Unveiling the new global Crypto-Asset Reporting Framework: Key components and implications

Published on 12 June 2023 by masternode.one in Research

Introduction

The market of crypto assets is rapidly growing worldwide, presenting new challenges for tax authorities and regulators. In 2014, the OECD (Organisation for Economic Co-operation and Development) developed the Common Reporting Standard (CRS), improving the exchange of tax-related information on accounts held abroad between tax authorities on a global level. This policy increased tax transparency worldwide and improved coordination between countries on issues such as tax evasion and money laundering.

However, since then, the financial markets have evolved rapidly, with crypto assets rising as a whole new component, rapidly growing in popularity and usage. Therefore, the G20, a prominent economic forum consisting of 19 countries and the European Union, requested the OECD to create a framework providing guidelines for tax-related activities regarding crypto assets. This Crypto Asset Reporting Framework aims to provide clear guidelines and harmonize tax-related activities pertaining to crypto assets, enabling tax authorities to better regulate this rapidly growing sector.

While countries are not obligated to adopt the frameworks developed by the OECD, implementation of the organization’s policies is usually widespread. The CRS, for example, has been adopted by over 100 countries. Therefore, we expect that the Crypto Asset Reporting Framework (CARF) will be implemented on a large scale in the future too.

In this article, we delve into the key features and implications of the new Crypto Asset Reporting Framework, shedding light on its significance for global taxation and the crypto ecosystem as a whole.

Why develop such a framework?

The apparent need for the development of a framework regulating tax-related activities pertaining to crypto assets stems from the decentralized character of crypto assets. Crypto assets can be transacted and stored without reliance on conventional financial intermediaries or centralized administrators, who are usually the ones to report on tax-related information to the relevant authorities. The elimination of these parties in the decentralized crypto asset ecosystem results in diminished visibility for tax authorities into the tax-related activities within this sector. This poses challenges for the verification and assessment of tax liabilities and decreases global tax transparency, an issue that the Common Reporting Standard was designed to address. Therefore, the decentralized character of the crypto asset markets has given rise to the need for a framework addressing tax-related activities within this sector, in order to safeguard tax transparency, keep up with anti-money laundering standards, and reduce the risks that crypto assets are used for illegal activities and tax evasion practices.

The CARF aims to reach these goals by providing a framework for the automated exchange of tax-relevant information on crypto assets.

The main components of the Crypto-Asset Reporting Framework

The CARF consists of four key components:

The scope of crypto assets to be covered under the policy
The individuals and organizations that are obligated to comply with the reporting requirements
The type of transactions that are to be reported, along with the information that needs to be included about these transactions
The due diligence procedures regarding identifying crypto asset users and determining relevant tax jurisdictions

In addition to the development of the CARF, amendments to the CRS have been proposed and approved, which include extending the scope of this regulation to include certain electronic money products, Central Bank Digital Currencies, and indirect investments in crypto assets through derivatives and investment vehicles.

Scope of crypto assets to be covered by CARF

The first component of the CARF outlines the scope of the crypto asset to which the reporting requirements will apply. In its definition, the CARF distinguishes crypto assets from other financial products by their use of cryptographically secured distributed ledger technology. The definition revolves around assets that someone can hold and transfer in a decentralized manner, including stablecoins, certain NFTs, and derivatives issued in the form of a crypto asset.

The OECD report also mentions that the CARF can be applicable to new financial products resembling crypto assets emerging in the future, thus preventing new ways of tax evasion by the development of new products.

Entities obliged to follow reporting requirements

Entities or individuals who engage in business activities that facilitate the exchange of relevant crypto assets for or on behalf of customers would fall under the category of Reporting Crypto-Asset Service Providers as outlined in the CARF. The OECD expects these intermediaries and service providers to possess the most comprehensive access to the value of the relevant crypto assets and the exchange transactions conducted with these. In addition to exchanges, this definition encompasses other intermediaries and service providers offering exchange services, such as brokers and dealers involved in relevant crypto-assets. The CARF also incorporates provisions to prevent redundant reporting in situations where a reporting crypto-asset service provider has connections with multiple jurisdictions, achieved by establishing a hierarchy of nexus rules.

