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Cryptoactives and International Exchange of Information

Dec. 22, 2021, 8:00 AM

We are witnessing a historic period in terms of tokenization of the economy—also called Web3—as an evolutionary stage of the internet. Its development began after the financial crisis of 2008, when the Bitcoin blockchain was introduced on Oct. 31, 2008 with a white paper under the name of Satoshi Nakamoto.

Within this economy, asset tokenization is a process by which the value of a real-world asset (tangible or intangible) is digitized and becomes a token under representation on a blockchain.

There are multiple cryptographic tokens, payment tokens being the most used, where cryptocurrencies are included. There are also utility tokens that grant rights of use or access; security tokens (which represent ownership shares in a company that does business using blockchain technology); asset tokens that represent an asset, within which can be included non-fungible tokens (NFTs), currently experiencing an amazing expansion within the art world; and hybrid tokens as a combination of the above.

Faced with this phenomenon, states are trying to regulate these operations, in the first place to identify them in order to enhance them, but also to protect consumers and avoid criminal activity around their taxation within current regulatory frameworks.

Challenges for Countries

In the first place, there is no uniform tax treatment in different countries, as the Organization for Economic Cooperation and Development (OECD) warns in its report Taxing Virtual Currencies. The OECD discusses 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.

The report was prepared and endorsed by the 137 members of the OECD/G-20 Inclusive Framework on base erosion and profit shifting (BEPS), providing a comprehensive analysis of the approaches and gaps in the main types of taxes (income, value-added tax and property), in relation to more than 50 jurisdictions which participated in the study.

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

In addition, for countries in general, and for tax authorities in particular, the following difficulties arise:

  • lack of centralized control over crypto assets;
  • pseudo-anonymity, with difficulties related to obtaining information on the operations, particularly in identifying the corresponding intermediary, the reportable event, the available reportable information, and the valuation of the assets;
  • valuation difficulties resulting mainly from possible high volatility, lack of a uniform database, and frequently inadequate documentation;
  • hybrid features, which create difficulties in classifying as a financial instrument or an intangible asset;
  • the rapid development of the underlying technology (blockchain).

Financial Action Task Force and its Activities

While the Financial Action Task Force (FATF) recognizes that virtual assets are an innovative technology for transfering value globally, such as sending payments, and for reducing commissions, it also regularly cautions that 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 may be committed through the use of cryptocurrencies.

For this reason, the FATF published a report aimed at combating money laundering and terrorist financing, which points out, among other factors, 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, those made in small amounts or at a level below the amounts that institutions must report when they receive an alert (similar to the case of cash transactions);
  • carrying out multiple high-value transactions, or transactions in rapid succession, where 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.

2021 Guidance

In October 2021, the FATF updated its 2019 Guidance for a Risk-Based Approach to Virtual Assets and Virtual Asset Service Providers (VASPs). This updated guidance forms part of the FATF’s ongoing monitoring of the virtual assets and VASP sector.

The FATF standards require countries to assess and mitigate risks associated with virtual asset financial activities and providers; license or register providers; and subject them to supervision or monitoring by competent national authorities. VASPs are subject to the same relevant FATF measures that apply to financial institutions.

This guidance will help countries and VASPs understand their anti-money laundering and counter-terrorism financing obligations, and effectively implement the FATF’s requirements as they apply to this sector. The guidance provides relevant examples and potential solutions to implementation obstacles.

The 2021 guidance includes updates focusing on the following six key areas:

  • clarification of the definitions of virtual assets and VASPs;
  • guidance on how the FATF Standards apply to stablecoins;
  • additional guidance on the risks and the tools available to countries to address the money laundering and terrorism financing risks in peer-to-peer transactions;
  • updated guidance on the licensing and registration of VASPs;
  • additional guidance for the public and private sectors on the implementation of the “travel rule”; and
  • principles of information-sharing and cooperation among VASP supervisors

Need for International Exchange of Information

As we can see, the challenges faced by states are numerous, and go beyond the strictly fiscal issues.

For the reasons outlined above, I believe that it is a priority for countries to have access to information on these operations, which is why many jurisdictions have already established information regimes. To this end, VASPs are obliged to report their operations both to the organizations in charge of the fight against money laundering and the financing of terrorism, as well as to tax administrations.

The great limitation for states is that they only have the power to demand that subjects residing in their jurisdictions, whether exchanges or VASPs, report operations with crypto assets; they do not have the power to regulate the information regimes obliging nonresident subjects to report such operations.

In short, states do not currently have information on operations carried out through exchanges located abroad, since these do not have an obligation to share information with central banks, tax authorities or other public bodies.

For this reason, the OECD promoted an initiative to collect information on these assets at the national level, in order to exchange it; leveraging the experience of the automatic exchange of financial accounts in accordance with the Common Reporting Standard (CRS), which has been operating since 2017 and has increased year-on-year the number of participating countries, accounts reached, and amounts covered.

Recall that the CRS urges jurisdictions to obtain information about their financial institutions and to automatically exchange this information annually with other jurisdictions. The CRS defines the type of financial information that must be exchanged, the financial institutions called upon to transmit this information, the different types of accounts, and the taxpayers involved, as well as the reasonable common diligence procedures that financial institutions must follow.

The results of the CRS have been very successful since its implementation, enabling the detection of offshore operations and their taxation.

I believe that it would therefore be a good initiative to include operations involving crypto assets within the CRS information regime. If this does not happen, we will continue to see a proliferation of information regimes in different countries, which will also create complexity for parties that carry out operations in many countries.

In the face of global developments such as those we are experiencing, the path of cooperation, collaboration and multilateralism between states is more appropriate than taking unilateral measures. I say this both from the perspective of legislating to regulate and promote the development and digital transformation of countries, and as regards the fight against tax fraud, money laundering, terrorism and other crimes.

I am convinced that today, more than ever, we must continue to advance in cooperation and multilateralism at the international level.

Collaboration between the public and private sectors is also imperative in order to monitor the virtual assets sector and new business models, given their technological dynamism.

Countries should promote faster mechanisms to define legal frameworks, always prioritizing multilateral solutions for the new business models of the digital and tokenized economy that seek on the one hand to enhance them, but also guarantee transparency, security and certainty in terms of their tax legal framework, all with a view to improving the quality of life of citizens.

This column does not necessarily reflect the opinion of The Bureau of National Affairs Inc. or its owners.

Author Information

Alfredo Collosa is a consultant and tutor in Tax Administration at the Inter-American Center of Tax Administrations (CIAT), professor, investigator, author of books and publications, and lecturer. He holds an Official Masters in Public Finance and Tax Administration (UNED-IEF).

The author may be contacted at: aecollosa@gmail.com