Thursday, August 29, 2019

Tax crackdown on cryptocurrencies open audit and dispute risks

The UK tax authorities requested customer information in August from cryptocurrency exchanges in an effort to recover back taxes. In July, Singaporean tax authorities released a draft bill on tax treatment of payment tokens under its goods and services tax (GST), while US tax authorities released letters to cryptocurrency traders on correcting tax disclosures. These are recent signs of digital currencies developing a stronger foothold in international business and various tax authorities are looking to establish tax frameworks and collect the back taxes.

"People [taxpayers] are being put in a position where they’re being asked to certify under the penalty of perjury that they’ve [abided by] rules that haven’t been published yet," said James Foust, senior researcher at Coin Center, about US tax authorities cracking down on cryptocurrencies.

Facebook stirs the pot

Facebook’s launch of its cryptocurrency Libra has really pushed governments, especially in G20 countries, to take a closer look at digital assets in an effort to address gaps in the tax treatment of such assets. Advisors expect wider changes in international tax as countries look to one another to standardise tax treatment of digital assets ahead of a higher demand for cryptocurrencies.

The co-founder of a US-based blockchain business said: "Facebook has certainly stirred the pot on whether Libra ends up being good or bad for the cryptocurrency industry. Nobody really knows."

Taxpayers continue to lack guidance on what accounting methodology to apply when calculating their tax liability, especially in the US, which last released cryptocurrency tax rules in 2014. Updated guidance on the tax treatment of cryptocurrencies is expected later in 2019.

As a result, cryptocurrency businesses, investors, and traders are worried about miscalculating tax on their assets because of the relatively immutable nature of blockchain structures that can leave an audit trail for tax authorities to follow.

Disputes begin

Tax calculations are troublesome under limited guidance, complicating blockchain features, and rule variations across jurisdictions. For example, there are tax and accounting issues in determining the fair value of cryptocurrencies in the event of a trade. Determining fair value to calculate the cost basis is an urgent issue because of events such as airdrops and forks that change the value of digital assets substantially. This changes the tax liability of holding and trading such assets, which is reflected on company profit-and-loss statements.

Brad Garlinghouse, CEO at financial technology company Ripple Labs, said that governments should be careful not to paint all cryptocurrency businesses with the same brush when it comes to establishing rules on digital assets given the complexity of the underlying technology.

Ripple Labs faces a lawsuit in the US on whether its cryptocurrency, XRP, was sold as an unregistered security. The lawsuit was amended in August based on changes to the SEC framework on digital assets in April to help classify digital assets as securities.

"[The lack of] standardisation in frameworks will lead to [tax and financial] disputes in the long-run," warned David Deputy, director of strategic development and emerging markets at Vertex and president of the Accounting Blockchain Coalition.

"The problem is even if they [governments] say we are going to agree at the global level to standard [financial and tax] treatment of cryptocurrencies, whether as stocks or whatever, then that thing they are treating it like is complex in itself. It’s not like you can just put it in a bucket and treat it one way, [but] there is so much complexity in the way we do things otherwise," added Deputy.

Sean Ryan, founder at cryptocurrency business Node40, said that the IRS guidelines have been the de facto handbook for investors opting to report their gains for the better part of five years. "Not reporting is not a viable strategy as the [tax] agency has begun to crackdown," he added.

The default position is to treat digital coins as property and note any value appreciation with the disposal of the asset under capital gains tax. However, given various tax jurisdictions ratifying rules to cover digital coins as a wider tradeable asset, including currency, this treatment may not fit and can change.

Slow tax progress could harm innovation

Tax authorities still need to address events such as airdrops and forks that complicate the tax treatment of cryptocurrencies under limited tax guidance. In the meantime, governments are adding financial checks-and-balances such as anti-money laundering policies and know-your-customer policies to these transactions.

However, one risk to overcomplicating rules on the tax and financial treatment of digital assets is a slowdown of blockchain feature developments and digital asset trading, according to Deputy.

The complexity comes at a time when cryptocurrencies can help expand the global money supply because deflation remains one of the biggest concerns to the global economy.

"[Blockchain developers] have got a long list of enhancements that are core technological features, and if you throw in one that is to address some governmental regulatory requirement then I am not sure they are going to adopt it," said Deputy.

However, multinational businesses and cryptocurrency exchanges that are engaging in taxable cryptocurrency transactions need guidance on the appropriate jurisdictional tax treatment of digital assets in order to avoid disputes.

Given that tax authorities are pursuing some companies for back taxes and revising the rules on cryptocurrencies across jurisdictions, businesses fear that innovation will be cut off early on in the cryptocurrency space if tax and finance rules do not consider the complexities of the technology involved in trading digital assets.

As tax authorities continue to look at gaps in the tax treatment of cryptocurrencies, taxpayers should be weary of the audit trail under distributed ledger technologies. The audit trail can lead to information enquiries or information exchanges with foreign governments, which can open lengthy disputes.

The above article was published on www.internationaltaxreview.com on August 19 2019 and has been republished with the approval of the Publisher.