Reporting requirements

As a third component, the CARF outlines three types of transactions that will be seen as relevant transactions for reporting obligations:

Exchanges between relevant crypto assets and fiat currencies;
Exchanges between one or more forms of relevant crypto assets;
Transfers of relevant crypto assets.

The framework states that transactions of crypto asset to crypto asset should also be reported in fiat currency.

Due diligence procedures

Finally, the CARF extends due diligence procedures to relevant crypto assets and related activities, focusing on transparency of crypto asset accounts and determining relevant tax jurisdictions. The CARF outlines the procedures that reporting crypto asset service providers must adhere to in order to effectively identify their crypto asset users, ascertain the appropriate tax jurisdictions for reporting purposes, and collect the necessary information essential for meeting the reporting requirements stipulated by the framework.

Possible implications for crypto asset markets and related businesses

The implementation of the Crypto Asset Reporting Framework could have several implications for the crypto assets market, particularly in terms of financial consequences and the usage of crypto assets.

Financial consequences

The CARF’s implementation is likely to introduce greater transparency and accountability to the crypto assets market. By requiring reporting crypto asset service providers to identify users, determine tax jurisdictions, and collect relevant information, the framework aims to enhance the ability of tax authorities to assess and regulate tax liabilities associated with crypto assets. This increased scrutiny may lead to more accurate reporting and assessment of taxes, potentially resulting in financial consequences for both individuals and entities involved in crypto asset transactions. It may also deter tax evasion and illicit activities, ultimately fostering a more regulated and compliant crypto assets market.

Possible effects on the usage of crypto assets

The introduction of the CARF could have mixed implications for the usage of crypto assets. On one hand, the framework’s reporting requirements may deter some individuals or entities seeking to engage in crypto asset transactions to evade taxes or engage in illicit activities. This could potentially lead to a decrease in usage among those who prefer anonymity and freedom from traditional financial regulations, whether this be for illegal activities or more legitimate reasons.

On the other hand, the CARF’s implementation may also increase confidence and trust among individuals and institutional investors who prioritize compliance and transparency. This increased trust could result in a broader adoption of crypto assets, as they become viewed as a more legitimate and regulated investment or transactional option. The increased clarity about tax and reporting requirements can also persuade people and institutions to start activities on the crypto asset market.

Tension between CARF and the ideology behind decentralization

The increased supervision by tax authorities that is implied by the CARF can raise questions about the values of individual freedom and anonymity around which many major crypto asset networks revolve. One of the main reasons behind the development of decentralized markets is to eliminate the need for a trusted third party, thus also preventing the risk of fraud and censorship. Increased surveillance does not quite align with these principles. The framework’s requirements for identification, tax jurisdiction determination, and data collection may be seen by some as infringing upon the principles of decentralization, as they introduce a level of centralized oversight and control. However, proponents of the CARF argue that it is essential for governments and regulatory bodies to establish frameworks that balance the need for oversight with the protection of users’ interests, including investor protection, consumer rights, and combating financial crimes. Striking this balance is crucial to ensure the long-term viability and acceptance of crypto assets within the existing financial system.

It is up to individual users and organizations looking to get into crypto assets to decide whether increased regulation fits their needs and desires. Overall, clarity on guidelines and rules for crypto assets can prompt new investments and innovations in a safe environment.

Conclusion

The development of the Crypto-Asset Reporting Framework marks an important step towards enhancing tax transparency and regulation within the rapidly growing crypto assets market. By addressing the challenges posed by the decentralized nature of crypto assets, the CARF aims to provide clear guidelines and harmonize tax-related activities, fostering a more regulated and compliant ecosystem. However, the increased supervision and centralized oversight introduced by the framework may be seen as conflicting with the principles of individual freedom and anonymity that underpin many major crypto asset networks. Striking a balance between regulatory oversight and the principles of decentralization is essential to ensure the acceptance and long-term viability of crypto assets within the existing financial system.

Ultimately, the implementation of the CARF will have implications beyond the financial and regulatory aspects. It will shape the future of the crypto assets market, influencing user behavior, technological advancements, and international coordination. It is important for policymakers and regulators to strike a balance between regulation and the principles of decentralization, ensuring that the benefits of decentralized currencies are not compromised while addressing legitimate concerns such as tax evasion, money laundering, and investor and customer protection.