CryptoUK and Members respond to the OECD public consultation as it seeks input on new tax transparency framework for crypto-assets and amendments to the Common Reporting Standard
We are grateful for the opportunity to respond to the OECD consultation on the proposed Crypto-Assets Reporting Framework (CARF). We have not commented on the proposed amendments to the Common Reporting Standard.
CryptoUK is the UK’s trade association representing the digital asset sector. Our members, composed of leading companies from across the sector, believe that crypto and digital assets can help enhance the way we undertake financial transactions, to the benefit of consumers, business and security. We are working to help educate policy makers and regulators about the crypto and digital asset industry, and to work with them to develop a balanced and fit-for-purpose regulatory framework for the UK and Europe. Our members believe that by working together with policy makers and with each other, we can ensure that the UK fulfils its potential to be a global leader in this exciting new industry.
You can read the full response below, or download a PDF version here.
Crypto-Asset Reporting Framework – SECTION 1
Crypto-Assets in scope
1. Does the CARF cover the appropriate scope of Crypto-Assets? Do you see a need to either widen or restrict the scope of Crypto-Assets and, if so, why?
As currently drafted, the scope of CARF is likely to be far wider than the CRS.
In particular, NFTs which reflect certain underlying assets will be reportable even where the underlying assets would not otherwise be reportable under CRS.
NFTs which cover artworks, property, domain names, rights in intellectual property such as music etc will be reportable under CARF where they are a representation of value. However, these asset classes would not typically be reportable where they are held by investors today. We believe that CARF should be used to achieve a level playing field with financial services, and a look-through to the underlying assets would be a more appropriate basis to determine the reportability of NFTs.
Despite a very limited number of highly publicised NFTs purchased for high values, the overwhelming majority of NFTs are and will remain close to worthless. NFTs can be generated (“minted”) today almost as easily as writing an email or sending a text message. As the NFT technology evolves and the consumer adoption broadens, the ownership of digital objects in the form of NFTs should become common to anyone with an internet connection. As most of the NFTs are expected to have little to no economic value they pose extremely limited ML/TF risks. Whilst there will be numerous practical and desirable applications of NFTs, whether for consumer brands to promote digital identity or access, regulatory measures aimed at a tiny minority of NFTs with meaningful impact should not be applied across all the broad categories of NFTs thus potentially thwarting development of this nascent innovative technology.
We, therefore, recommend:
- capacity building by regulators with regard to understanding of the diverse NFT landscape;
- the development of a taxonomy, in coordination with subject matter experts, to promote a common and proportional understanding of NFTs in their diversity; accompanied with
- an educational approach, in order to promote awareness of the benefits and risks amongst the NFT creators, buyers and sellers, the marketplaces, and the regulators.
In addition, we note that the acquisition of Crypto-Assets for fiat currency is reportable under the proposed rules. Since the acquisition of assets with fiat currency should not be a taxable event, we are of the view that it is not appropriate to include that in reporting requirements.
2. Does the definition of Closed-Loop Crypto-Assets contain the correct criteria for identifying Crypto-Assets that operate in a closed-loop environment?
It is likely that the definition of Closed-Loop Crypto-Assets is too narrow to be of practical use – and so a number of current and potential uses of blockchains as part of a wider business will be caught unnecessarily based on the requirements.
Our members have found it difficult to find real world examples which would be covered by the definition as currently drafted. In particular, because of the nature of Crypto-Assets which are by definition decentralized and permissionless, there will seldom be restrictions which prevent the holder of a utility token from transferring it to a third party.
We would suggest that the definition of a Closed-Loop Crypto-Asset should include as a minimum:
- provision for customer to redeem directly from the vendor
- provision for the Closed-Loop Crypto-Assets to be exchanged for other Closed-Loop Crypto-Assets within the same ‘loop’
- provision for the Closed-Loop Crypto-Assets to be exchanged for other Closed-Loop Crypto-Assets, provided that all such assets meet the definition
However, we are of the general view that the exclusion is likely to be of limited benefit where tokens are written on existing blockchains and it would be preferable for the OECD to restrict the scope of reporting on tokens based on the underlying purpose of the token rather than its features.
