This op-ed is part of CoinDesk’s Tax Week, presented by TaxBit. Erin Fennimore is the VP of Tax Solutions at TaxBit.
The digital asset industry has seen significant regulatory movement in the United States and abroad, all to promote tax transparency.
This trend for global transparency is driven by many factors, such as tax evasion and avoidance, and the overall goal of ensuring a fair and transparent global tax system.
The primary vehicle of tax transparency is the exchange of information between enterprises and local tax authorities. Outside of the U.S., the Organization for Economic Co-operation and Development (OECD) and G20 have led the initiative to promote global tax transparency.
This article will help highlight the key takeaways from the proposed digital asset broker regulations in the U.S. and other key initiatives across the globe, highlighting important commonalities and timelines.
U.S. proposed digital asset broker regulations
The U.S. Treasury Department issued proposed regulations clarifying the definitions, requirements and implementation timelines for digital asset brokers' tax information reporting requirements as outlined in the Infrastructure Investment and Jobs Act (IIJA) passed by Congress in 2021.
See also: The IRS Should Offer a Free Tax Reporting Tool to DeFi Users | Tax Week
"These proposed regulations are designed to help end confusion involving digital assets and provide clear information and reporting certainty for taxpayers, tax professionals, and others," said IRS Commissioner Danny Werfel.
The regulations are a significant step in the regulation of digital assets in the United States. They are expected to have a significant impact on the digital asset industry. The regulations are also expected to increase transparency in the digital asset market and help combat money laundering and other financial crimes.
It is important to note that these regulations are not finalized. The IRS is accepting comments on the proposed regulations and held a virtual public hearing on Nov. 13. All comments made to the IRS are public and can be viewed on the federal commentary docket website.
The key areas that highlight the impact on the digital asset community are summarized below.
Digital asset broker
A “digital asset broker” in the proposed regulations is defined as any person who provides services facilitating the sale or exchange of digital assets, including centralized exchanges, digital asset payment processors and certain decentralized protocols where there is sufficient control or influence over the protocol to make changes to it.
Along with the clarification and more narrowly tailored digital asset broker definition, the proposed regulations refined the language to focus on three types of enterprises.
- Centralized exchange operators that facilitate digital asset transfers on behalf of users
- Digital asset payment processors
- Decentralized protocols accessible to U.S.-based individuals that meet certain requirements.
The third categorical example necessitates the most nuanced analysis. At a high level, an enterprise that falls into the third category will need to determine if two factors are met under the proposed regulations:
- Provides a facilitative service and
- Based on the nature of the service, would know or be in a position to know both (1) The identity of the party making the sale and (2) the nature of the transaction potentially giving rise to the proceeds from the sale.
Looking at the first factor, the regulations define facilitative services as facilitating the sale (or exchange) of digital assets regardless of whether that is done through an autonomous protocol, access to a trading platform, automated market maker systems or any order matching service. This approach illustrates the Treasury’s understanding of how digital asset trading services differ from traditional financial broker services.
Regarding the second factor, the regulations explain that a person would know or be in a position to know if they can set or change the terms under which the services are provided. This focuses on whether a person has sufficient control over an autonomous protocol to make changes, updates or otherwise influence its operation.
Suppose the DeFi protocol can be managed, controlled or overwritten by a centralized group in any way. That protocol will likely be viewed as sufficiently centralized to be treated as a digital asset broker. Conversely, suppose the protocol truly operates autonomously, without any oversight, intervention or influence from a particular group. In that case, it will not be considered a digital asset broker and not be subject to the reporting requirements.
Along with helping to define who is in scope, the proposed regulations specified who will be considered out of scope, including miners, stakers and wallet software providers.
Digital assets defined
Digital assets are defined as assets that include any digital representation of value that is recorded on a cryptographically secure distributed ledger, even if not every transaction is individually recorded. These proposed regulations clarified that stablecoins and non-fungible tokens (NFTs) are considered in scope and is already a key area of focus for the commentary that the IRS has received.
Form 1099 reporting
The core function of being a broker involves broker related onboarding procedures, cost basis tracking and ultimately 1099-B reporting. Historically, Form 1099-B has been used in traditional finance to report the required information. Although not specifically referenced in the proposed regulations, the IRS has commented publicly about creating a new form (1099-DA) to be used for digital assets.
