CARF：A New Era of Global Cryptocurrency Tax Regulation

Foreword

On October 10, 2022, the Organisation for Economic Co-operation and Development (OECD) issued a document titled "Crypto-Asset Reporting Framework and Amendments to the Common Reporting Standard." The Crypto-Asset Reporting Framework (CARF) is a global tax framework established by the OECD with the aim of collecting and automatically exchanging information on cryptocurrency transactions. It requires taxpayers to report tax information related to certain cryptocurrency transactions in a standardized manner to address the challenge of low tax transparency in the global cryptocurrency market.

Although CARF has not been implemented in any country yet, the OECD stated in its press release in October 2022 that they will further advance the legal and operational aspects of CARF in the coming months to ensure its effective and widespread deployment. The CARF is expected to gain recognition and implementation in more countries in the future. Therefore, to understand the tax responsibilities and risks associated with cryptocurrencies and to stay informed about the changes and opportunities in the cryptocurrency market, investors need to closely monitor the provisions and developments of CARF. This article will outline the key content of CARF and compare it with other international tax regulatory frameworks.

CARF Overview

Background of CARF Implementation

CARF was developed in light of the fast-paced expansion of the cryptocurrency market, which presented tax-related challenges, as well as the growing interest in international cooperation on cryptocurrency taxation. Its primary objective is to create a standardized tax framework that tackles cryptocurrency tax regulation concerns and offers tax authorities additional third-party information on taxpayers' cryptocurrency transactions.

Rapid Growth and Expansion of the Cryptocurrency Market

The cryptocurrency market, including cryptocurrencies and crypto-based tokens, is experiencing rapid growth, presenting new challenges and opportunities for tax authorities. Cryptocurrencies are characterized by their decentralized issuance, recording, transfer, and storage without the need for traditional financial intermediaries or central governing bodies. According to data from Coin Market Cap as of July 4, 2023, the global cryptocurrency market cap reached $1.18 trillion, and Fortune Business Insights predicts an annual compound growth rate of 11.1% in the cryptocurrency market cap from 2021 to 2028. This indicates that as the cryptocurrency market expands, tax authorities increasingly need to shift from traditional regulatory approaches to ensure taxpayer compliance and effective tax collection.

Risks and Challenges in Global Tax Transparency

The development of the cryptocurrency market precipitates risks, particularly in global tax transparency. The regulatory landscape of the cryptocurrency market involves a shift in regulatory subjects, moving from traditional financial intermediaries to a range of new intermediaries and service providers, many of which have only recently come under financial supervision and may not yet be subject to tax reporting requirements in various countries. Additionally, individuals can hold relevant cryptocurrencies in wallets unrelated to any service provider and transfer them across countries and regions, creating risks of cryptocurrency being used for illegal activities or tax evasion. The low transparency in the cryptocurrency market inherently makes it difficult for tax authorities to verify whether taxpayers are earnestly fulfilling their tax obligations.

The Need and Motivation for International Tax Cooperation

To tackle the tax difficulties and potential risks linked to cryptocurrencies, governments globally have taken diverse regulatory actions. Nevertheless, the absence of standardized international norms and coordination mechanisms has led to fragmented cryptocurrency regulation, causing challenges in cross-border transactions and taxation. Consequently, international tax collaboration has become a pressing requirement for nations.

CARF

Types of Cryptocurrencies Covered by CARF

CARF defines cryptocurrencies as "a digital representation of value that can be digitally traded and functions as a medium of exchange, without being legal tender, and without the need for a central issuer, whether public or private, that is acting as an intermediary." This definition includes various types of cryptocurrencies, such as cryptocurrencies, stablecoins, and NFTs (Non-Fungible Tokens). CARF specifies that unless reporting entities can adequately determine that these cryptocurrencies cannot be used for payment or investment purposes, they fall within the scope of reporting. However, the following three types of cryptocurrencies are excluded from the reporting scope:

Closed-loop cryptocurrencies: Cryptocurrencies that can only be used within a closed network (i.e., a closed environment) for purchasing goods or services provided by participating merchants, with low tax evasion risk, such as Starbucks stars cards, Amazon gift cards, etc.

