Introduction – Biden’s Tax-Compliance Agenda Includes
Mandatory Reporting by Cryptocurrency Exchanges about Account
Holders
In May 2021, the US Department of the Treasury released a report
describing the tax-compliance initiatives forming a part of US
President Joe Biden’s American Families Plan. The report
reveals that the Biden Administration certainly appreciates that
cryptocurrency “poses a significant detection problem by
facilitating illegal activity broadly including tax evasion.”
In response, the President’s tax-compliance agenda proposes a
new third-party reporting regime, which leverages the
“information that financial institutions already collect to
shed light on those taxpayers who misreport income derived from
opaque sources.”
The new reporting regime will build on current information
returns, like Form 1099-INT, which reports to the Internal Revenue
Service (IRS) each US taxpayer who received at least $10 in
interest from a bank, brokerage, or other financial institution.
Under the new regime, financial institutions would “report
additional data on the financial accounts of these existing
information returns.” In particular, financial institutions,
including “foreign financial institutions and crypto asset
exchanges and custodians,” must file an annual return
reporting “gross inflows and outflows on all business and
personal accounts. including bank, loan, and investment
accounts.” Moreover, the new financial-account reporting
regime will cover “cryptocurrencies,” “cryptoasset
exchange accounts,” “payment service accounts that accept
cryptocurrencies,” and “business that receive
cryptoassets with a fair market value of more than
$10,000.”
Although the Treasury report doesn’t go into specifics, the
new financial-reporting obligation will likely save the Internal
Revenue Service the hassle of prying this information from
cryptocurrency exchanges, one by one-the approach that the IRS has
taken to date. On March 30, 2021, for instance, the Internal
Revenue Service obtained a court order requiring the San
Francisco-based cryptocurrency exchange, Kraken, to surrender
information about account holders with at least $20,000 in
cryptocurrency transactions during the period from January 1, 2016,
to December 31, 2020. Two days later, the IRS obtained a similar
court order against the Boston-based cryptocurrency exchange,
Circle Internet Financial Inc. and on its spinout company, Poloniex
LLC. And in 2017, the IRS hit virtual-currency exchange, Coinbase,
with a similar demand. A nation-wide reporting requirement
obviously permits the Internal Revenue Service to identify
non-compliant cryptocurrency users without blowing its budget on
litigation against individual cryptocurrency exchanges.
How Cryptocurrency-Information Reporting in the United States
Could Spell Trouble for Canadians with Unreported Cryptocurrency
Income
Many Canadian cryptocurrency traders and investors hold accounts
with US-based cryptocurrency exchanges. Some cryptocurrency users
even shy away from Canadian-based cryptocurrency exchanges because
they view Canadian exchanges as less trustworthy-a stigma that
probably traces back to the Ontario Securities Commission’s
finding that QuadrigaCX, once thought to be Canada’s largest
cryptocurrency exchange, was nothing more than a Ponzi scheme.
Cryptocurrency-information reporting in the United States should
alarm Canadian taxpayers who use US-based cryptocurrency exchanges
and failed to report cryptocurrency profits or holdings on their
Canadian income-tax returns. There are at least two reasons
why.
First, Canada and the US have long committed to sharing taxpayer
information for tax-enforcement purposes. The CRA and the IRS
mutually exchange taxpayer information by virtue of their
participation in the Canada-US Tax Treaty. Article XXVII of the
Treaty obligates the two countries to exchange any information that
may be relevant to enforcing either country’s domestic tax
laws. Moreover, in the summer of 2018, an international coalition
of tax administrators-including the Canada Revenue Agency and the
United States Internal Revenue Service-promised to pool their
resources and expose cryptocurrency users who dodged their tax
obligations. The project seeks to uncover unreported income and
assets stemming from holdings in Bitcoin SV (BSV), Tether (USDT),
Monero (XMR), EOS, Binance Coin (BNB), and other cryptocurrencies,
such as Facebook’s soon-to-be-released Diem (formerly called
Libra). As a result, after extracting taxpayer information from the
new cryptocurrency-reporting regime, the Internal
Revenue Service will likely share its findings with the CRA,
thereby allowing the Canada Revenue Agency to identify, audit, and
prosecute Canadian cryptocurrency traders and investors who
attempted to dodge Canadian tax obligations by using US-based
cryptocurrency exchanges.