See also: Form 1099-B Is Not the Solution to Your Cryptocurrency Tax Woes | Tax Week 2023
Similar to reporting on traditional financial assets, digital asset reporting will require a broker to include the following pieces of information for each transaction:
- Name, address, taxpayer identification number
- Digital asset details (name, type, number of units)
- Date and time (UTC)
- Gross proceeds of the sale and adjusted cost basis
- Transaction ID or hash
- Digital asset addresses involved
- Form of consideration received
For assets that were transferred into a Broker and subsequently disposed of, the following information will also be required:
- Date and time of such transfer-in transaction
- Transaction ID or hash of such transfer-in transaction
- Digital asset address (or digital asset addresses if multiple) from which the transferred-in digital asset was transferred
- Number of units transferred in by the customer as part of that transfer-in transaction
Customer tax onboarding requirements
To effectively comply with 1099 reporting, digital asset brokers will need to know who their customers are for tax reporting purposes. This means they will need to be able to identify and collect the following information for reportable accounts:
- Identification of accounts as U.S. or non-U.S.
- Collection of names, addresses, and certified U.S. tax identification numbers (TIN)
Brokers within the traditional finance industry currently have an obligation to collect certified tax identification numbers (TINs). Accordingly, digital asset brokers will assume that same obligation. This requirement will impact digital asset customer onboarding in a significant way.
Digital asset brokers will be required to collect certified taxpayer identification numbers (TINs), achieved by collecting a Form W-9 or Substitute W-9. The information collected on a Form W-9 is used to populate and file Form 1099-B, and the new Form 1099-DA, specific to digital asset broker reporting.
Global trends for tax transparency
The U.S. is not the only country issuing regulations related to digital asset tax transparency. With the rise of use cases with digital assets across the globe, there has been a myriad of proposals and frameworks that have also arisen for enterprises within digital assets and e-money. While the objectives of these frameworks and regulations all center around tax transparency, it is important to understand their differences, timelines and impact to your enterprise.
Crypto-asset reporting framework
On Oct. 10, 2022, the 38-member country OECD published the final guidance for the Crypto-Asset Reporting Framework (CARF). It read: “In light of the rapid development and growth of the crypto-asset market...”
On Nov. 10, approximately 47 countries published a statement that they plan to “swiftly transpose” the CARF into domestic law, and intend for active exchange of information to commence by 2027. The intended effective dates for the remaining 38 countries are still unknown, but the OECD, intends to work towards global adoption and implementation of the framework, so it’s incorporated into the local laws of member states.
On the heels of CARF, on Dec. 8, 2022, the E.U. Commission issued the seventh amendment to the Directive on Administrative Cooperation (DAC8). The adopted directive entered into force on Nov. 13, 2023 and E.U. member states will have until Dec. 31, 2025 to transpose the new rules into local law with the first application from Jan. 1, 2026.
The DAC8 will extend the scope under DAC to crypto service providers on exchanges and transfers of crypto assets and e-money. The provisions of DAC8 have significant overlap with CARF, and will ultimately mean that crypto asset service providers will be obligated to report certain information about transactions involving EU residents.
Markets in Crypto Assets Regulation (MiCA)
On June 30, 2022, the European Parliament and Council reached a provisional agreement on the Markets in Crypto-Assets (MiCA) regulation. MiCA’s objective is to increase the safeguards for digital asset investors by requiring common E.U.-wide definitions and rules. MiCA requirements will be effective as of Dec. 30, 2024.
As a result, crypto-asset service providers operating in E.U. providers will be required to have registered offices within the trading bloc.
The Central Electronic System of Payment Information (CESOP) is a new E.U. initiative to combat Value Added Tax (VAT) fraud related to cross-border payments. By Q1 2024, payment service providers in the E.U. will be required to report cross-border payments on a quarterly basis. This initiative aims to bring transparency and compliance to cross-border transactions, particularly those involving e-money institutions.
- Crypto exchanges should be aware of CESOP as it will likely have an impact when an exchange facilitates the buying and selling of cryptocurrencies between a buyer and seller across different E.U. member states
- CESOP reporting will be triggered when a buyer (i.e. payer) is located in the E.U. and has engaged in a cross-border transaction with a seller (i.e. payee) in either an EU or non-E.U. state
- CESOP limits reporting in a variety of ways, primarily by requiring 25 or more cross border payments to a seller (i.e. payee)
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