Central Bank Digital Currencies (CBDCs): Cryptocurrencies that represent claims on a central bank or currency authority for legal tender, functioning similarly to currency held in traditional bank accounts, such as China's digital RMB, Sweden's e-krona, etc.

Specific Electronic Currency Products: Digitized forms of legal tender issued under the condition of receiving equivalent funds, used for payment transactions, and can be exchanged at any time according to regulatory requirements at the same value as the currency, such as Alipay, WeChat Pay, etc.

Entities Subject to CARF Regulation

According to CARF, the reporting entities are referred to as Cryptocurrency Asset Service Providers (CASP), which include the following categories:

Cryptocurrency Exchanges: Platforms that offer cryptocurrency trading services to customers, including fiat-to-crypto exchanges, crypto-to-fiat exchanges, and crypto-to-crypto exchanges.

Custodial Services and Wallet Providers: Service providers that offer customers storage, management, or transfer of cryptocurrencies through software or hardware, providing services like custodial wallets, custody vaults, hot wallets, cold wallets, hardware wallets, etc.

Other Service Providers: Institutions that offer other cryptocurrency-related services to customers, such as payment services, lending services, agency services, consulting services, etc.

CARF mandates that CASPs must conduct due diligence on their customers, identify their identities, residence, and tax residency countries. They must aggregate customers' total cryptocurrency holdings and relevant transaction values for tax purposes based on cryptocurrency types and transaction types and report them accordingly. Therefore, while taxpayers bear the actual tax obligations, the regulation is directly aimed at CASPs, and taxpayers are subject to indirect supervision.

Core Reporting Obligations of CARF

For individual users and entity users participating in cryptocurrency market transactions, CARF stipulates that they must provide a self-certification to the CASP to confirm their tax residency and other relevant information. The self-certification should be provided when the customer establishes a relationship with the CASP (for customers before the implementation date of CARF, they must provide it within one year), and the CASP must retain the self-certification for at least six years for regulatory inspection.

CASP bears more reporting obligations compared to customers: First, upon receiving the self-certification, CASP needs to verify whether the self-certification is consistent with other information they hold, including any documents collected through Anti-Money Laundering/Know Your Customer (AML/KYC) procedures, and adheres to its authenticity. Secondly, CASP needs to collect and retain information on the total value of cryptocurrencies held or controlled by customers and the total value of cryptocurrency transactions conducted during the reporting period, and this information must also be retained for at least six years. Finally, CASP needs to submit reports to the tax authorities in their jurisdiction.

CARF sets out reporting obligations between different jurisdictions (countries or regions that commit to implementing CARF), and after CASP reports to their jurisdiction, they need to exchange report information with other jurisdictions using the Cryptocurrency Reporting Standard Format (CRSF) developed by the OECD.

Succinctly, CARF accomplishes cryptocurrency regulation through the following steps: Firstly, it delineates the range of cryptocurrency assets under its purview. Secondly, it mandates CASP to acquire customers' tax-related data and report their cryptocurrency holdings and transaction particulars to tax authorities. Lastly, it defines the procedure and timeline for tax authorities to automatically exchange the reported information. As a result, CARF establishes a comprehensive global structure to counteract illicit activities like tax evasion and money laundering involving cryptocurrencies.

CARF and CRS

CARF is largely based on the global tax transparency framework for general financial assets known as CRS. CRS (Common Reporting Standard) is an international standard developed by the OECD for the automatic exchange of financial account information between jurisdictions. Similar to CARF, CRS requires jurisdictions to obtain financial account information from their financial institutions (banks, insurance companies, investment funds, etc.) and automatically exchange this information with other participating jurisdictions.

