How Can the U.S. Combat Cryptocurrency Tax Evasion?Oyster Protocole and Bruno Bullock tax evasion case

In October 2018, crypto platform Oyster Protocol suffered a serious crisis, and its founder, Bruno Block (real name Amir Bruno Elmaani), took advantage of a vulnerability in smart contracts to mint a large number of new Oyster Pearl (PRL) tokens and sell them in the market, causing the price of PRL tokens to plummet. Elmani was then charged with tax evasion and fraud, and was sentenced to four years in prison on October 31 this year.

This article will provide an overview of the facts and background of the Bruno Block fraud and tax evasion case, analyze the legal basis for the U.S. government to charge him with tax evasion, and analyze the regulatory and compliance requirements of the U.S. government and the Internal Revenue Service (IRS) for cryptocurrency issuance, in order to provide reference for the industry.

1 Facts and background of the case

[if !supportLists]1.1 [endif]Oyster Protocol and its Business Model

Launched in September 2017 by an anonymous founder under the pseudonym Bruno Block, Oyster Protocol is a blockchain-based data storage platform that uses IOTA and Ethereum technologies to provide a decentralized, privacy-preserving and low-cost data storage and transfer solution for websites. The goal of Oyster Protocol is to provide decentralized storage and encryption services to websites by leveraging the user's browser's free storage space and CPU, while providing a new revenue stream for website owners.

The native token of Oyster Protocol is Pearl (PRL), which is an Ethereum-based ERC20 token that can be used to buy and sell data on Oyster Protocol. PRL can also be used to incentivize nodes in the network and maintain the security and stability of the network.

The reason for the issuance of PRL is to enable the operation and monetization of a data storage platform. Oyster Protocol enables their users to store and retrieve files through a decentralized, anonymous, and secure system. On the one hand, as long as the internet accesses a website that uses the Oyster Protocol, it is possible to store data in a distributed ledger for other users by contributing a fraction of their computing power. At the same time, users who need to use cloud storage can use PRL tokens to pay for data storage, and can also earn PRL token rewards by participating in network maintenance. On the other hand, website owners and content publishers can also earn revenue by using the Oyster Protocol. They only need to add a line of code to the website, and they can use the computing resources provided by the users to store their content and receive a percentage of the PRL tokens paid by the users. This way, they don't need to rely on traditional ad models and don't need to worry about issues like ad blockers or malware. Oyster Protocol claims that PRL is issued to create a win-win ecosystem where both websites and users can benefit from data storage, and enable value exchange and incentives through PRL tokens.

1.2History of Oyster Protocol

In October 2017, Oyster Protocol conducted its Initial Coin Offering (ICO), raising approximately $3 million in funding.

In January 2018, Oyster Protocol released its testnet, showcasing its data storage and retrieval capabilities. In April of the same year, Oyster Protocol officially launched its data storage service with the release of its mainnet. Mainnet also introduced a new token, Shell (SHL), which is used to pay for network connections and decentralized applications (Dapps), which is distributed to PRL holders via airdrops. The launch of the mainnet marks the transformation of Oyster Protocol from an idea to a usable product, and also opens up more possibilities for its future development.

In October 2018, Oyster Protocol suffered a serious crisis, when its founder, Amir Bruno Elmaani (aka Bruno Block), exploited a vulnerability in smart contracts to privately mint a large number of new PRL tokens and sell them in the market, causing the price of PRL tokens to plummet. Elmani was then charged with tax evasion and fraud and sentenced to four years in prison.

In November 2018, Oyster Protocol announced a rebranding to Opacity and launched a new token, OPQ, to replace the PRL token. Opacity inherited the technology and vision of Oyster Protocol, but severed all ties with Elmaani. Opacity is still up and running with a user base and community support.

2 Analysis of Elmaani's tax evasion and fraud

In addition to criminal charges from the U.S. government, Elmaani is facing a civil lawsuit filed by the U.S. Securities and Exchange Commission (SEC) for minting and cashing out PRL. The SEC filed a lawsuit alleging that Elmaani violated the securities and exchange laws by selling and issuing PRL through false promises and deception, and requested the court to confiscate its illegal gains and impose civil penalties. According to the existing U.S. law precedents,[1] fraudulent income is also taxable, so the judgment of the civil lawsuit filed by the SEC does not affect the determination of whether Elmaani has taxable income, so this article will mainly focus on the criminal lawsuit filed by the U.S. government.

