New global tax reporting rules could soon extend to cryptocurrencies, non-fungible tokens (NFTs) and decentralized finance (DeFi), but some worry that the inflexible framework of the Organization for Economic Co-operation and Development (OECD) could restrict a sector that is still rapidly evolving.
Proposals put forward by the international organization in March would require details of crypto holdings to be shared with foreign tax authorities. But blockchain and tax experts have told CoinDesk they are concerned the rules are neither well aligned nor well coordinated with other waves of regulation that will hit the sector.
The OECD, which sets international guidelines on key tax issues, wants new rules to prevent tax evasion by anyone trying to hide their Bitcoin (BTC) abroad, along the lines of procedures already in place for foreign bank accounts.
In a March consultation paper, the OECD proposed that crypto providers report to authorities any crypto transaction, such as exchanging bitcoin for fiat. This information would then be sent back to the tax authority in the owner's country of residence. The OECD also proposes to extend existing banking regulations to new payment instruments such as electronic money and central bank digital currencies.
It is easy to see how even well-intentioned changes aimed at conventional financial transactions involving regulated intermediaries could fail because of the realities of distributed ledger technology. Recent controversies over the application of money laundering regulations designed to curb dirty money by making crypto users prove their identity to non-hosted crypto wallets are a case in point.
At a meeting scheduled for May 23 in Paris, some industry advocates will argue for a rethink of the plans, which they say could stifle growth, while others simply hope the rules can be streamlined to avoid too much administrative burden.
The OECD's proposal to extend the existing information exchange system to virtual assets was expected and, in some cases, welcomed. Tax authorities want to ensure that cryptocurrencies are treated the same way as Swiss bank accounts - once famous for their absolute discretion, but no longer.
It's clear why officials might be concerned. According to a May 11 research note from Barclays (BCS), only about half of crypto taxes due in the U.S. are declared correctly. The note estimates the country's crypto tax deficit at about $50 billion, or 10% of the total amount missing from the Internal Revenue Service. In a speech on May 17, U.K. Secretary of State Lucy Frazer welcomed the OECD's plans.
However, some were surprised at how far the OECD wants to extend existing measures beyond ownership of currencies like Bitcoin and Ether (ETH) to the Web 3 space - in a way that is seen as unfair and potentially harmful.
"What they are proposing is very burdensome regulation, much more so than for the traditional sector," Luzius Meisser, founder of the Bitcoin Suisse association, told CoinDesk. "This is an unfair burden on the crypto sector."
Applying the rules to non-fungible tokens is difficult to do because, unlike gold or stocks, you don't always know the value of a given token at a given time, he said. But that also means your Bored Apes will be treated differently than their offline equivalents, because a regular art collector wouldn't see their paintings reported to the authorities under the current rules.
It's even worse when the rules are applied to rapidly evolving and therefore less well-defined sectors like decentralized finance.
"Their DeFi rules are based on vague definitions, which of course hurts legal certainty," Meisser said.
"There is a strong tendency to control everything," he said, with corresponding costs to economic growth. "The various obstacles and frictions created by this type of regulation are particularly harmful to innovative sectors."
Poorly thought out
Regulators often run into trouble when they try to apply old rules to a new sector - and this is no different. Tax reporting conventions rely on the assumption that there is an intermediary, namely a bank, to identify and report customer data to the authorities. But in the crypto world, that's not always the case.
One problem the OECD wants to address. "The ability of individuals to hold cryptoassets in wallets that are not linked to any service provider, and to transfer such cryptoassets across national borders, creates a risk that cryptoassets will be used for illicit activities or to evade tax obligations," the Paris-based organization said in its March 22 consultation document.
In countries like the European Union, lawmakers have already been tangled up trying to figure out how to apply anti-money laundering rules to wallets whose custody is not provided by a regulated crypto-asset service provider.
Equally unclear is what should happen to the tax - for example, in cases where a person uses a non-hosted wallet to make a small payment in a store.
"The most ill-conceived requirement is that service providers like BitPay are responsible for identifying everyone who buys something from one of their affiliated merchants," Meisser said.
"You don't want to send in a copy of your passport and fill out identification forms just because you buy a piece of bread," he added. "That's completely unrealistic."
The OECD's Common Reporting System (CRS), which takes the form of the Foreign Account Tax Compliance Act (FATCA) in the U.S., was introduced nearly a decade ago to make it harder to hide foreign interest and dividends from the taxman.
Although the OECD includes the major developed countries, it has also persuaded countries like the Cayman Islands and Liechtenstein, which are small but important for tax evasion, to join.
At least part of the motivation for the OECD's work is to ensure that cryptocurrencies don't become a loophole that renders these rules meaningless - and that's welcomed by banks, which bear the brunt of administering the current system.
"It makes perfect sense for there to be a level playing field and for the CRS to be expanded," Roger Kaiser, a senior policy advisor at the European Banking Federation, told CoinDesk.
"To some extent, a loophole in the reporting framework can be seen as unfair competition," he said. "The loopholes have to be closed, otherwise there is no point in imposing such requirements."