Due to the inefficiency of CRS in regulating financial activities involving cryptocurrencies, CARF was constructed as an independent framework to regulate cryptocurrencies. Its independence is reflected in three aspects: First, CRS only covers customers who hold or transact cryptocurrencies through traditional financial institutions, and it does not cover customers who directly use cryptocurrency service providers. As a result, the CRS may not capture a significant number of cryptocurrency users, especially those using decentralized platforms or wallets. Secondly, CRS only reports customers' financial account balances and does not report their cryptocurrency transaction details. This means that CRS cannot reflect customers' cryptocurrency trading behavior and it is difficult to account for value appreciation. Therefore, CARF is necessary as it can cover more cryptocurrency service providers and transaction types, thereby increasing transparency and regulatory capacity in the cryptocurrency market.

However, on the other hand, CARF's independence is relative, and its regulatory process draws on the principles and experience of CRS. The scope of regulation between the two is not entirely distinct. For example: (1) CRS amendments include the regulation of CBDCs and specific electronic currency products to complement CARF and form a comprehensive digital asset regulatory system; (2) CRS does not require reporting of cryptocurrency transaction income information that has already been submitted under the CARF mechanism.

CARF and Other International Tax Regulatory Frameworks

Although CARF is the only international tax regulatory framework for cryptocurrencies, other international tax regulatory systems may also have an impact on cryptocurrency transactions, such as the BEPS Inclusive Framework and the EU Digital Services Tax. The BEPS Inclusive Framework is a multilateral cooperation mechanism initiated by the OECD/G20 to address Base Erosion and Profit Shifting (BEPS) through tax reforms. It comprises 141 member countries and jurisdictions, including China.

BEPS Action 1 involves addressing tax challenges of the digital economy, including defining and taxing digital services, and determining Permanent Establishments (PE) of digital economy participants, which may bring some cryptocurrency transactions into the tax framework; Action 2 involves neutralizing the effects of hybrid mismatch arrangements, including the establishment of a Global Anti-Base Erosion (GLOBE) system, which could result in additional tax implications for cross-border cryptocurrency transactions; Action 5 involves countering harmful tax practices, including the establishment of a mandatory disclosure mechanism, requiring reporting of potentially harmful tax arrangements to tax authorities, thus requiring cryptocurrency traders to be mindful of the impact of these rules on their disclosure and risks. However, compared to CARF, the main regulatory focus of the BEPS Inclusive Framework is not on cryptocurrencies, and therefore, it lacks a systematic approach in this regard.

Furthermore, certain countries or regions have developed their own individual regulatory frameworks for cryptocurrency taxation. For example, in the United States, the IRS considers cryptocurrencies as capital assets and requires cryptocurrency service providers to provide user transaction information for tax compliance; in Germany, cryptocurrencies are treated as private money, and if held for more than one year, they are exempt from capital gains tax. If disposed of within one year, capital gains tax needs to be paid at the individual income tax rate. However, these regulations are specific to individual countries or regions and focus on defining, classifying, and taxing cryptocurrencies; they lack the comprehensive nature of a global framework like CARF. Additionally, CARF's core purpose is to increase tax transparency of cryptocurrencies through automatic exchange of information, an aspect where regional regulatory frameworks have made less effort.

Conclusion

In the long run, CARF will enhance tax transparency and compliance in the entire cryptocurrency industry, thereby strengthening the stability of the cryptocurrency market and boosting investors' trust in the market. This may attract more investors and users to participate in cryptocurrency transactions, promoting innovation and development in the cryptocurrency market. However, CARF may also impact the decentralization and privacy features of cryptocurrencies, as users' identities and transaction information will be disclosed to tax authorities. With the implementation of CARF, traders who value the privacy of their cryptocurrency activities may need to reassess the value of their assets.

Prospective cryptocurrency traders should proactively familiarize themselves with and adhere to CARF's stipulations and their respective tax regulations to mitigate avoidable risks and penalties. Furthermore, they should remain vigilant about developments and prospects in the cryptocurrency market, empowering them to make well-informed choices and aptly manage their cryptocurrency investments.