- Crypto industry experts charge that the CARF is not proportionate and does not reveal how it will use information collected by crypto service providers
- Exchange of identity information exposes individuals to privacy leaks as the information can be revealed.
- Identity information can leave wallets vulnerable to theft of crypto assets.
- CARF needs to be accommodative towards early-stage start-ups.
- CASPs may find it difficult to report a bulk of retail transactions despite a threshold.
- Gathering data on wallet addresses can be turned into a tool of mass surveillance.
“What’s proposed in the CARF (Crypto-Asset Reporting Framework) is not proportionate, and it’s unclear what the information that’s being asked to be collected will be used for,” Liz Chien Head of Global Tax, Protocol Labs, said in a panel discussion held by the Organisation for Economic Co-operation Development (OECD).
The panel had gathered to deliberate upon the proposed due diligence and reporting requirements under the CARF, valuation methods for reporting crypto transactions and reporting with respect to wallet addresses, transfers, and what kind of retail payment transactions should be reported by service providers. .
Paul Hondius, Senior Adviser, International Co-operation Unit, International Co- operation and Tax Administration Division, OECD Centre for Tax Policy and Administration, moderated the session which saw participation of the following panellists:
- Lauren Griffin, Head of Tax Transparency, HM Treasury, United Kingdom
- Corné Plooy, Software Developer, Bitonic
- Andreas Rohrer, Tax Specialist in Banking at Swiss Bankers Association
- Jamison Sites, Blockchain/Digital Assets Tax Lead and Financial Services, Senior Analyst, RSM US LLP
The panel discussion was held as part of the public consultation meeting put together by the OECD to discuss feedback including concerns on CARF which was floated in March this year.
OECD is one of the most influential economic bodies in the world with over 35 countries as members including the US, UK, and several European nations, among others. The decisions taken by OECD have global implications and serve as a critical blueprint for emerging economies like India.
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What are the issues with CARF’s reporting rules?
Develop tax slabs first: Chien said that the regulators should develop coherence around the substantive tax treatment before coming up with the reporting rules. “The reporting rules should not precede the framework on substantive tax treatment because unless you know what’s taxable or not in the country, it’s hard to know what data would be useful to help assess whether taxpayers in that jurisdiction are in compliance or not in compliance,” Chien added.
CARF is proportionate to its aims: Griffin clarified that the reporting information requested focuses on identifying risks of tax noncompliance, not calculating tax liabilities, at its core. “Crypto is a digital sector with customer relationships that are primarily online. It’s based on transactions, and most importantly, is rapidly evolving. It’s necessary that the new framework be bespoke to the sector. (A) CRS (Common Reporting Standard) approach will not be sufficient for us to assess tax noncompliance risks; it’s (CARF) proportional to the aims of the framework,” Griffin said.
Potential privacy concerns: Sites said that a lot of these transactions are on chain and the only thing hidden is the identity. “They’re public. You can go into a Block Explorer and see wallet balances and transactions. And if that identity were to leak out, those (wallets) are permanently and forever compromised, and there are (steep) transaction costs associated with moving balances out of those wallets. It’s not like there’s a master of Bitcoin that can just hit a reset button and give everyone a new address,” Sites explained.
Vulnerable to thefts: Plooy added that crypto assets are sensitive to theft and robberies. “Let’s suppose somebody got access to your bank account and moved all the funds to his own account then the identity of the thief would be quickly known and maybe the transaction could be reversed. But when somebody robs bitcoins, they can take the bitcoins to an address that has no identity attached to it or no known identity. So when it gets publicly known that a certain person holds a large amount of crypto assets, there’s a real risk of violent robberies,” Plooy cautioned.
Exclude reporting of certain assets: Sites said that it is a bit difficult to report transactions in the decentralised context. “It gets more and more complicated as you start talking your way down (to) NFTs and other decentralised protocols that don’t necessarily operate as an exchange. You can capture 95 per cent of it in the centralised context. It would be helpful if there is some safe harbour or ability to flag why certain things aren’t reported,” he proposed.
Crypto and traditional finance are different: Griffin reiterated that there is a difference between the traditional financial services and the crypto sector. “You only need to read recent news reports to see the level of volatility in the crypto market. We’re trying to develop a framework which works for business but also gives us enough information to assess tax compliance,” Griffin countered.
Burden of costs of compliance: Chien recommended that the regulators should look at the size of the company before deciding upon the timing of implementation of these rules. “There are still a number of different participants coming into the industry whether it’s infrastructure providers or just other participants. They’re already regulated under local rules. These regulations oftentimes require the pledging or the keeping of reserves. It becomes difficult for a lot of early-stage intermediaries to either pledge reserves or to pay an external software provider to be fully compliant with these rules,” she added.
