The OECD recently published rules and commentary in relation to a new “Crypto-Asset Reporting Framework” or CARF. The CARF provides a mechanism for the reporting of tax information on cryptoassets that will be automatically exchanged between tax authorities. The new rules come hand in hand with changes to the existing Common Reporting Standard (CRS) to fill in gaps in that regime and to prevent duplication with the new CARF. In this blog, we look at the who, what, why, when and how of the new framework.
Why are these rules being introduced?
Many cryptoassets provide a challenge for regulators seeking to ensure tax compliance, as their very nature makes it hard to track who holds what at any given time. Not only are these novel types of assets that were not anticipated by the existing reporting regimes but, in addition, those regimes rely on reporting by traditional financial intermediaries that are have not historically been party to transactions in cryptoassets. The distributed ledger technology (such as blockchain) that underpins cryptoassets means that there is no need to involve such intermediaries and therefore (until now) it was possible for these transactions to slip outside the reporting net.
This lack of visibility understandably gives rise to concerns for tax authorities about the potential misuse of these assets for illicit activities and tax evasion. In addition, without changes to the existing reporting rules to include newer types of assets, the risk is that there would not be a level playing field between cryptoassets and more traditional products.
The new CARF and the changes to CRS seek to address these concerns by ensuring that the reporting obligations apply to new types of assets and new types of intermediary. The intention is that improving transparency in this area will assist tax authorities in determining whether tax is being appropriately reported and assessed.
What do the rules apply to?
What assets are in scope? The CARF rules apply to “cryptoassets” which are defined as “a digital representation of value that relies on a cryptographically secured distributed ledger or similar technology to validate and secure transactions”. This means there is yet another definition of cryptoassets to keep an eye on for those involved in this area. In the words of the OECD, this definition is intended to target “assets that can be held and transferred in a decentralised manner, without the intervention of traditional financial intermediaries, including stablecoins, derivatives issued in the form of a cryptoassets and certain non-fungible tokens (NFTs)”.
To avoid duplicate reports having to be made, central bank digital currencies and specified electronic money products are out of scope of the CARF and are instead added to the products covered by the CRS. In addition, if the reporting entity has adequately determined that a cryptoasset cannot be used for payment or investment purposes, then this is excluded from the CARF on the basis that the risk of tax non-compliance is limited for such assets. This exclusion builds on concepts developed by the Financial Action Task Force (FATF).
The CRS will additionally be extended to apply to derivatives referencing cryptoassets, to ensure equivalent treatment with derivatives that reference other financial assets (that are already covered by the CRS).
Noting that this is a rapidly evolving market, the OECD intends to continue developing guidance and is ready to implement further changes as technological advances change the nature of the products offered in this sphere. In particular, the OECD is keeping an eye on the development of decentralised finance.
What transactions are in scope?
There are three types of transactions that have to be reported under the CARF: (i) exchanges between cryptoassets and fiat currencies; (ii) exchanges between different cryptoassets; and (iii) transfers of cryptoassets, including as payment for goods or services. In each case, they must be recorded at their value in fiat currency (for instance an exchange of cryptoassets must be recorded as a disposal at market value in fiat currency of the first type of cryptoasset and an acquisition at market value in fiat currency of the second).
Who do the rules apply to?
Who is the entity that has to report? Obligations to report under the CARF apply to “reporting cryptoasset service providers”, which are individuals or entities that effectuate exchange transactions on behalf of customers. “Exchange transactions” means either (i) exchanges between cryptoassets and fiat currencies or (ii) exchanges between different cryptoassets. This is expected to include not only exchanges, but also brokers and dealers in cryptoassets and operators of cryptoasset ATMs.
Who do reports have to be made about? Those with an obligation to report must provide information on “cryptoasset users”, effectively, customers of the reporting intermediary, that are “reportable users”. This is, broadly, entities or individuals tax resident in a jurisdiction with relevant international information sharing agreements in place. Those investing in cryptoassets through funds or other investment vehicles should also be covered under the extended definition of investment entity under the changes to the CRS.
How does CARF reporting work?
The reporting cryptoasset service provider will have to provide the information specified in Section II of the CARF for each reporting period (which may be aligned with the calendar year). This information includes the name, address, jurisdiction of residence, date and place of birth of each reportable user, as well as aggregated information on the amounts paid and market values of cryptoassets that have been the subject of relevant transactions for that user for the reporting period.
There are rules setting out the tax authority to which the reporting cryptoasset service provider must provide the information. Broadly, this may be where the provider is tax resident, incorporated, managed, has a regular place of business or a branch through which it carries out relevant transactions. To avoid duplicative reports, the CARF establishes a hierarchy between these nexus rules, with priority given to the provider’s place of tax residence.
It could potentially be challenging for reporting entities to ascertain who is a reportable user and which are the relevant tax jurisdictions for that user. The due diligence procedures in the CARF address this by providing that there must be a self-certification from the user, which the reporting entity has to confirm is reasonable. For instance, this may be by cross-checking against information provided as part of existing anti-money laundering or KYC procedures. This mechanism builds on processes already used in relation to the CRS and is intended to ensure the two systems are aligned to the extent possible.
When does this take effect?
The rules and commentary on the CARF and the changes to the CRS will now have to be transposed into domestic law. Work on an implementation package to ensure consistent application is ongoing, as is the work on ensuring mechanisms are in place for the automatic exchange of this information.
This is also an issue on the EU’s radar, with the Commission consulting in 2021 on amendments to the Directive on Administrative Co-operation (i.e. DAC 8) to address reporting and information exchange in relation to cryptoassets. The EU is still expected to present a legislative proposal on this issue by the end of the year, possibly as early as next month. In any case, the EU will be following the OECD developments closely as it would make sense for the EU to align its proposals with these new OECD rules.
However, even though the OECD’s CARF is a significant step towards bringing cryptoassets within the tax reporting net and ensuring regulatory alignment, it may be some time before the aims of improving transparency in this area are realised.