How CARF, MiCA, and DAC8 will impact tax transparency in relation to the WEB 3 and other recent web developments

The development of new web communication systems such as WEB3 is making it very difficult for tax authorities to trace taxable transactions.  However, measures proposed by the OECD and the European Union aim to provide a framework that will permit traceability of tax transactions. 

The technical characteristics of a crypto asset make it difficult for tax administrations to trace and identify taxable events.

Crypto assets represent a modern method for exchanging value that does not involve the traditional actors of banking and financial systems. While on the one-hand, this can remove the need for intermediaries, potentially resulting in greater efficiencies, it can also lead to difficulties in tracing transactions and parties to transactions.

The problem intensifies when trading is carried out using crypto-assets service providers or crypto-assets operators located in another country, or when it takes place directly between individuals or entities established in another jurisdiction. The multiplication of actors in a decentralised system tends to complexify the follow up of these operations.

Regulators all over the world are grappling with how to regulate this market. Since January 2020, firms carrying on crypto asset activity in the UK have had to comply with the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (the ‘MLR’s). This includes the requirement to be registered with the FCA to continue to carry on business.

France has also introduced regulations to address issues such as fraud, money laundering, and terrorism financing (visa for initial coins offering, digital assets services providers registration, etc.).

International institutions, such as the OECD and the European Union, are also active in developing harmonised reporting requirements in this area. The main purpose of these measures is to combat tax evasion and secure tax collection.

OECD solutions

The OECD developed Common Reporting Standard (CRS) and the US developed Foreign Account Tax Compliance Act (FATCA) introduced a strict framework for financial institutions to report financial accounts held, for example, by banks, insurance companies, investment entities.

However, the service providers in transactions involving cryptocurrencies were not covered by these regulations

On October 10, 2022, the OECD published a new global tax transparency framework to provide for the automatic reporting and exchange of information regarding crypto assets – the crypto asset reporting framework (CARF). The CARF uses a definition of crypto assets that is quite broad so that it covers all crypto currencies, as well as fungible, or non-fungible (NFT) tokens, stable coins, and derivatives.

The CARF places reporting obligations on crypto asset service providers (CASP). A CASP can be any person or entity “in the course of its business, provides exchange services, for or on behalf of its customers, including acting as a counterparty or intermediary to exchange transactions, or by providing a trading platform.”.

In practice, these are buyer-resellers, ATM operators, investment services, or crypto asset trading platforms.

While blockchain transactions are public and traceable by principle, the person behind the wallet usually remains anonymous. The CARF will change this position as it requires the providers involved to report annually to their jurisdiction’s tax authorities information about their client’s and transaction beneficiary identities, as well as information on the transactions (date, amount, type of crypto assets etc.).

This information is automatically communicated to the signatory states adopting this new measure whose effective beneficiaries are tax residents.

To make the reporting obligations effective, the CARF also requires reporting entities to implement verification procedures in a similar manner to CRS and FATCA. They will have to collect self-certifications to establish the tax residence of their clients and confirm the consistency of the information provided.

CARF is expected to be adopted as from 2024 or 2025.

European Union solutions

In the EU, the Crypto-Asset Markets Regulation (MiCA), adopted in March 2022, sets the main conditions for access to the European market for crypto-asset service providers and establishes a consumer protection framework. However, the MiCA regulation does not provide regulation for the collection and exchange of the information that states need to tax income derived from crypto assets.  A vote on the final MICA regulations is expected in April (after being deferred due to issues connected with translating the regulations into different languages).  It is expected to come into force in 2024.

Going further, in December 2022 the EU published draft DAC8 (see here), aligned with the definitions included in the MiCA Regulation, in order to subject crypto-asset service providers (CASP) to the reporting obligations arising from the Mutual Assistance Directive (DAC), whose, until now, were not within the scope of DAC.

The scope of DAC8 and MiCA is relatively similar to the CARF scope.

The DAC8 requires Member States to subject the CASP under their jurisdiction to an annual reporting obligation for crypto asset transactions conducted through them as well as an annual reporting obligation to the competent authorities of other member states.

CASPs will be required to implement a self-certification procedure for the purpose of establishing the tax residency of their customer, which must be dated, signed, and contain customer identification details.

The DAC8 builds on the authorisation requirement introduced by MiCA and considers the CARF project. Any CASP subject to a comparable reporting obligation in their home state are exempted from this obligation under the DAC8 project, thus avoiding duplicated administrative burdens.

Regulations of crypto assets by the international institutions establish here an interesting framework of transparency for the Web3 ecosystem. Market participants must exercise particular vigilance must be given to the evolution of these regulations in order to continue to be seen to operate legitimately.