Limit scope to exchanges: Chien added that concerns surrounding tax compliance and transparency should be addressed by focusing on the points where people use these assets in a meaningful way. She said that these points rest with CASPs. “They’re essentially the points where people (avail) on ramp and off ramp (services) and there will be reporting at that point already. People are not going to be transacting amongst each other via self-hosted wallets in the vast majority of cases,” she explained.
What was the idea behind denominating transactions in crypto and fiat?
The draft of the CARF stipulates that the intermediaries have to report transactions both in crypto and fiat denominations. Griffin elaborated that having the value both in fiat and crypto is integral to making information useful.
“The value of crypto fluctuates, and without the fiat representation, it would be difficult to understand the scale of possible non reported taxable events in that reporting year. Liquidating digital assets into fiat currency is relatively straightforward, and many crypto asset exchanges such as Coinbase, Binance, or Kraken, enable users to exchange crypto assets for fiat currency. it is reasonable for intermediaries to maintain valuations on the equivalent via currency fair market values of crypto assets,” she added.
‘Valuation of crypto assets into fiat currency may not reflect actual value’
Chien countered that there are sometimes delays in settlement from the time of a transfer to the recipient. It is one of the reasons why, according to her, fiat translation may not actually say much about the actual value of a transaction whereas reporting of the quantity itself would be more accurate.
“You don’t need a fiat equivalent if the purpose of this framework is to assess risk and whether (there is) tax compliance. You just need to know that somebody is holding balances of crypto, and those balances of crypto have changed throughout the course of the year,” Chien added.
‘Reporting retail payments will be difficult’
Griffin explained that the CARF applies to certain instances where a CASP processes payments on behalf of a merchant accepting crypto assets in payment for goods or services.
“In such instances, the CASP is required to also treat the customer of the merchant as its customer. So the CASP would report the aggregated retail payments that the merchant receives from customers in addition to reporting on any other activity the merchant conducts using CASP as part of the wider reporting requirements,” Griffin outlined.
Tax authorities are keen on retail payments: “I want to reflect that retail payments are of interest to tax authorities. We also wanted to keep this a proportionate framework and do not think it would be desirable to have every retail payment transaction reported. We have drafted a de minimis threshold so that only retail payments above this (threshold) are reported. The crucial point that I want to bring out with this threshold is that it’s not an aggregated threshold but applies to the value of each individual retail payment,” Griffin explained.
Concerns flagged by experts
CASPs do not get identity information: Plooy flagged the proposal as difficult and expressed the industry’s inability to carry out the exercise. “…the customer of the merchant is not a customer of the CASP. They don’t have identity information. How are they supposed to get this (data)? You cannot send metadata like identifying information with crypto transactions. You would have to build some sort of infrastructure next to the transaction infrastructure to communicate this identity information from the source to the destination. It could be a privacy issue.,” he added. Plooy also pointed out that most customers use a private wallet for merchant payments. “There is no service provider who is going to send information. The customer could send this information himself, but you don’t know if you can trust that information. I don’t see how this is going to work.” he said.
Can stifle innovation: “…what I’d hate to see happen here is regulation being such a high bar that it stifles innovation and new business start-ups, as well as being used by incumbents to protect their lead. Why do we not see a lot of people using Bitcoin to buy coffee? It’s still early. The World Bank chart came out and showed that if you overlay crypto adoption and growth over the internet, we’re in 1998 right now,” Sites said, suggesting that the regulation must carve out some exceptions for start-ups.
‘Reporting wallet addresses can lead to mass surveillance’
Chien said that if these identities are linked to certain wallet addresses through software, one can create a map of people’s social networks and interactions. “There are many places around the world, coupled with the right software and automation, that could (use) this information as an instrument of mass surveillance,” she cautioned.
Griffin explained that the provision on external wallet addresses can help tax authorities know when users have transferred their assets onto a non-reporting CASP or a cold wallet. She explained that the CASP will only have to submit reporting of wallet addresses where they are not attributed to a CASP in scope.
Harms outweigh potential benefits: Chien explained that the data in wallet addresses contains all transactions from the beginning. “It’s not just a matter of getting transparency into the transactions of a particular wallet address. You have access to trace backwards and (identify) every other account that has ever paid into or out of that wallet address. This illustrates how much detailed information is there, and not just for a particular snapshot in time. We need to weigh the benefits of encouraging transparency on tax compliance versus the potential harm and danger of providing this level of detailed transactional information,” Chien warned.
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