Nowhere to hide. That’s the goal behind new tax transparency obligations for crypto-assets being planned by the European Union through DAC8.
Concerned that global tax transparency improvements achieved through the Common Reporting Standard (CRS) and US Foreign Account Tax Compliance Act (FATCA) will be undermined by crypto-assets, the OECD has been developing proposals for a Crypto-Asset Reporting Framework (CARF). The eighth Directive on Administrative Cooperation (known as DAC8) will see the EU follow suit.
Rules are expected to be finalised by the end of 2022.
DAC8 aims to counter potential tax compliance and fraud issues arising from the digitalisation of financial markets through crypto-assets and e-money. Since digital assets bypass traditional financial intermediaries, they aren’t subject to the same tax reporting obligations as conventional investments, “creating a significant blind spot for tax authorities,” notes EY.
The concern is such decentralised assets allow for underreporting or non-reporting of income and gains (whether due to insufficient taxpayer awareness or deliberate evasion or avoidance), resulting in lost tax receipts for member states.
DAC8 is expected to introduce “uniform disclosure requirements for e-money and crypto intermediaries (e.g. crypto exchanges) to ensure tax authorities across the EU have increased visibility in respect of the evolving digital economy and crypto-assets in particular,” observes a recent Grant Thornton factsheet. “DAC8 could impose significant mandatory reporting requirements on e-money and crypto intermediaries in respect of their customers.”
Intermediaries will likely be required to file returns containing details of their customers’ acquisitions, disposals and income earned over the period, note the Grant Thornton authors. To avoid driving business offshore, the rules could apply to any intermediaries providing services to EU-based customers.
Crypto tax reporting obligations
What will DAC8 mean in practice?
While the exact form and frequency of the tax reporting requirements under DAC8 are, as yet, to be confirmed, what it will do is bring digital assets and cryptocurrencies into the scope of the Automatic Exchange of Information (AEOI) framework.
According to EY, crypto service providers will likely have to:
- Perform due diligence on all their customer accounts.
- Ensure clients are registered with local tax authorities.
- Collect and exchange financial information with other jurisdictions.
- Certify customers and collect documentation.
- Ensure data is collected and stored in a compliant manner.
Prospectively this means gathering additional personal information from customers, such as Taxpayer Identification Numbers (TINs), dates of birth and tax residence declarations, and periodically reconfirming the information to ensure records are properly maintained. Users (customers, sellers and payees) will have to be classified to determine their reportable status. Where information is lacking, the service provider may need to freeze the accounts. Intermediaries will also need to monitor for changes in client status and submit reports to their tax authority.
Achieving DAC8 compliance
Digital onboarding processes – to ensure all the necessary client information has been properly captured and stored, and stringent AML/KYC checks carried out – will be crucial to DAC8 compliance.
Once onboarded, ongoing client due diligence will be essential. Accounts must be reviewed to ensure documents and data remain current. Automated ongoing screening for any change of circumstance and for sanctions and politically exposed persons (PEPs) allows potential issues to be flagged. Real-time activity monitoring will help catch any trigger events and suspicious transactions, enabling accounts to be blocked if a suspicious event occurs.
Automated tracking of indicia such as place of birth, citizenship, address and phone number – with systematic logic to see where any curative documentation is required – will allow crypto service providers to accurately determine clients’ tax residency status. Reports will then need to be submitted using the appropriate format and in the correct schema.
DAC8, like the OECD’s CARF proposals, is intent on extending global tax transparency efforts to the fast-developing crypto world. With countries’ tax coffers under severe pressure, the transparency drive will be relentless. That may come as a shock to the world’s crypto investors and service providers. But compliance will be non-negotiable. Firms facing these new-found reporting responsibilities had better start preparing.
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