The impact of new information reporting requirements on digital assets

October 2022  |  TALKINGPOINT | BANKING & FINANCE

Financier Worldwide Magazine

October 2022 Issue

FW discusses the impact of new information reporting requirements on digital assets with Jason McGarvey, Tim Rappoccio, Chloe Tuffin and Ryan Carey at Deloitte LLP.

FW: How would you describe the rise and spread of digital assets in recent years? In what ways have they affected financial markets?

Carey: Market adoption of digital assets is still at a very early stage. Despite the recent growth in digital asset opportunities, crypto users are still a small percentage of the total population of internet users. Market sponsors believe that crypto may be on a similar ‘user’ growth trajectory as the internet was in the late 1990s. It is expected that financial markets regulators will continue to pay close attention to this and will increasingly look to regulate market activity. The digital asset product suite is also expanding, including the use of derivatives, collateralised lending and yield farming. The combination of more global adoption of asset allocations into crypto, more complex product suites and greater inflows of capital could have a significant impact on the balance sheets and liquidity positions of firms offering services in this space. It is possible that this could create systemic risk and regulators have a key part to play in managing that. Companies that engage in this space should continue to focus on risk and control frameworks and keep a keen eye on the regulatory environment as it evolves and is clarified.

FW: In your opinion, how have financial institutions (FIs) adapted to the opportunities and risks presented by digital asset trends?

Tuffin: Despite increasing demand for crypto-oriented financial product offerings, to date we have seen large banks and asset managers react relatively tentatively in their adoption of this asset class. Investor protection, asset liquidity and market integrity concerns are still creating some caution. While some financial institutions (FIs) are forging ahead to launch digital asset products, we are more commonly seeing incumbent FIs take a phased approach. They are carefully adapting their operational infrastructure, IT, security and governance structures to manoeuvre into position. For example, several banks are evolving their traditional bank custody frameworks to prepare for expected future storage, safeguarding and accounting for digital assets. Equally, large institutional investors are enforcing new liquidity, legal and regulatory expectations on crypto exchanges in readiness to capitalise on the emerging asset class. In this way, FIs are adapting to position themselves as a trusted connection between the digital asset and traditional financial services world and set a solid foundation for future growth.

FW: How would you characterise the impact of cryptoassets on global tax transparency? What complexities do they create for the Common Reporting Standard (CRS)?

McGarvey: Cryptoassets can present a material threat to global tax transparency. The rapid evolution of cryptoassets is raising legitimate questions of whether global tax systems are fit for purpose in the digital age. Applying bricks and mortar tax concepts to digital assets can present challenges for the next generation of taxpayers who are likely to be more geographically mobile and demand a better taxpayer ‘user experience’. The common reporting standard (CRS) regime applied to traditional finance (TradFi) has achieved significant success in implementing cross-border tax information exchange, and while tax authorities have already made changes to create an atmosphere of transparency for digital assets, the decentralisation of market participants can make it a challenge to ensure that all the money flows are captured end to end. There has been a lot of wealth created, stored and extracted already from digital assets, and therefore the expansion of CRS is playing catchup in an environment of massive change and disruption.

FW: Could you explain how the Organisation for Economic Co-operation and Development (OECD)’s proposed Crypto-Asset Reporting Framework (CARF) attempts to address the repercussions of cryptoassets?

McGarvey: The Crypto-Asset Reporting Framework (CARF) proposals seek to level the playing field between TradFi and digital assets. The proposed framework would bring transparency to the holding of digital assets but would also go further by adding transactional transparency by requiring those market participants that effectuate any movement between fiat currency and digital assets or between digital assets to report both the biographical information of the account holders and the financial information in relation to the assets themselves. Due to its transactional nature, the CARF would be a significant expansion beyond the existing TradFi version of the CRS regime. Concurrently, the Organisation for Economic Co-operation and Development (OECD) is also proposing an expansion of the TradFi regime to apply to e-money and digital currencies to create a broadly similar regime between fiat currency and digital currency.

FW: What due diligence and reporting obligations would the CARF impose on cryptoasset exchanges and wallet providers? How would you compare and contrast the merits, or otherwise, of the CARF and the CRS?

Tuffin: In-scope providers would be required to collect and report information on individual and entity cryptoasset users as well as the natural persons controlling certain cryptoasset users. This due diligence could be completed by obtaining a self-certification from the user and confirming its reasonableness based on the information otherwise obtained by the relevant provider. These due diligence requirements mirror the CRS, however the CARF would introduce some additional operational complexity. For example, under the CRS, self-certifications are generally valid until indication of a change in circumstance. The CARF, however, may introduce a 36-month self-certification refresh obligation. Reporting under the CARF would also be similar to the CRS, with reporting of users’ names, addresses, tax identification numbers and value of transactions. However, the CARF would introduce additional reporting on the transaction or cryptoasset type. Although the CARF would impose additional obligations compared to the CRS, it would also provide some comparatively robust measures to assist providers to remain compliant. For example, the CRS does not mandate that FIs must terminate or close accounts with non-compliant account holders, whereas the CARF could require providers to refuse to intermediate relevant transactions with users that do not provide a self-certification. This could create a helpful legislative basis for providers seeking to resolve accounts with non-compliant users.

