how cryptocurrencies should be taxed.

Although on this issue, as on the issue of the digital economy, the multilateral solution is optimal and as long as this does not happen, the TAs should act quickly.

It is clear that the TAs must work with the regulatory framework of their country and determine in each specific case if there are taxable events that are subject to taxation, but I think they can contribute a lot to the subject of proposing regulatory changes necessary to give certainty to the issue, consumer protection and, above all, improve their control strategy.

As the OECD says in its report, each country must have clear guidance and an applicable legislative framework, where guidance is provided on how virtual currencies fit into the existing tax framework, that is, a guide that is comprehensive and addresses the main taxable facts and forms of income associated with the virtual currencies.

In this sense, the US IRS[4] has been working actively and warns that according to its legislation, the sale or other exchange of virtual currencies, or the use of virtual currencies to pay for goods or services, or the possession of virtual currencies as an investment, generally has tax consequences that could result in tax liabilities. They have issued IRS Notice 2014-21 , IRB 2014-16, as a guide for individuals and businesses on the tax treatment of transactions using virtual currencies.

The IRS also published Frequently Asked Questions on Virtual Currency Transactions for people who own cryptocurrency as a capital asset and are not involved in the cryptocurrency trading or selling business.

It is evident that the main difficulty is the lack of information, which is why the TAs more than ever should promote cooperation with other organizations and institutions, both internally and internationally.

The issue is very complex, since, as stated by Begoña Pérez Bernabéu[5], although the TAs have access to the information stored in the blockchain, they would still need to be able to link the public key with the real identity of a taxpayer in order to ensure compliance with the tax obligations on the part of the latter.

For this purpose, in the USA, the IRS formed a special working group whose mission is to reduce tax evasion with cryptocurrencies. The unit is made up of agents trained in the tracking of cryptocurrencies and the services of blockchain analysis companies.

The important thing is that these companies analyze blockchain using modern techniques and allow cryptocurrency transactions to be deanonymized and thus attributed to US taxpayers[6].

For its part, the European Commission is preparing a reform to improve cooperation between national tax authorities so that they have a greater capacity to identify taxpayers, who are actively using new means of payment and investment, such as crypto assets and electronic currencies, and thus be able to reduce fraud and evasion.

The work of this initiative is still in a preliminary phase, but it has recently published a public consultation on an extension of the current directive on administrative cooperation (DAC 8), so that it also covers crypto assets and digital money.

I share what Pablo Porporatto affirmed,[7] that the OECD plans to begin in 2021 to collect and exchange information on these assets at the national level, taking advantage of the experience of the automatic exchange of financial accounts, according to the “Common Reporting Standard” (CRS), which has been operating since 2017, increasing year after year the participating countries, accounts reached, and amounts covered.

Another issue that is very important is that the TAs include the issue in their tax control plans.

In this regard, the AEAT of Spain in its 2021 Annual Tax and Customs Control Plan in relation to cryptocurrencies proposes the following actions:

  • Obtaining information from various sources on operations carried out with cryptocurrencies. Its incorporation into the model of goods and rights abroad is expected, as well as the establishment of an autonomous information obligation on cryptocurrencies.
  • Systematization and analysis of the information obtained, in order to facilitate the actions of control of the correct taxation of the operations carried out and the origin of the funds used in the acquisition of cryptocurrencies.
  • Develop international cooperation and participation in international forums in order to obtain information on operations with cryptocurrencies and other virtual assets.

Other control strategies relate to preventive control actions, such as sending letters or informing the taxpayers about the information collected by the TAs.

In this regard, the IRS periodically sends letters to taxpayers with transactions in virtual currency, which potentially do not report income or pay the tax resulting from transactions in virtual currency or do not report their transactions correctly.

One aspect that I also consider vital is that the TAs must permanently train their staff, in order to carry out a better cryptocurrency control strategy.

The training refers not only to in-depth knowledge of the subject but to new skills to use modern data analysis and research techniques. The use of the new technologies by the research units of the Tax Administrations for the collection and analysis of information in all types of networks is very important.

In short, in my opinion, the TAs should act on the issue right now, therefore I have stated some of the measures that can be applied as cryptocurrency control strategies, although, as always, the issue remains open to debate.

Disclaimer: Content posted is for informational & knowledge sharing purposes only, and is not intended to be a substitute for professional advice related to tax, finance or accounting. The view/interpretation of the publisher is based on the available Law, guidelines and information. Each reader should take due professional care before you act after reading the contents of that article/post. No warranty whatsoever is made that any of the articles are accurate and is not intended to provide, and should not be relied on for tax or accounting advice.

You can access Law including Guidelines, Cabinet & FTA Decisions, Public Clarifications, Forms, Business Bulletins for all taxes (Vat, Excise, Customs, Corporate Tax, Transfer Pricing) for all GCC Countries in the Law Section of GCC FinTax

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