Crypto-assets and the OECD
Bitcoin (BTC) has been back in the news again recently, as values surged and continue to fluctuate. Investors are increasingly considering alternative assets, including crypto-assets, amidst the on-going economic gloom.
At the same time, human interest stories circulate about those who have forgotten their access details, such as Stefan Thomas who may be locked out from BTC that has been valued in the region of $220 million if he makes two more password access errors.
However, even horror stories like this do not appear to be putting off potential investors.
Crypto within sights
Crypto-assets have long been a concern for national authorities, due to their perceived opaque nature and the suspicion that they may be associated with tax evasion, money laundering and terrorist funding. The G20 Leaders’ Declaration from the June 2019 Osaka Summit noted that “While crypto-assets do not pose a threat to global financial stability at this point, we are closely monitoring developments and remain vigilant to existing and emerging risks".
The EU has also been taking an increasing interest in this area. Further regulation has always been likely and is potentially even more relevant as values rise and governments are looking to raise funds to pay for Covid-19 relief measures.
The OECD to the rescue
Against this backdrop, the OECD Report: "Taxing Virtual Currencies: An Overview of Tax Treatments and Emerging Tax Policy Issues" noted that measures to date have largely been made on a national level, and that most lack an effective framework for tackling the issues raised. It is an especially difficult area to regulate as it is constantly evolving.
In view of these issues, the OECD plans to introduce an international crypto-asset reporting regime. These rules are expected to be brought in this year, although much of the detail is still awaited.
It is expected that the new regime will follow the Common Reporting Standard (CRS) model. The CRS was approved on 15 July 2014, and since then has been widely adopted. It has been very successful as a transparency measure, providing national authorities with detailed information about financial accounts that they can use to uncover and combat tax evasion. It requires jurisdictions to obtain information from their 'financial institutions' and then automatically exchange the information with other jurisdictions on an annual basis.
How will the regulatory regime operate?
The new regime is expected to require crypto-exchanges to collect Customer Due Diligence (CDD) information on customers that they will then pass to the relevant authorities in the individual's country of residence. Customers are likely to be required to provide additional information when entering into transactions and to give details about their crypto-assets, including values and gains.
What are the potential issues with such a regime?
These measures are expected to increase the running costs of crypto-exchanges, which will be required to implement more detailed systems and bring in the expertise to manage the collection and exchange of information. Such a regime would also represent a major cultural shift in terms of how crypto-asset owners have been treated to date.
One significant challenge is how the OECD intends to deal with crypto-assets that are held personally, in 'cold storage'. Such assets have no presence within the crypto financial system – they are not to be found on crypto-exchanges or in wallets. Rather, they are code which is represented solely on a blockchain, and the OECD has no means of imposing regulation over a decentralised blockchain. The OECD could compel registration of all crypto-assets on crypto-exchanges, a potentially draconian and illiberal action.
Are there any potential benefits?
There is a view such a regime may benefit the owners of crypto-assets. It is hoped that this system would streamline the various national reporting regimes and reduce the scope for tax calculation errors. It should also make it easier for crypto-investors to demonstrate their source of wealth, e.g. when opening a bank account or instructing lawyers.
Limitations of scope
It should be noted that the CRS only applies to cross-border activity. If the new crypto-regime follows normal CRS principles, there will be no reporting if individuals hold their crypto-assets within their country of residence. For example, a UK resident individual holding crypto-assets through Binance Singapore may consider transferring their assets to a UK exchange in order to avoid reporting.
At present, this would ensure HMRC would not have access to their crypto-asset data. However, the UK government has recently launched a public consultation on its regulatory approach to crypto-assets and stablecoins, so the situation may change in the future. In any event, there may be other tax matters to consider before repatriating crypto-assets to the UK.
It will also be interesting to see how the United States, who do not operate within the CRS, respond to the initiatives and whether they will incorporate equivalent measures into their own automatic exchange of information regime ('FATCA').
Will old solutions work for new challenges?
As crypto-assets continue to enter the mainstream – the adoption of BTC within the Paypal system is a recent watershed moment – it is perhaps inevitable that they enter a CRS-style system.
However, the OECD should consider seriously whether the CRS model works for crypto-assets: old solutions do not necessarily work for new challenges. It must appreciate that, with crypto-assets, it is grappling with a different beast to conventional bankable assets.
BTC and similar crypto-assets are ultimately decentralised, and although they are now entering the financial system, it will remain possible for crypto-assets to operate outside the conventional financial system and even the crypto-exchanges. The OECD must determine how it can bring decentralised assets within a reporting regime designed for a centralised system.
Julia Ramsden Gunduz is Counsel and James Brockhurst is a Senior Associate in the Private Client team.