FW: How confident are you that proposed regulatory changes will improve automatic exchange of information regimes? What challenges are likely to persist?

Rappoccio: It is a step in the right direction, but there is still some more work to do. One of the biggest recommendations raised by the financial services industry with respect to CARF was the pace of implementation. It not only takes time for the industry to adapt and build the required systems and processes to report, it also takes time for governments to ingest and interpret the data they are receiving. Many in the industry have recommended a phased approach to these rules and also voiced concerns around duplicative reporting and privacy.

FW: What advice would you offer FIs on preparing for a new cryptoasset reporting framework, such as the OECD’s CARF?

Rappoccio: It is important for those potentially impacted to not only understand the scope of the new rules but also how it affects them. It is important to remember that these rules are broader than what we have seen so far from the US under the Infrastructure Bill. More digital assets and providers seem to be in scope here, so understanding your business in comparison to the rules is paramount. Another key preparation point is to understand where there may be differences in the various regimes. CRS, CARF, and anti-money laundering (AML) and know your customer (KYC) standards may not be all created equally, requiring different compliance measures for each.

FW: Do you expect the current volatility in the digital asset market to have an impact on market participants’ ability to comply with the new regulations?

Carey: Volatility across the many classes of digital asset is likely to create additional complexity and compliance burdens for those organisations which hold the compliance responsibilities under the CRS and CARF regimes. There may be a number of impacts. First, the global uptake of digital assets is still in relative infancy. There are many institutions and individuals who may choose to ‘test the market’, holding digital assets for a short period and then either reducing holdings or leaving the market altogether, particularly during periods of volatility. This could give rise to account holder churn, which in turn creates additional reporting, and organisations will need to stay on top of their account holder data. Traditional FIs within the scope of existing CRS rules are likely to experience a much more stable account holder base. Greater volatility in markets also means lots of short-term price movements and potentially a higher frequency of sales and redemptions of digital assets. This can put a lot of pressure on the financial controls and processes in place to track sales and redemptions by account holders in order to report accurately.

FW: Is there any evidence of tax authorities using the information they receive in global information exchange? What do you expect the impact to be for digital asset holders?

Tuffin: Tax authorities are certainly using the information they receive under the global information exchange regimes. In 2021, 90 percent of tax authorities that responded to the Global Forum’s annual survey reported having already used the data to increase tax compliance domestically, including in tax audits, to conduct risk assessments and to investigate taxpayers. The OECD estimates that over €100bn of additional revenues – tax, interest and penalties – have been linked to these initiatives. We would expect a similar impact for digital asset holders under the CARF, with the regime expected to be adopted by most, if not all, of the more than 100 countries that currently participate in CRS. The proposed measures could exponentially increase the visibility that a country’s tax authorities have over its residents’ transactions in digital assets.

Jason McGarvey is a partner based in London and leads Deloitte’s global information reporting practice in the UK and its global information reporting technology efforts globally. He has more than 15 years’ experience working in international tax, financial services tax and global information reporting. He has led some of the largest tax compliance and reporting technology transformation programmes for tier 1 financial institutions globally, including global client tax data remediation and client outreach programmes. He can be contacted on +44 (0)20 7303 0412 or by email: jmcgarvey@deloitte.co.uk.

Tim Rappoccio is a managing director in Deloitte’s global information reporting practice with more than 16 years of experience in tax information reporting and withholding. Prior to joining Deloitte, he focused on the investment banking and investment management sectors as an internal tax counsel, providing support for a variety of business units. He can be contacted on +1 (203) 423 4452 or by email: trappoccio@deloitte.com.

Chloe Tuffin is a director based in London. She has broad experience in tax and information exchange policy, compliance and reporting technology transformation. She supports a wide range of clients, including FinTech and RegTech businesses, with the complexities of global tax transparency compliance. She can be contacted on +44 (0)20 7303 4652 or by email: chtuffin@deloitte.co.uk.

Ryan Carey is a partner based in London and leads Deloitte’s emerging growth companies tax business in the UK. In his role he works predominantly with UK headquartered venture capital backed technology businesses across the UK tech sector. He has a particular market interest and sector experience in FinTech and more specifically payment technologies. He can be contacted on +44 (0)20 7007 8276 or by email: rcarey@deloitte.co.uk.

© Financier Worldwide

THE PANELLISTS

Jason McGarvey

Tim Rappoccio

Chloe Tuffin

Ryan Carey

Deloitte LLP