It should be noted that, although according to relevant news reports, Elmaani pleaded guilty to the judge on April 5, 2023, and the judge handed down the formal verdict on October 31 of that year,[2] as of the time of publication, the author is still unable to retrieve the original verdict. The most recent relevant legal document that the author was able to retrieve was a "slip copy" signed by the presiding judge of West Law on April 4, 2023, which is an unpublished draft judgment. [3] Considering that Elmaani pleaded guilty to the judge the day after the draft judgment was released, and that Elmani did not raise any objection to the main facts of the case based on the draft judgment, this article will sort out the court's judgment based on the draft judgment.

2.1 Prosecution investigation and evidence against Elmaani

According to the prosecution's indictment, which was filed on behalf of the U.S. government, the prosecution has evidence that Elmaani is suspected of tax evasion and fraud for:

First, between 2017 and 2018, Elmani sold the PRL he owned in US dollars through a series of intermediate steps. Elmaani exchanged a large amount of PRL held on its first cryptocurrency exchange ("Exchange-1") for other cryptocurrencies. After that, Elmani transferred the new coins to a second cryptocurrency platform ("Exchange-2") and exchanged them for US dollars.

Second, in October 2018, Elmaani secretly issued millions of PRLs, selling them and keeping the proceeds ("Exit Scam"). Elmaani has created millions of new Pearl tokens for itself for free by modifying PRL's smart contracts. At the same time, Elmaani used the same method as the first step to convert PRL into US dollars. In doing so, Elmani used cryptocurrency services known as "mixers, or tumblers" to combine transactions from multiple clients, making it difficult to track individual transactions, and he also transferred cryptocurrency and U.S. dollars through the accounts of his friends and family, including his spouse, all of which had the effect of concealing cryptocurrency movements.

Third, Elmaani took other measures to conceal its income, including trading precious metals.

The consequences of Elmaani's series of transactions led to the PRL becoming almost worthless. When Exchange-1 discovered the exit scam, it stopped all trading in PRL and delisted PRL from its exchange two weeks later, which resulted in investors losing a significant amount of money. Two days after launching the exit scam, Elmani said part of the reason he executed the exit scam was that "taxes are very nasty."

2.2 Prosecution charges against Elmaani

The U.S. government alleges: In 2017 and 2018, defendant Amir Elmani received millions of dollars in income, including income from a new type of cryptocurrency he created called the Pearl token, and he did not pay taxes on almost all of that income. The U.S. government's indictment alleges that Elmani evaded paying most of the income tax for both years by a variety of means, including:

(a) filing a false income tax return for the 2017 filing year and failing to report substantial income to the IRS;

(b) in 2018, use the nominee to receive a portion of his or her own unreported income and transfer that income to him/herself;

(c) in 2017 and 2018, earning unreported income by operating a business under a pseudonym and concealing their true identity;

(d) in 2017 and 2018, through anonymous entities and in the name of others;

(e) obtain additional unreported revenue through a cryptocurrency exit scam in October 2018 while attempting to conceal his involvement in the scam;

(f) heavily traded cryptocurrency, cash, and precious metals transactions in 2017 and 2018 to mask its unreported revenues.

2.3 Elmaani's Defences

Elmani did not deny that he had committed some of the acts listed by the prosecution, and even admitted that he knew he had a tax liability, but he nevertheless raised three defences. First, Elmani asserted that he did not commit the aforementioned acts for the purpose of tax evasion, but only to evade the scrutiny and tracking of Pearl investors, members of the company, and members of the Pearl community. Second, Elmani claimed that he did not receive a tax bill from Exchange-2 and therefore did not know exactly how much tax he would have to pay, and therefore could not pay it. Thirdly, Elmani argued that he suffered from mental illness (Insanity) during the aforesaid acts, so he did not have the intention to evade taxes, let alone take the relevant acts for the purpose of tax evasion. Interestingly, his explanation for this mental illness is that after setting up the scam, he began to worry about the collapse of the world's financial system, so he wanted to revamp the yacht he bought after making a profit, so as to provide financial security for his family in the wake of the financial crisis.