3. Are you aware of existing types of Crypto-Assets, other than Closed-Loop Crypto-Assets or Central Bank Digital Currencies that present a low risk from a tax compliance perspective and should therefore be excluded from the scope?
- Large number of NFTs – see below….
- Secure record of ownership.
- Credentials/Identity.
4. An NFT is in scope of the FATF Recommendations as a virtual asset if it is to be used for payment or investment purposes in practice. Under the Crypto-Asset Reporting Framework, an NFT would need to represent value and be tradable or transferable to be a Crypto-Asset. On that basis it is expected that relevant NFTs would generally be covered under both the CARF (as a Crypto-Asset) and the FATF Recommendations (either as a virtual asset or a financial asset). Are you aware of any circumstances where this would not be the case, in particular, any NFTs that would be covered under the definition of Crypto-Assets and that would not be considered virtual assets or financial assets under the FATF Recommendations or vice versa?
As noted above, the scope of digital assets reportable under the CARF is likely to be far wider than the scope of assets under CRS.
The approach adopted in the CARF is also likely to be wider than that under FATF. Whilst the FATF rules require a digital asset to be used for payment or investment purposes in practice, the CARF only requires that assets represent value.
NFTs are not written in isolation, and are typically written using specific protocols on existing blockchains. In addition, since NFTs are typically transferrable, they will typically have a value even where they are not held for investment purposes. In some cases, the value of NFTs may vary significantly within that NFT ecosystem – for example where the NFT represents underlying digital assets for gaming or domain names, there may be a large number of NFTs with a low value but with some NFTs having higher value based on rarity etc.
In a number of circumstances, it may therefore be difficult to determine whether an NFT is held for investment purposes or not, based on any value ascribed. This could lead to uneven application between CASPs, or between jurisdictions.
We believe that the OECD should overall seek to establish a level-playing field with financial services. As noted in Q1 above, we would recommend a look-through approach to the underlying asset to ensure that there is a level-playing field with CRS. If there are concerns over NFTs that are distinct from concerns over the underlying assets, it would be helpful for the OECD to have an open forum with industry to discuss the issues and how they might be addressed through reporting.
In addition, the market for NFTs is new and rapidly evolving. There is a risk that rules written to require reporting which are finalized in 2022, may already be outdated by the time the CARF comes into force, or that the rules may stifle innovation in the NFT market in adopting countries. The OECD could consider a phased approach to the introduction of reporting rules, which would first require reporting of cryptocurrency to fiat transactions and potentially cryptocurrency to cryptocurrency transactions. Transactions in NFTs could be subject to reporting from a later date which would allow time for the market to mature and a better understanding of the tax risks involved in NFT ownership.In addition, we believe that an exclusion for NFT-to-NFT transactions should be introduced in the CARF, at least during the initial implementation. Transactions would continue to be reportable where an NFT is converted to something that would be considered payment, either in fiat or cryptocurrency.
Intermediaries in scope
1. Do you see a need to either widen or restrict the scope of the intermediaries (i.e. Reporting Crypto-Asset Service Providers)?
The use of the phrase ‘effectuate’ in reference to a transaction is too widely drawn, and likely to be too vague to be applied to a sector which is highly innovative and developing new products.
In particular, the application to any person who ‘effectuates’ a transaction is likely to be too uncertain to reach a consistent standard, particularly given that this will be a rapidly evolving sector with new use cases being developed. This is likely to result in an uneven implementation of the rules between jurisdictions and CASPs who may reach differing interpretations.
There are already use cases in which it may be difficult to determine whether an intermediary ‘effectuates’ a transaction – for example where software is provided which allows direct interaction with a blockchain or where a user interface is provided to interact with underlying smart contracts.
