The EU’s Cryptoasset Tax Strategy Needs Coordination

As the cryptoasset industry awaits a much-discussed European Commission proposal that would extend EU tax reporting rules to cryptoassets and e-money, at least one tax-tech startup is courting investors in anticipation.

Austria-based Blockpit is one of a growing number of companies providing automated tax calculations for cryptocurrency trades, income generated from staking, and other crypto-related activities. The commission’s upcoming directive on administrative cooperation (DAC8) proposal is prompting Blockpit to think big. The company runs its tax platform in five European countries and the United States, but it is eyeing an EU-wide expansion, and hoping that a recent $10 million round of series A funding will help.

Blockpit’s funding dash may seem a bit premature considering that there is no DAC8 draft yet, but it’s pragmatic, based on several indicators. In late July the European Commission released a collection of DAC8 comments and feedback solicited over the past few months, and the prevailing sentiment is that the EU will, in fact, need some sort of standardized tax treatment.

Reasonable minds differ on when that should happen. Some argue that policymakers should shelve the idea until the EU creates a legal definition of cryptoassets. But the important point is that no one argued against an EU-wide approach, although many urged the commission to tread with caution.

DAC8 Background

Europe is in the early stages of a digital renaissance: its Digital Europe project. Over the next several years, the bloc will be shelling out €7.5 billion to turn the EU into something more futuristic by 2030 — think a digital highway between Europe and Latin America, the world’s first artificial intelligence legal framework, and 5G connections all over the bloc.

The regulatory web that will support this “digital decade” is just as ambitious. Up on the roster is a digital finance strategy to digitize the EU’s financial sector as well as a Regulation on Markets in Cryptoassets (MICA) that would allow passporting for cryptoasset providers and place strict regulations on things like capital requirements and investor rights.

DAC8 will complement all of these by helping authorities automatically exchange data about cryptoassets and e-money so they can accurately tax income and revenue from investments and payments using cryptoassets, e-money, and other digital products.

Why does the EU need a DAC8 when some cryptoasset providers are already subject to reporting rules under the EU’s fifth anti-money-laundering directive?

Two years ago, the European Banking Authority drafted an advice report for the European Commission and warned that cryptoassets typically fall outside the scope of the EU’s financial services regulations, except in limited cases, like those in which cryptoassets are considered to be e-money.

Compounding that, cryptoasset regulation is a patchwork across the EU. After years of drafting anti-money-laundering and tax transparency directives, the EU is concerned that decentralized, partially anonymous cryptoassets could provide a conduit to the shadow economy and undercut the market for traditional financial instruments, especially if cryptoasset-based income is underreported or not reported at all.

Defining Cryptoassets

DAC8 is wading into a world in which some of the terminology, like “cryptoasset,” is amorphous.

There’s no standard international definition for cryptoasset; it is a malleable term for a malleable industry. The European Commission has offered up its own proposed efinition as part of MICA: “A digital representation of value or rights which may be transferred and stored electronically, using distributed ledger technology or similar technology.”

DAC8 could rely on that definition; however, it may not cover all forms of cryptoassets, according to some commentators. In separate comments, KPMG LLP, the Malta Business Bureau, and Malta’s Institute of Financial Services Practitioners said it is “dubious” that MICA’s definition is specific enough for DAC8, particularly because the definition is broad enough to include assets that lack cryptographic elements. They suggest the language should distinguish between “digital representations” and “cryptographic representations,” which would provide more specificity and distinguish DAC8 from other DAC directives.

MICA’s definition does not distinguish between centralized and decentralized cryptocurrency systems. That’s a problem for some stakeholders, who argue that this could undermine any future enforcement because the two are so different.

There’s already a concern reflected in stakeholder comments that the DAC8 consultation largely focused on centralized approaches to the detriment of decentralized systems. After all, distributed ledger technologies were designed with decentralization and are likely to become more prevalent. That merits additional assessment on how the EU’s plans could affect decentralized systems.

Intermediaries

Decentralized ledgers like blockchain are intended to eliminate the need for intermediaries. In that context, it’s unclear how authorities should identify the best reporting intermediaries. It’s a question that will likely become more complex as more decentralized finance products and applications hit the market. 

PwC suggests that the commission think about identifying criteria. That’s not going to be a simple task, however. As the industry grows, the criteria could need frequent revisions. Already, intermediaries like cryptoasset exchanges, cryptoasset brokers and dealers, cryptoasset cash point ATMs, cryptoasset issuers or sponsors, cryptoasset trading platforms, and cryptoasset wallet providers all have very different functions.

Meanwhile, the French Banking Federation believes banks and other financial institutions are inappropriate intermediaries because it would be “impossible” for those institutions to determine whether account holders have those sorts of assets. Banks should bear these kinds of reporting obligations only if they offer cryptocurrency services, the federation said.

Relatedly, commentators like CFE Tax Advisers Europe are concerned about reporting obligations on intermediaries and advisers because they could be as “ignorant and blind” as the tax authorities seeking information.

“Criminals will in all cases positively engineer non-compliance which means it is the ignorant or negligent ‘non-criminal’ and his/her advisers who could fall foul of the law,” the organization said. “Rather than . . . issue DAC8 with compliance requirements which, frankly, may be unenforceable, what makes sense is to prepare the way for ‘crypto compliance’ coupled with clear explanations of what it means.”

Individual traders should be responsible for handling their compliance requirements — that should be part of the cost of doing business, according to CFE.