2.4 Review of court decisions

Section 7201 of the Internal Revenue Code (IRC) provides for the Federal Crime of Tax Evasion, which is a felony in the United States and is punishable by up to five years in prison and a fine of $100,000 (up to $500,000 for a company). The presiding judge in the Elmani case noted that the prosecution should follow the United States v. The Josephberg case,[4] demonstrated that Elmaani's conduct met three elements at the same time: (1) the existence of a substantial tax debt, (2) the intent to evade taxes, and (3) the act of positive action. As mentioned above, Elmaani had admitted that element (1) had been established, and although he denied his intention to evade taxes, Elmani decided not to object to element (2). Therefore, the focus of the case ultimately fell on element (3), i.e. whether Elmaani had engaged in active tax evasion, which was mainly related to Elmaani's third defence.

The prosecution refuted Elmaani's plea in motion. The prosecution argued that evidence of mental health should be strictly limited, and that the evidence of mental illness presented by Elmaani was "impermissible evidence that seeks to 'excuse' the crime." The reason is that even if Elmaani does have the illusion and fear of the financial crisis and the end of the world, this mental problem will not conflict with paying income tax, that is, Elmaani can have this mental illness and the intention to evade taxes at the same time. The prosecution's rebuttal was upheld by the court, while Elmaani's plea was excluded by the court. Ultimately, the court found that there was no evidence or explanation that could help Elmaani get out of the tax evasion charges, and of course, the draft did not contain a specific verdict, and the detailed reasoning and arguments will be made public after the official judgment is issued.

On the whole, there was no fierce exchange of opinions, no difficult theoretical problems, and no ambiguous facts in the Elmaani case, and the focus of the dispute was on the traditional judgment of the elements of the crime, which did not directly reflect the characteristics of cryptocurrency tax crimes and the tendency of judicial trial. However, considering that the Elmani case occurred at a time when the ICO boom was in decline, and there are few criminal cases involving cryptocurrency taxes, this case does have a certain cutting-edge and representative significance in the field of cryptocurrency cases in the United States and even the world.

3.Analysis of the tax-related content of this case

[if !supportLists]3.1 [endif]U.S. Cryptocurrency Tax System

Taxation of cryptocurrencies is premised on a clear understanding of the legal nature of cryptocurrencies, and different organizations and institutions in the United States have different views on this. For example, the SEC considers cryptocurrencies to be securities, the U.S. Commodity Futures Trading Commission (CFTC) characterizes cryptocurrencies as commodities by explaining the nature of cryptocurrency derivatives, and the IRS defines cryptocurrencies as property. Since the IRS is the tax authority, the designation and regulations of the IRS should prevail when it comes to the cryptocurrency tax regime.

The U.S. cryptocurrency tax system mainly revolves around income tax and capital gains tax, of course, broadly speaking, capital gains tax is also a type of income tax, but it is often established separately due to legislative policy considerations. Back in 2014, the IRS set out the rules for calculating the taxation of cryptocurrencies in the Investor's Guide and Rules (Notice 2014-21), requiring that cryptocurrencies be subject to the same tax regime as property. Specifically, there is no tax on the purchase and holding of cryptocurrencies, in terms of income tax, there is income tax on obtaining cryptocurrencies from airdrops, decentralized finance lending (DeFi), mining, and receiving cryptocurrencies as salaries, remuneration, etc., and the fair market value is used to calculate the income. Cryptocurrency swaps, for example, are subject to capital gains tax, and on top of the cost, different tax rates are applied depending on the length of time they are held. [5]

However, there is something special about Elmaani's actions in this case, as he also minted Pearl tokens before selling them. It goes without saying that capital gains tax is payable on the proceeds from the sale of tokens, and the IRS is still inconclusive on whether the act of minting tokens should be taxed. In this regard, there is a view that both minting tokens and mining are to create new digital assets through calculation, so the income from minting tokens should also be taxed. This paper argues that whether the minted tokens are taxable income should depend on its market liquidity, and when there is a lack of liquidity, the true value of the tokens is difficult to determine, and naturally the income cannot be determined, and the tokens minted by Elmaani in violation of regulations after a period of time after the token issuance, because the token market already has a certain amount of liquidity at that time, the value of these newly minted tokens is relatively clear, and they belong to Elmaani's income and should be taxed.