FATF provides, or seeks to provide, five clear categories of Virtual Asset Service Providers:
- Exchange between virtual assets and fiat currencies;
- Exchange between one or more forms of virtual assets;
- Transfer of virtual assets (where, transfer means to conduct a transaction on behalf of another natural or legal person that moves a virtual asset from one virtual asset address or account to another)
- Safekeeping and/or administration of virtual assets or instruments enabling control over virtual assets;
- Participation in and provision of financial services related to an issuer’s offer and/or sale of a virtual asset.
It would be useful for CARF to adopt the same definition as FATF for these purposes, and not to rely on the interpretation of ‘effectuate’.
In any event, we would suggest that the obligation only applies where a relevant service (under the FATF definition) is provided AND the service provider has sufficient knowledge to comply with the reporting obligations in their possession.
This would mean that potential CASPs are not required to collect transaction-level information which they would otherwise not hold solely to comply with the CARF.
2. Are there any circumstances in which multiple (affiliated or unaffiliated) Reporting Crypto-Asset Service Providers could be considered to effectuate the same Relevant Transaction with respect to the same customer? If so, which types of intermediaries (e.g. the one with the closest relationship with the client) would be best placed to ensure reporting?
We believe that it is likely that certain transactions, in particular smart contracts, could result in multiple reporting obligations. However, at this stage there is not a common market practice on who would take responsibility for reporting in such circumstances.
At this stage, the best approach would be to allow, but not require, CARFs who know that the same transaction will be reported multiple times to agree between them who will report the transaction.
3. Do the nexuses described in paragraph A of Section I of the CARF ensure a comprehensive coverage of all relevant Reporting Crypto-Asset Service Providers? If not, under what circumstances would relevant Reporting Crypto-Asset Service Providers not have a nexus in any jurisdiction? In your view, should this be a potential concern, and if so, what solutions could be considered to address it?
The primary concern is not whether there are CASPs that do not have a nexus to any jurisdiction, but the fact that there may be a wide range of CASPs who do not have a nexus to a participating jurisdiction.
We have included additional comments on this point below.
Reporting requirements
The CARF requires reporting with respect to Relevant Transactions in Crypto-Assets on the basis of their fair market value, determined and reported in a single Fiat Currency at the time of each Relevant transaction.
1. Do intermediaries maintain valuations on the equivalent Fiat Currency fair market values of Crypto-Assets? Do you see challenges in reporting on the basis of such fair market value? If yes, what do you suggest to address them?
This requirement is likely to create a significant burden for CASPs as there is a large amount of data that will be required to calculate the equivalent values in fiat currency. Note that this differs significantly from FATCA/CRS which only requires year end conversions.
CASPs may or may not already maintain this information depending on existing reporting obligations, but they are unlikely to hold this information on a consistent basis – i.e., how one exchange calculates this balance may not be the same as another.
2. Are there preferable alternative approaches to valuing Relevant Transactions in Crypto-Assets?
Reporting should be permitted in native cryptocurrency, or if this cannot be agreed, then a least within a subset of the larger existing cryptocurrencies (ETH, BTC etc)
Organizations who already convert values to fiat currency for any other purpose (accounting, regulatory, customer reporting) should be permitted to use whichever basis they already have to report, and if necessary the xml schema should allow them to declare/describe their approach.
3. Are there specific difficulties in applying the valuation rules for illiquid tokens, for example, NFTs or other tokens that may not be listed on a marketplace, to identify a fair market value? If so, please provide details of any preferable valuation methods that could be adopted within the CARF.
Yes, where an NFT is transferred rather than sold there may be no associated market value. their value can only be determined at spot prices, particularly where the NFT represents a unique underlying asset.
In the absence of an active market in a Crypto-Asset, CASPs should be able to report the actual cost of the asset where the asset is transferred. Where the NFT is exchanged, the exchange value should be taken as the fair market value.