Along those lines, should cryptocurrency wallets owned by private people be reportable? There are privacy and de minimis concerns at play.

Swedish cryptocurrency accounting firm Monetax argues that reporting requirements for those kinds of wallets could make people vulnerable to information breaches. Custodian wallets — those offered by cryptocurrency service providers — are a different animal, however, and are already covered by the fifth anti-money-laundering directive.

Few threshold numbers have been suggested for cryptoasset reporting. Monetax suggested that profits below €10,000 could be tax free for private individuals. But a more pressing issue is determining where and how reportable transactions occur in the first place, according to PwC.

E-Money

It’s unclear whether the term “e-money” under DAC8 will refer to traditional e-money (regulated under several EU laws), new e-money tokens like stablecoin, or both. It matters because the two are not the same.

Broadly speaking, e-money tokens are treated as cryptoassets. MICA defines electronic money tokens as cryptoassets that are mainly used as a means of exchange and maintain a stable value by referring to the value of a fiat currency that is legal tender.

Electronic money, on the other hand, is defined under the EU’s electronic money directive as an electronically and magnetically stored monetary value that is represented by a claim on the issuer that is issued when funds are received for making payment transactions and are accepted by a natural or legal person other than the electronic money issuer.

Considering that e-money tokens are folded into cryptoassets, the commission, when referring to e-money, may mean traditional e-money. On the other hand, e-money tokens need regulation more than traditional e-money. The distinction between the two will need to be teased out.

Both the Malta commentators and KPMG said they interpret “e-money” in the DAC8 consultation in line with the MICA “e-money tokens” definition. If that is correct, they suggest the commission use the term “e-money tokens” because it is not interchangeable with “e-money.”

The distinction is also important because the EU has been regulating e-money for over 10 years by an e-money directive (2009/110/EC) and under the second payment services directive (2015/2366/EU), as well as EU anti-money-laundering and know-your-customer reporting requirements.

Given this regulatory landscape, some commentators, like the European Payment Institutions Federation (EPIF) and the French Banking Federation, are unconvinced that e-money and e-money institutions need additional regulation under DAC8. The federation thinks e-money issuers would be better served under DAC2 — the automatic exchange of financial account data — and not DAC8.

Existing regulations aside, the EPIF contends that e-money issuers should be exempted from DAC8 for de minimis uses. E-money products are often used in low-value ways — for example, digital payments or public transportation tickets — although they are being used more for luxury items.

EPIF would like an exemption for customer accounts with balances that do not exceed €15,000, as well as an exemption for accounts in which the average end-of-day balance over a 30-day calendar period does not exceed €15,000, reflecting that customers may occasionally hold more than €15,000 for specific transactional reasons.

€15,000 would be a logical threshold because it’s the threshold used for the EU’s anti-money-laundering/know-your-customer requirements that e-money issuers already follow, as well as the Financial Action Task Force’s customer due diligence recommendations. “In this case, e-money issuers would have to upgrade their compliance systems but not fundamentally re-design them.”

Aligning DAC8 with the €15,000 threshold would also give e-money issuers more control over their business models — they could choose to avoid compliance costs by exclusively working with clients under that threshold, or they could choose to service higher net clients and corporate clients and take on the costs of DAC8 compliance.

Regardless of the approach, commentators say a carveout for low-risk transactions and low-value payments is necessary. If DAC2 were to apply, the federation would like to see a carveout based on a few possibilities such as:

• product value;
• intended use of the e-money product; or
• limitations on the types of users.

As e-money usage becomes more widespread, EPIF says any new regulations need to clearly distinguish between instances in which e-money holders are using the instruments to park capital for extended periods of time and those in which holders are using them for purchases.

Reporting Exemptions

Along those lines, commentators suggested a few other exemptions. EPIF wrote that the commission should distinguish products that are used as passthroughs, like money remittance platforms, platforms that enable merchants to acquire transactions, or platforms that are used to pay suppliers or employees.

These sorts of accounts seem to pose little transparency risk, according to EPIF. They’re not depository accounts or custodial accounts that could give rise to asset sheltering, nor do they qualify as financial accounts under the OECD’s common reporting standard, which, under Section VIII, paragraph C, are defined as accounts maintained by financial institutions that include both a depository and custodial account.

Also, trading activities are already being scrutinized by tax authorities and are being addressed through other avenues, suggesting they could be exempted from DAC8 as well, according to PwC.

Alignment With Other Standards

The European Commission is approaching a fork in the road with DAC8 and its digital regulatory plans. Parallel cryptocurrency regulation projects are underway at the OECD and the Financial Action Task Force, and some believe the commission should wait to align its standard with the others.

Cryptocurrency is new enough that premature decisions on tax and reporting requirements could stifle the industry, according to CFE. “Regulation of crypto is far wider than the tax implications and the tax systems designed to accommodate it should be followers not leaders,” the organization said.

The European Commission has an unenviable job ahead in ensuring that DAC8 aligns with the Financial Action Task Force, the OECD, the EU’s suite of anti-money-laundering directives, and the MICA proposal. The stakes are high — discord could create opportunities for tax arbitrage or throw more uncertainty into an already uncoordinated space.

In a similar vein, it’s important to think about how smaller companies, in an industry rife with startups, can reasonably comply with all these emerging regulations.

One interesting idea floated by CryptoValues, an Italy-based blockchain policy center, is a crypto-related one-stop shop for small and medium enterprises to consolidate anti-money-laundering and other regulatory compliance and truly ensure EU-wide cooperation as the bloc continues to grow its digital governance.