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In June the Group of Seven finance ministers agreed to adopt, globally, a 15 percent minimum corporate tax proposed by the Organization for Economic Cooperation and Development. By July 1, 130 countries and jurisdictions representing 90 percent of the global economy had signed on. It was a rare instance of the international community agreeing to crack down on corporate tax avoidance in a meaningful way. But a booming cryptocurrency sector risks undermining this effort.
Cryptocurrency is a form of digital currency that records transactions through a decentralized “blockchain” and is impossible (or nearly impossible) to counterfeit. As with other financial instruments, gains from crypto assets are taxed at capital gains rates when sold or exchanged. But compliance leaves a lot to be desired. The Internal Revenue Service (IRS) asks filers on their income tax forms whether they received or made any transactions with cryptocurrency, but third-party reporting in the sector is scarce; unlike brokerages, crypto exchanges are not required to provide traders with 1099s. Types of income that are not subjected to third-party reporting are, as you can imagine, a much greater source of tax evasion than types that are.
It isn’t only crypto gains that are easy to hide; so, too, are the crypto assets themselves. They’re highly portable, making it very easy for tax cheats to transfer assets across (digital) national lines. Because cryptocurrencies are not “fiat dollars” tied to one nation’s or group of nation’s central bank, tax evasion and other financial fraud schemes are typically international in character. One of the earliest lawsuits involving bitcoin involved parties from or based in the US, New Zealand, Singapore, the UK, and China.
President Biden has proposed several laudable measures to prevent crypto-related tax evasion, including expanded reporting requirements for crypto exchanges and businesses that accept cryptocurrencies. But they aren’t enough.
The U.S. must also sign onto Common Reporting Standards developed by the OECD. The Foreign Account Tax Compliance Act (FATCA), passed in 2010, requires foreign financial institutions to report to the IRS on accounts held by U.S. persons or endure financial penalties. But that allows the U.S. to police only its own tax cheats; it does nothing to police foreign tax cheats who store their assets in the U.S. Because CRS establishes reciprocal information sharing between member nations, if the U.S. were to sign on that would ensure that we didn’t crack down on foreign tax havens just to create our own.
But that’s not all the U.S. needs to do. Neither CRS not FATCA currently subject crypto assets to reporting (although the OECD has been working on incorporating crypto reporting since last year). As a consequence, wealthy tax cheats can convert assets subject to FATCA and CRS reporting requirements and/or automatic withholding to cryptocurrency and evade detection. The U.S. needs to broaden FATCA’s reportable assets not only to cryptocurrency, but also to real estate, art, wine, collectibles, and precious metals, and cryptocurrency. And it needs to work with the OECD to ensure a synchronized approach to digital assets that leaves no room for tax arbitrage.
The Biden administration needn’t wait on Congress to make these changes. CRS is not a treaty, so Biden could commit the U.S. to it without Senate ratification. And given the breadth of its language, the application of FATCA to new financial products is well within the executive branch’s authority. The text of FATCA explicitly allows the Treasury secretary to reinterpret the terms “financial institution” and “financial account.” Even without reinterpretation, FATCA defines “financial institution” as an organization that “as a substantial portion of its business, holds financial assets for the account of others.” That describes crypto exchanges just fine.
Another step the Biden administration could take to crack down on tax evasion through cryptocurrency is to encourage whistleblowers. Cryptocurrency itself is invisible to outsiders, but blockchains, which are essentially public ledgers, are not. The FBI made good use of this fact when it recovered $2.3 million in bitcoin extorted by the crypto ransomware group DarkSide in relation to its attack on Colonial Pipelines.
With its depleted funds, the IRS can’t afford a specialized team of agents to trawl the blockchain 24/7 for instances of potential tax evasion or other financial crimes. But such a function would be well suited for researchers and concerned citizens who want to play watchdog on tax evasion. Given the IRS’s established use of whistleblowers to catch tax evaders, the agency would merely need to reify to the public that the IRS views whistleblowers as partners, not enemies, in tax administration.
This is not just a matter of revenue. Like traditional financial assets, distribution of crypto assets is economically unequal on a massive scale, with holders of bitcoin and other assets predominantly white, male, and wealthy. Those who stand to benefit the most from tax evasion are those with the most means to pay. Without proper measures against tax evasion, crypto will remain just another loophole that the wealthy can exploit to skirt paying taxes.
Crypto is a global phenomenon, and one with a rapidly growing capacity to upend tax administration worldwide. The U.S. has been slow to act to combat this threat, but clever use of extant unilateral and multilateral laws on information sharing and programs that capitalize on expertise and information outside government provide opportunities for much better protection against tax evasion. If Biden and his administration are committed to closing tax loopholes, they must use every tool available.
IMAGE: “Tax text with Bitcoin” by wuestenigel is licensed under CC BY 2.0