Where there is a sale of an asset in which there is no active market, the sale value should be taken as the fair market value.
4. Regarding Reportable Retail Payment Transactions, what information would be available to Reporting Crypto-Asset Service Providers pursuant to applicable AML requirements (including the FATF travel rule, which foresees virtual asset service providers collecting information on originators and beneficiaries of transfers in virtual assets) with respect to the customers of merchants in particular where the customer does not have a relationship with a Reporting Crypto-Asset Service Provider, for whom it effectuates Reportable Retail Payment Transactions? Are there any specific challenges associated with collecting and reporting information with respect to Reportable Retail Payment Transactions? What measures could be considered to address such challenges? Would an exclusion of low-value transactions via a de minimis threshold help reducing compliance burdens? If so, what would be an appropriate amount and what measures could be adopted to avoid circumvention of such threshold by splitting a transaction into different transactions below the threshold?
Need to differentiate between a ‘push’ payment and a ‘pull’ payment.
Where the CASP offers a product to a customer which allows Retail Payment Transactions to be initiated by the customer, they are likely to hold information for AML purposes and to have an onboarding process.
We would suggest that there is an exemption for payment providers who only allow retail payment transactions to be linked to a hosted wallet at that provider and only allow transfers in from another CASP. This would be broadly similar to the pre-paid credit card rules, and should pose low risk as the transfer of assets from CASP to payment provider will be reported in any event.
Where a CASP provides a service to a merchant rather than a customer which allows them to receive payments in cryptocurrency, there may be no direct relationship between the customer and the CASP and it may therefore not be possible to obtain a self-certification.
5. Concerning the requirement to report transfers based on certain pre-defined transfer types (e.g. hardforks, airdrops due to other reasons, loans or staking), do Reporting Crypto-Asset Service Providers have the knowledge necessary to identify, and classify for reporting purposes, transfers effectuated according to such transfer types? Are there any other transfer types that typically occur and that are separately identified for customers or for other purposes?
N/A
6. Concerning the proposal for reporting with respect to wallet addresses, are there any specific challenges for Reporting Crypto-Asset Service Providers associated with the proposed requirement to report wallet addresses that are the destination of transfers sent from a customer’s wallet maintained by a Reporting Crypto-Asset Service Provider? Do Reporting Crypto-Asset Service Providers have, or are they able to obtain, information to distinguish wallet addresses associated with other Reporting Crypto-Asset Service Providers from wallet addresses that are not associated with another Reporting Crypto-Asset Service Provider? The OECD is also considering to require, in addition, reporting with respect to wallet addresses that are the origins of transfers to a customer’s wallet maintained by a Reporting Crypto-Asset Service Provider. Is this information available and would providing it materially increase compliance burdens for Reporting Crypto-Asset Service Providers? Are there alternative requirements (e.g. reporting of the public keys associated with Crypto-Asset Users instead of wallet addresses) that could be considered to more efficiently increase visibility over transactions carried out without the intervention of the Reporting Crypto-Asset Service Provider?
Reporting of wallet addresses is a significant extension of powers beyond CRS from a data privacy perspective.
A cryptocurrency wallet address is not the functional equivalent of a bank account and sort code and the combination of wallet addresses with personal information would represent a significant privacy risk.
If the information were leaked or compromised in the future, it would create a risk that individuals could be targeted or extorted to transfer their assets without the protections that apply to assets held at financial institutions. In addition, in the event that data is compromised, it cannot be amended in the way that bank account information can.
The OECD should also note that this reporting requirement could extent to hundreds or thousands of wallet addresses for a single customer, it is wrong to assume that a customer only has one per currency.