3.2 U.S. Federal Tax Evasion

The three basic constituent elements of the federal tax evasion crime in the United States have been mentioned above, and these three elements seem simple, but in fact, after being supplemented and improved by many judicial precedents, these three elements have relatively rich connotations, some of which are not mentioned in the draft judgment of the court in this case, but are crucial to the understanding of this case.

Element (1) requires that there is a substantial amount of tax debt, that is, the actual amount of tax paid by the taxpayer is far from the amount that should be paid. There are three points to note about this. First, the income tax liability in the United States is measured on an annual basis, that is, the tax liability is independent for each year, and if a taxpayer has taxable income in three tax years and commits tax evasion, the taxpayer will be charged with three counts instead of one, so the amount of tax evasion for three years cannot be combined. From this perspective, Elmani could have committed one federal tax evasion charge in 2017 and one in 2018. Second, the prosecution of federal tax evasion (usually the U.S. federal government) does not need to prove the exact amount of tax evasion by the defendant, because the purpose of imposing penalties for tax evasion is not to recover a specific amount of tax, but to punish tax evasion and violation of the tax system. As for how to determine whether an imprecise number is "substantial", American case law does not establish an absolute standard or use a specific formula, but it is often up to the jury to decide whether the evaded tax is "substantial" on a case-by-case basis. [6] Understanding this, it is understandable why the judge, the prosecution, or Elmaani did not investigate or contest the amount of the tax in the aforementioned draft judgment. Thirdly, as mentioned above, the source of income does not affect its taxability, and illegal income such as fraud is also within the scope of income tax. [7] Therefore, regardless of the outcome of the SEC v. Elmaani securities fraud case, the Elmani tax evasion case will not be affected.

Element (2) requires that the defendant has the intent to evade tax, and there are a number of criteria for determining "intent". First, "good motive" cannot justify "good", and the prosecution does not have to prove that there is some evil and negative motive behind "intentionally", "intentionally" only needs to be voluntary, intentional (intentional) violation of a known legal obligation. [8] Second, willful ignorance should also be found to be intentional. The so-called willful ignorance refers to the fact that the taxpayer knows that he or she is not aware of the relevant tax regulations, but still makes tax returns in such a state of ignorance. However, there are exceptions to this situation, and ignorance and misunderstanding of the law can be used as an effective justification when the provisions of the tax law itself are unclear and ambiguous. [9] Finally, the decline or loss of willpower can also be a valid excuse, provided that there is a direct connection between the problem of will and the criminal act, otherwise some mental illness not related to paying taxes cannot be used as a reason to exempt from tax evasion, as the prosecution argues in this case.

Element (3) requires the existence of positive conduct for the purpose of tax evasion, which manifests itself in two broad categories: evasion of assessment, underreporting of income or overreporting of deductions, and evasion of payment, which refers to concealing assets after the completion of tax assessment to avoid taxes, and simple non-payment of taxes is not the target of federal tax evasion. Elmaani is the most common form of tax evasion, and if Elmaani refuses to pay taxes after selling her tokens instead of filing false tax returns, anonymous business and trading, etc., then she will be punished with a misdemeanor of willful non-payment under Section 2703 of the IRC, rather than a felony of federal tax evasion.