Second, if cryptocurrency-information reporting proves fruitful
for tax collection in the US, Canada’s Parliament will likely
follow suite. Indeed, the IRS has already inspired the Canada
Revenue Agency to pry taxpayer records out of cryptocurrency
exchanges. Mirroring the IRS’s blitz on the US-based
cryptocurrency exchanges Circle Internet Financial, Poloniex,
Coinbase, and Kraken, the CRA obtained a Federal Court order
requiring the Canadian cryptocurrency exchange Coinsquare to
identify all Canadian customers that held cryptocurrency accounts
with a value of $20,000 or more during the period from 2014 to 2020
or that held cryptocurrency accounts with total deposits over
$20,000 since the account’s creation. In the same way that
Canadian tax administrators have been influenced by the tactics of
their US counterparts, the Canadian government might adopt measures
that resemble the Biden Administration’s
cryptocurrency-reporting requirement. This, of course, should worry
all Canadian taxpayers with unreported cryptocurrency income, not
just those using US-based cryptocurrency exchanges.
First Steps Toward an International Tax-Reporting Regime for
Cryptocurrency Exchanges
Indeed, Canada has already imposed cryptocurrency-reporting
obligations on domestic and foreign cryptocurrency exchanges under
Canada’s Proceeds of Crime (Money Laundering) and Terrorist
Financing Act. On June 1, 2021, substantial regulatory
amendments created new virtual-currency reporting obligations for
all reporting entities under the Proceeds of Crime (Money
Laundering) and Terrorist Financing Act.
This legislation had already required various entities
(including accountants, casinos, banks, insurance companies, and
money-services businesses) to report certain cash transactions and
electronic transfers to the Financial Transactions and Reports
Analysis Centre of Canada (FINTRAC). But as of June 1st,
all reporting entities must now keep records and file FINTRAC
reports for “large virtual currency transactions.”
In particular, each reporting entity must maintain a “large
virtual currency transaction record” for amounts received in
cryptocurrency of C$10,000 or more in a single transaction, or
across multiple virtual currency transactions that total C$10,000
or more within a span of 24 hours. These records must include the
identity of the person from whom the reporting entity received the
cryptocurrency, the date, the amount received, the type of
cryptocurrency, and the exchange rate. The reporting entity must
take reasonable measures to determine whether the transaction was
made on behalf of a third party. If so, the reporting entity’s
records must include the identity of the third party.
In addition to maintaining records of large cryptocurrency
transactions, the reporting entity must report these transactions
to FINTRAC by filing a Large Virtual-Currency Transaction Report
(LVCTR). The reporting entity must file an LVCTR if (1) the entity
receives cryptocurrency of C$10,000 or more in a single transaction
or (2) the entity receives cryptocurrency of C$10,000 or more
within a 24-hour window, and the transaction was conducted by, on
behalf of, or for the same person. The reporting entity must submit
the Large Virtual-Currency Transaction Report to FINTRAC within 5
business days of receiving the threshold amount.
Moreover, the new money-laundering-and-terrorist-financing rules
also require cryptocurrency exchanges, both foreign and
Canadian-based, to comply with the record-keeping requirements and
FINTRAC-reporting requirements. Under section 5 of the Proceeds
of Crime (Money Laundering) and Terrorist Financing Act, the
record-keeping requirements and FINTRAC-reporting requirements
extend to both:
- “persons and entities that have a place of business in
Canada and that are engaged in the business of [.] dealing in
virtual currencies”; and - “persons and entities that do not have a place of business
in Canada, that are engaged in the business of [dealing in virtual
currencies] that is directed at persons or entities in Canada, and
that provide those services to their clients in Canada.”
This means that Canadian and non-Canadian cryptocurrency
exchanges must submit a Large Virtual-Currency Transaction Report
to FINTRAC if the cryptocurrency exchange maintains an account into
which a Canadian person deposited (or beneficially owned a deposit
of) fiat money or cryptocurrency of C$10,000 or more, either in a
single transaction or across multiple transactions within a span of
24 hours. In certain circumstances, the new rules also require
these cryptocurrency exchanges to verify their client’s
identity by requesting a copy of valid government-issued photo ID,
by running a credit check, or (in the case of an entity) by
obtaining the articles of incorporation, partnership agreement,
trust deed, or other constating document.