If this information is being requested to allow tax authorities to de-anonymise the blockchain either in response to specific investigations or on a more holistic basis, they should be transparent in this by publishing and making taxpayers aware of this fact and stating whether and how the tax authority plans to use this information. The provision of wallet addresses doesn’t just allow governments to determine the amount of Crypto-Assets held by taxpayers at any given time, but also to determine the entirety of an individual’s transactions on that blockchain.
We would strongly encourage the OECD to consider whether bulk reporting and exchange of information is appropriate for such sensitive data, and perhaps consider whether an Exchange of Information on Request regime targeting specific taxpayers would be more appropriate if this data is considered necessary.
7. Information pursuant to the CARF is to be reported on an annual basis. What is the earliest date by which information on the preceding year could be reported by Reporting Crypto-Asset Service Providers?
We would recommend that reporting is required on a level-playing field should apply with CRS, not least since it is likely that many FIs may also be CASPs, and in the future a number of CASPs may increasingly be FIs.
It should also be noted that in the case of smart contracts, there may be a number of predetermined steps which take place as a result of predefined external events. The execution of a smart contract may result in a CASP effectuating a transaction which it cannot stop or amend. For example, if a smart contract requires a payment to be deducted, that will happen automatically and a CASP refusing to release funds would undermine the security and certainty of the transaction. If freezing of transactions is required, rules should provide that where a smart contract results in automatic steps, a CASP has not breached any requirements by allowing those predetermined steps to occur.
Due diligence procedures
1. The due diligence procedures of the CARF are in large part based on the CRS. Accordingly, the CARF requires Reporting Crypto-Asset Service Providers to determine whether their Entity Crypto-Asset Users are Active Entities (corresponding largely to the definition of Active NFE in the CRS) and, on that basis, identify the Controlling Persons of Entities other than Active Entities. Would it be preferable for Reporting Crypto-Asset Service Providers to instead document the Controlling Persons of all Entity Crypto-Asset Users, other than Excluded Persons? Are there other elements of the CRS due diligence procedures that should be included in the CARF to ensure that Reporting Financial Institutions that are also Reporting Crypto-Asset Service Providers can apply efficient and consistent due diligence Procedures?
The introduction of self-certifications, and particularly the requirement to certify as to tax residency are likely to introduce considerable friction into on-boarding processes, with a user community who are less likely to be expecting or willing to provide such information.
Self-certifications already create a significant issue for financial institutions who are more familiar with the requirements to collect certifications and whose customers are likely to be familiar with such requirements.
The model rules for digital platforms do not require self-certifications, with platforms reporting based on information held and a requirement to request a taxpayer identification number (TIN). We believe that this model would be more appropriate for CASPs as well. The rules could allow for a taxpayer to voluntarily provide a self-certification if their tax residency differs from their AML information in order to align reporting to the correct tax authority.
2. An Entity Crypto-Asset User qualifies as an Active Entity if less than 50% of the Entity’s gross income is passive income and less than 50% of the assets held by the Entity produce, or are held for the production of, passive income. The Commentary on the term “Active Entity” provides that passive income includes “income derived from Relevant Crypto-Assets”. Are there any specific instances in which such income (e.g. income from mining, staking, forks or airdrops) should qualify as active income?
We would suggest that where the jurisdiction of an Active NFE treats any particular item of income as trading income, that should also apply for the classification of the Active NFE.
The determination of Active NFE status should be based on the law of the jurisdiction of the Active NFE and not the jurisdiction of the CASP.
3. The CARF removes the information collection and reporting obligations with respect to Crypto-Asset Users which are Excluded Persons. The OECD is still considering whether Reporting Crypto-Asset Service Providers should be included in the definition of Excluded Persons. Against this background, would Reporting Crypto-Asset Service Providers have the ability to obtain sufficient information on clients that are Reporting Crypto-Asset Service Providers to verify their status?
We are not aware of any data sources which are currently available to support this.
