Everything from Bitcoin to non-fungible tokens (NFTs) raises concerns over tax evasion and avoidance. The boom in digital currencies means tax authorities must catch up quickly to tax these assets correctly.
Governments around the world are setting their sights on cryptocurrencies and other crypto assets because of the risks these assets may present. The nature and diversity of digital currencies can also complicate the tax classification and subsequent treatment.
The rapid mainstream adoption of digital currencies means national authorities are starting to consider the implications of these products, as well as the best ways to regulate them. In many cases, the existing tax framework will not suit digital currencies – echoing the challenges in taxation of the digital economy.
So far, tax laws aimed at collecting revenue from digital assets have brought their own risks and disadvantages.
A digital currency is considered any currency or asset that holds value and can be traded, which may seem simple. However, the breadth and diversity of currencies make tax classification an arduous task.
In some cases, crypto equivalents mirror traditional financial instruments and products and can be treated as such. How these assets are used will also guide how to tax them. There are many ways to group a digital currency, including foreign currency, a commodity or security, a business asset or an intangible for active trading – each with a different tax impact.
Digital currencies effectively sidestep existing financial systems through their often decentralised nature. By using blockchain on digital ledgers, the use of digital currency speeds up transactions. As a result, tax authorities are still getting to grips with the booming growth.
In many cases, digital currencies still bypass the usual intermediaries, meaning that these assets do not fall into scope for tax reporting obligations. These digital, cross-border, often encrypted transactions can provide another avenue for tax evasion and avoidance.
Some companies are already starting to accept crypto as payment or paying salaries in digital currencies, which can provide some advantages. However, regulators are increasingly scrutinising these practices.
As authorities start to grapple with digital currencies and look for ways to address the blind spot in reporting, it is likely that these unregulated activities will come under supervision. For example, the US recently signed the Infrastructure Investment and Jobs Act to make brokers responsible for digital currency reporting.
The OECD has also issued guidelines for policymakers to strengthen the legal and regulatory frameworks for taxing digital currencies. These include:
The speed of change and growth of new products means that uncertainty is common in the digital economy, including with digital currencies. Determining what transactions are taxable and how much to pay is a continuing challenge for tax authorities around the globe.
The next challenge is assigning digital currencies to a specific jurisdiction. Tax authorities need to know if crypto assets are domestically sourced or foreign sourced for tax purposes, but this cannot be decided until there is a multilateral classification of digital assets.
The OECD is reviewing the common reporting standards (CRS) to include new financial products – such as cryptocurrencies. Similarly, the EU’s Directive on Administrative Cooperation (DAC7) covers digital platforms, but many stakeholders say that this needs to go further, and the European Commission has launched a consultation to include reporting obligations on crypto assets and e-money in DAC8.
The development of transnational frameworks for digital currencies will be helpful, but it is unlikely to come quickly. Many countries will seek to move forward with their own structures first, presenting unique challenges for tax authorities.
Management consulting company Gartner says that 20% of large enterprises will use digital currencies by 2023, meaning that these assets are significant for tax administrations and could be a new potential source of revenue
Authorities that move to address this quickly, will stand to gain the most, as setting a foundation for the taxation of crypto assets will support future tax framework development. Tax authorities must consider many tough questions.
Building tax laws and introducing new policies must be supported by robust, flexible, scalable compliance systems.