But exactly how to do that is still up in the air. Kaiser hopes it doesn't mean creating new overlaps or inconsistencies - not least because banks no longer see crypto as a competing financial system, but as something they need to come to terms with.
"I can already see the difference from the positioning we had a year ago," Kaiser said. "Then we were talking about potential competitors, and now we're thinking about whether this new framework can affect us as a provider."
The worst outcome would be the creation of a new parallel system that repeats itself without repeating itself exactly - meaning banks, for example, would have to follow slightly different procedures to certify their customers' identities depending on whether they hold crypto or fiat.
Welcome.
Tax experts seem to agree that the new rules are necessary, and see them as part of integrating cryptocurrencies into the mainstream economy.
"In my world, there's a strong desire to bring this [cryptocurrency] into the fold, to make sure that it's ethical, that it works, that people trust it, that there are consumer protections and that there's no money laundering associated with it," Grant Wardell-Johnson of KPMG told CoinDesk.
With the Financial Action Task Force already setting money laundering standards and other international bodies potentially looking at areas such as financial stability and consumer protection, Wardell-Johnson hopes to see a more unified approach.
"If you end up with a multitude of regulations for each of these areas, multiplied by many regions and countries, it becomes a nightmare," said Wardell-Johnson, who is responsible for global tax policy at the accounting firm.
Different regulators "are at different stages and have different ways of thinking," Wardell-Johnson said. "You have to try to have consistent definitions, and if there is a reporting requirement, then that information should be able to be used as much as possible for other reporting requirements to avoid duplication.
In some areas, he notes, tax standards are in open conflict with innovations like DeFi. Where you're taxed often depends on where you're located or registered, but that's hard for a nebulous software protocol to determine. Wardell-Johnson suggested simply changing the rules to focus on where a decentralized autonomous organization's (DAO) customers are located.
But that's just another example of how crypto technology can't always be reconciled with conventional regulations - and how blockchain can mess with public sector procedures.
That can be a risk - sharing crypto data is more vulnerable to hacking and therefore needs to be better secured, Wardell-Johnson said - but smart regulators can also harness the power of public ledgers by allowing tax collectors to directly verify crypto wallet addresses, for example.
The OECD plans say that "if a country requires it, users' addresses should be reported so they can track the flow of your funds on the blockchain," said Meisser of Bitcoin Suisse. "This is the only idea in the proposal that leverages the openness of blockchain technology."
"It sounds like a privacy nightmare," he said. "But I think it would be more desirable than forcing decentralized protocols into traditional structures and thereby destroying the value of disintermediation."
Meisser goes beyond purely technical quibbles to question whether the OECD's entire approach isn't an overreaction, tantamount to imposing special rules to monitor Apple (AAPL) shares - which, he notes, have a larger market capitalization than the entire crypto universe.
"Cryptocurrencies are still very far from taking over the financial system," he said. "So the fear that cryptocurrencies could be used to hide wealth on a global scale is unfounded."
Detax
Meisser argues that it would be better to eliminate taxes on cryptocurrencies altogether, as the U.S. did with sales taxes on e-commerce in the 1990s, instead of imposing new, intrusive regulations. However, a global consensus on a zero tax rate seems a long way off: even agreeing on a framework for the treatment of cryptocurrencies would be a difficult undertaking.
"Can we reach an agreement for all countries on the taxation of cryptocurrencies? ... Certainly not for a very long period of time," Wardell-Johnson said, referring to the wide variation in approaches noted by the OECD in a 2020 report.
Some have argued that the OECD should wait until there is more clarity on the substantive tax rules in each country before it blasts taxpayers for miscalculations.
That's already the case in some cases - such as the German guidelines released Wednesday that set out the tax rules for mining currencies, lending bitcoin or redeeming utility tokens - but not yet everywhere.
"The tax treatment of crypto assets can either be unclear to users or poorly understood, depending on the maturity of their national tax authority," lobby group Global Digital Finance (GDF), whose members include Coinbase (COIN) and the London Stock Exchange, said in a written submission to the OECD.
"Collecting information on users without establishing a clear tax treatment of assets is likely inherently unfair to taxpayers," it added.
That plea follows unexpected surprises in countries such as the U.K., where a recent guidance document on how the tax authority plans to treat DeFi lending led to an industry outcry.
Meisser agrees that the OECD shouldn't rush into anything and that it would be better to delay the rules until they no longer disproportionately harm the sector.
So far, progress has been relatively slow-perhaps because tax officials have been busy with much more far-reaching reform of the international corporate tax rules. Even after an agreement is reached, it would take banks several years to put the new crypto rules into effect, Kaiser said.
But the issue of crypto taxation is not going away, and once the rules are in place, we could be stuck with them for a very long time.
"Once the OECD definitions are in place, it's very hard to change them around the edges," KPMG's Wardell-Johnson said, adding that any attempt to make the rules more flexible now could also make them less legally certain.
"It will be difficult to future-proof this," he said.
In the fast-paced world of Web 3, that could be a big problem.