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DAC8 is Coming—What Crypto Stakeholders Need to Know and Do

March 24, 2022, 7:00 AM

Crypto technologies are much more than secure payment and investment mechanism enablers. They are seen as vital to a much broader “Web3”-based digital future. In this new digital economy, digital assets, decentralized finance, blockchains, smart contracts, tokens, and decentralized autonomous organizations work together in innovative ways—enabling new forms of human collaboration and value exchange. These include new ways of establishing, owning and participating in business, all with the promise of significantly lower costs, greater security, larger equity, and far wider participation.

It is worth noting that the global crypto market includes everything from crypto mining companies to hardware wallet providers, payment networks, blockchain-enabled businesses, venture capital firms, marketing and media firms, and other players.

Balancing Risk and Reward

The rise of the crypto industry is driving governments to adapt and create regulatory frameworks that help deliver these promised rewards, while minimizing the potential risks.

Most governments—at least progressive ones—understand the huge potential for crypto to drive economic activity, increase innovation, and broaden inclusion, especially in countries with populations that have not traditionally been able to engage in global commerce or service provision.

On the flipside, governments are naturally concerned about possibly significant risks from a growing crypto economy. Tax authorities, in particular, are concerned about the potential for crypto technology to reduce transparency and enable tax evasion or fraud.

The decentralized nature of blockchain-based finance—which bypasses traditional, centralized financial institutions—makes it much harder for authorities to see and assess transactions that would ordinarily trigger some form of reporting, and taxation, when performed using a fiat currency.

Governments are therefore having to grapple with pressing issues around the application of taxes. They are concerned that the absence of a clear taxation framework for cryptoassets has the potential to fuel risk, upset markets and create unfair tax competition between different jurisdictions.

Europe Taking a Regulatory Lead

Perhaps the most significant of the current initiatives to address these issues is a proposal from the European Commission called the Directive on Administrative Cooperation 8. DAC8, as it is known, will be much broader in scope than current EU regulations, giving financial authorities new options for taking action against tax evasion or fraud, and is expected to be implemented within 12 to 18 months.

One key challenge right now is that EU member states apply different rules—or no rules at all—in relation to cryptoassets and any relevant tax payment or disclosure of ownership. This raises the risk of under-reporting of taxable income, and consequential revenue losses.

It is with this risk in mind, together with a lack of transparency and risk of money laundering, that the Commission has decided to take more definitive action.

DAC8 is the latest in a number of global and regional initiatives that improve or seek to improve the monitoring and reporting of transactions involving cryptoassets, and to implement anti-money laundering (AML) screening.

In 2015 and 2019, the G-7’s Financial Action Task Force (FATF) updated its guidance for a risk-based approach to virtual assets and virtual asset service providers (VASP); for example, by amending its Recommendation 15 and introducing definitions for virtual assets and VASP. In March 2021, the FATF suggested adopting a similar approach to that applied in traditional finance, including the mandating of know-your-client (KYC) and AML laws.

At the EU level, the fifth AML Directive (AMLD V) does not refer specifically to virtual assets, but only to virtual currencies—a narrower definition, which is due to be revisited. The September 2020 proposal for an EU Regulation on Markets in Cryptoassets (MiCA), includes a definition of cryptoassets as follows: “a digital representation of value or rights which may be transferred and stored electronically, using distributed ledger technology or similar technology.”

Defining the Shape and Scope of DAC8

In March 2021, the Commission launched a public consultation designed to strengthen its rules on administrative cooperation, and expand the exchange of information on e-money and cryptoassets. This public consultation closed in June 2021, and the findings will feed into DAC8 over the coming months.

Regulating such a fast-changing and multi-faceted environment as the crypto industry is a complex and challenging task. One of the main purposes of the consultation was to build a detailed map of crypto market stakeholders to understand exactly who is involved, what kinds of activities they perform, and how member states are currently defining cryptoassets to apply the relevant tax provisions.

The consultation involved a thorough examination of the crypto ecosystem. It collected vital information about the types of cryptoassets used by service providers, where such providers are registered or licensed, the size of investments, and the tax residency of the cryptoasset service providers.

The consultation also looked into the reporting obligations imposed by EU member states on cryptoasset service providers. Some countries have already imposed, or are planning to impose, reporting obligations. However, as the consultation documentation points out, having different national approaches across the EU would likely lead to extra administrative burdens for cryptoasset and e-money service providers.

This is why the Commission asked interested parties whether they thought cryptoasset service providers should be subject to reporting obligations, whether the same reporting obligations for tax purposes should be adopted throughout the EU, what would be the main challenges faced by the providers, and whether all entities should be subject to the same set of reporting rules—or whether some exemptions should also be introduced.

The ultimate goal of DAC8 is to limit opportunities for bad actors to take advantage of potential loopholes in cryptoasset-related legislation, while also avoiding any negative impact on innovation in nascent sectors or small businesses through excessive compliance and administrative burdens.

Where Next?

Cryptoassets are already a global phenomenon. Strengthening cooperation at both the global and regional levels will certainly help to avoid the under-reporting and non-reporting of income derived from such assets.

More specifically, DAC8 will need to help deliver a comprehensive and coordinated approach that encompasses all the actors involved, whose role in facilitating cryptoasset exchange is already central to the AMLD V and MiCA proposals. The use of public consultations, not just for DAC8 but also for the FATF guidance update, reveals a growing awareness by legislators and regulators that they need to engage with the stakeholders in this evolving ecosystem in order to apply the appropriate level of regulation.

Whenever DAC8 is implemented, it will have far-reaching implications for cryptoasset owners—both corporations and individuals—as well as cryptoasset creators and distributors. It will likely entail a host of additional regulatory requirements, new KYC and reporting requirements for cryptoasset service providers, and new disclosure obligations for cryptoasset owners.

Organizations active in this sector now need to ensure they are ready for this new regulation.

Planning Points

The first thing individuals and companies in the crypto industry will need to do is to conduct an assessment to identify whether they fall within the scope of DAC8.

The next step will be to identify their exact obligations under the new regulations, and the implications for their day-to-day operations.

Following this, it will be imperative to prepare an action plan for the implementation of robust compliance and reporting processes. These will likely include measures for KYC and AML, to help ensure the collation and high-quality reporting of the required data, transparently and accurately.

Day to day, it will be important to keep a close eye on evolving regulatory developments, in order to stay ahead of the curve, maintain compliance and keep surprises to a minimum.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Rodrigo Calleja is International Head of Regulatory & Compliance Solutions at TMF Group.

The author may be contacted at: rodrigo.calleja@tmf-group.com