[if !supportLists]3.2 [endif]U.S. Reporting Requirements for Cryptocurrency Taxes

There is no separate reporting content and filing process for cryptocurrency tax in the United States, and the relevant declaration is still carried out under the framework of income tax and capital gains tax, but the IRS's requirements for cryptocurrency tax declaration are becoming more stringent and refined, and law enforcement and supervision are also increasing, which is directly and indirectly. The so-called direct perspective refers to the IRS's increased tax collection and management of cryptocurrency traders. For example, since 2020, IRS Form 1040 has included questions such as "Did you receive any financial benefit from any virtual currency during 2021?" Another example is that the IRS has increased its budget and invested more human and financial resources to improve enforcement against crypto traders. As another example, with the new rules coming into effect in 2024, people who receive more than $10,000 worth of cryptocurrency in a transaction or business will have an obligation to report to the IRS. From an indirect point of view, the IRS mainly obtains tax-related information through pressure from centralized exchanges (CEXs) and other sources. Since KYC verification must be completed after registering with CEX before trading, even if taxpayers do not actively fill in the tax information for cryptocurrency transactions, CEX will indirectly provide the user's cryptocurrency transaction information to the IRS through Form 1099 and other forms when filling out their annual tax forms. In addition, the IRS is already using blockchain analysis technology to track relevant transaction information, and if the relevant address has interacted with some centralized exchanges, etc., then its holder's information and tax status may also be scraped.

Specifically, when filing cryptocurrency taxes, taxpayers may be required to fill out the following forms:

form | Filled in | content

Form 8949 | Anyone who has gained or lost capital as a result of cryptocurrency | Report on the disposition of each cryptocurrency

Schedule D | Anyone who has gained or lost capital as a result of cryptocurrency | Report your net gain or loss from cryptocurrency

Schedule C | Earn income from cryptocurrency Investors | Report the total revenue and profits of cryptocurrencies moistening

Schedule 1 (Form 1040) | Anything that gets extra through cryptocurrency People who earn money | Report cryptocurrency income

In addition, taxpayers may also receive a Form 1099-K, 1099-MISC, or 1099-B from the CEX, depending on the exchange. However, the 1099-K is not used to report taxes on individual transactions like the tables listed in the table above, but only for the IRS to know about the transaction, as are the 1099-MISC and 1099-B forms. However, these three forms are not entirely suitable for cryptocurrency trading, so the IRS is planning to introduce a Form 1099-DA that is more realistic for cryptocurrency trading.

4. Conclusion

In stark contrast to the vigorous and rapid development of cryptocurrencies, there is a relatively lagging and lacking legal system, especially for fraud and taxation in cryptocurrency transactions, and countries around the world, including the United States, have not yet formed a sound regulatory plan. The Elmani case involved both civil fraud in securities and criminal tax offenses, the former harming the legitimate rights and interests of investors, and the latter jeopardizing state revenues. This article focuses on the U.S. federal tax evasion crimes involved in the Elmaani case, analyzes the constituent elements of tax evasion, and analyzes the U.S. cryptocurrency tax system and its specific reporting requirements.

References

[1] See Moore v. United States, 412 F2d 974, 978 (5th Cir. 1969). See also United States v. Wright, 798 Fed. Appx. 849, 857 (6th Cir. 2019).

[2] See IRS. (2023, October 31). Cryptocurrency founder “Bruno Block” sentenced to four years in prison. Retrieved February 4, 2024, from https://www.irs.gov/compliance/criminal-investigation/cryptocurrency-founder-bruno-block-sentenced-to-four-years-in-prison.

[3] See UNITED STATES of America, v. Amir ELMAANI, 131 A. F. T. R. 2d 2023-1308 (20 Cr. 661(CM)).

[4] See United States v. Josephberg, 562 F.3d 478, 488 (2d Cir. 2009).

[5] 参见美国加密税制度概览 | By TaxDAO | CoinTime. (n.d.). Cointime. https://cn.cointime.ai/news/mei-guo-jia-mi-shui-zhi-du-gai-lan-35353

[6] See United States v. Cunningham, 723 F2d 217, 230–231 (2d Cir. 1983), cert. denied, 466 US 951 (1984).

[7] See United States v. Stafoff, 260 US 477, 480 (1923). See also United States v. Mueller, 74 F3d 1152, 1155 (11th Cir. 1996).

[8] See United States v. Phipps, 595 F3d 243, 247 (5th Cir. 2010)

[9] See Connally v. General Construction Co., 269 US 385, 391 (1926); McBoyle v. US, 283 US 25, 27 (1931).