4. Section III.D enumerates effective implementation requirements in instances where a ReportingCrypto-Asset Service Provider cannot obtain a self-certification from a Crypto-Asset User or Controlling Person. Notably, these requirements specify that the Reporting Crypto-Asset Service Provider must refuse to effectuate any Relevant Transactions on behalf of the Crypto-Asset User until such self-certification is obtained and its reasonableness is confirmed. Are there potential alternative effective implementation measures to those listed in Section III.D? If so, what are the alternative or additional effective implementation measures and which persons or Entities would be best-placed to enforce such measures?
The aim of the OECD should be to deliver a level playing field with financial institutions and banks. Since there is no requirement to freeze accounts or refresh self-certifications for CRS, this should not be required under CARF.
Other elements of the proposal
1. Comments are also welcomed on all other aspects of the Crypto-Asset Reporting Framework.
Commitment to ongoing review
The OECD should recognise that this is a rapidly developing and evolving sector area – and the rules should not cause a blocker to innovation or for smaller organizations entering the market.
There should be a periodic OECD review following the introduction of the CARF which allows submissions from industry on problems with the application of the CARF, areas of uncertainty etc with a commitment by the OECD to issue clarifications, FAQs or amend the rules where necessary. We would recommend that this is at least every two years following the introduction of the CARF.
We have also noted above that a phased introduction of the CARF would be preferable, with rules for NFTs and payment providers introduced in a second phase of implementation which would be supported by this ongoing review.
Need for clear rules on the tax treatment of Crypto-Assets
OECD and tax authorities should also recognize that tax treatment of Crypto-Assets may be either unclear, or poorly understood, by users depending on the maturity of their domestic tax authority. Collecting information about users without establishing a clear tax treatment for assets is likely to be inherently unfair for taxpayers.
We would recommend that prior to the first reporting date under CARF, the OECD encourages tax authorities to issue clear guidance to individuals and businesses on the taxation of cryptocurrency and digital assets. As with CRS, this could be published in a consistent format and available on the OECD website.
Prior to the adoption of CRS, many jurisdictions implemented disclosure facilities to allow the disclosure of offshore assets. In the case of Crypto-Assets, it may be appropriate for tax authorities to offer both a disclosure facility and an awareness raising campaign for taxpayers, particularly where rules are currently unclear.
Global consistency of reporting
To the extent that the CARF is not universally adopted, there is likely to be a flow of Crypto-Assets from participating jurisdictions to non-participating jurisdictions. Crypto-Assets are more mobile than traditional financial services relationships, and there is nothing that would prevent a taxpayer from moving any assets to an alternative jurisdiction.
It is also important to note that the culture associated with Crypto-Assets may accelerate any movement of assets outside of the scope of CARF. The Web 3.0 movement is characterized by a movement towards decentralization, privacy and user control; there is a risk that investors in Crypto-Assets seek to avoid being reported under the CARF as a matter of principle.
Finally, there are potential high costs to comply with CARF, and particularly for start-up business, innovative uses and highly-automated/low-margin businesses, the costs of compliance may provide an incentive to move to a non-participating jurisdiction.
The result may be that CASPs in participating jurisdictions are significantly disadvantaged against non-participating jurisdictions or even late-adopting jurisdictions. Unlike the introduction of CRS which applied to long-established businesses, the uneven introduction of the CARF could result in a permanent competitive advantage for non-participating jurisdictions.
Given the potentially broad scope of application, the OECD and tax authorities will need to make a firm commitment to enforcement, so that all CASPs are aware of and complying with their obligations and there is no incentive for taxpayers to move away from compliant CASPs or participating jurisdictions. There must be a mechanism for addressing non-participating jurisdictions to prevent the movement of nexus of Crypto-Assets outside of the CARF’s reporting net.
We believe that the OECD should not proceed with the implementation of these rules until there is a clear mechanism for addressing non-participating jurisdictions, or a global consensus on the simultaneous adoption of the CARF.
Amendments to the Common Reporting Standard – section 2
We do not have any comments on the proposed CRS amendments.