Although the CRA can request that FINTRAC share the information
it obtains from Large Virtual-Currency Transaction Reports, the
reporting entities are not yet required to submit this information
directly to the CRA. But there’s no reason to think that Canada
won’t institute a cryptocurrency-focused tax-reporting
obligation.
In fact, we may very well see the rise of an international
cryptocurrency tax-reporting regime, in which cryptocurrency
exchanges must file multijurisdictional tax reports disclosing the
identity and details of account holders whose cryptocurrency
transactions and holdings exceed a certain threshold. For starters,
the United States government doesn’t hesitate to demand that
the entire world comply with US tax law. In 2010, the US enacted
the Foreign Account Tax Compliance Act (FATCA), which
requires all non-US financial intuitions to notify the IRS about
accounts held by a US citizen or by a US resident. The United
States’ enactment of FATCA raised serious concerns for Canadian
banks. On one hand, if they ignored US FATCA requirements, they
exposed themselves to American sanctions because many Canadian
financial institutions had significant operations in the US. On the
other hand, if Canadian banks complied with the US FATCA
requirements, they risked breaching Canadian privacy laws. The
friction ultimately caused Canada and the US to enter the FATCA
Agreement in 2014. Under the FATCA Agreement, Canadian banks must
still report substantially the same information about accounts held
by US citizens or by US residents. But the information is initially
reported to the Canada Revenue Agency under Part XVIII of
Canada’s Income Tax Act. The CRA then forwards that
information to the IRS under the Canada-US Tax Treaty’s
information-exchange provisions, which require the two countries to
comply with their own domestic laws, including those concerning
privacy. The takeaway, however, is that the US had enough clout to
sway Canada into incorporating a US tax-reporting requirement into
Canada’s own domestic tax law. So, it’s conceivable that
other countries may cater to the Biden Administration’s
proposed cryptocurrency-reporting rules.
In addition, the Organization for Economic Co-operation and
Development (OECD) has pledged that, by the end of 2021, it will
release an updated common-reporting standard. The updated
common-reporting standard will feature model tax rules whereby the
tax authorities of OECD-member countries shall automatically
exchange information concerning cryptocurrency transactions and
holdings of taxpayers under their jurisdiction. Of course, if an
OECD-member country like Canada plans on implementing the
OECD’s recommendations, it must first enact a
cryptocurrency-reporting regime locally. Obviously, a country
cannot disseminate cryptocurrency-related information to its OECD
counterparts unless it already collects that information for
itself. Hence, the OECD’s recommendations will likely motivate
Canada and other member countries to enact robust
cryptocurrency-focused tax-reporting rules domestically. The
resulting network will create what is essentially a worldwide
tax-reporting regime for cryptocurrency exchanges.
Pro Tax Tips – Expert Canadian Tax Guidance from a Canadian Tax
Lawyer: Voluntary Disclosures Program for Unreported Cryptocurrency
Income & Solicitor-Client Privilege
The cryptocurrency-reporting measures proposed by the Biden
Administration and the cooperative efforts of tax authorities
signal the end of the anonymity that taxpayers had once associated
with cryptocurrency investing and trading. Canadian taxpayers with
unreported profits from cryptocurrency transactions should
rightfully find these developments concerning. If you filed tax
returns that omitted or underreported your cryptocurrency profits,
you risk facing not only civil monetary penalties, such as
gross-negligence penalties, but also criminal tax liability for tax
evasion. Keep in mind that an intermediate transaction, such as the
purchase of Bitcoin which is then used to purchase a different
cryptocurrency, may itself result in tax liability.
You may qualify for relief under the Canada Revenue Agency’s
Voluntary Disclosures Program (VDP). If your
VDP application qualifies, the CRA will renounce criminal
prosecution and waive gross-negligence penalties (and may reduce
interest). A voluntary-disclosure application is time-sensitive,
however. The CRA’s Voluntary Disclosures Program will reject an
application-and thus deny any relief-unless the application is
“voluntary.” This essentially means that the VDP must
receive your voluntary-disclosure application before the CRA
contacts you about the non-compliance you sought to disclose. Our
experienced Certified Specialist in taxation Canadian tax lawyer
has assisted many Canadian taxpayers with correcting non-compliance
involving cryptocurrency. Our Canadian tax law firm can carefully
plan and promptly prepare your voluntary-disclosure application. A
properly prepared disclosure application not only increases the
odds that the Voluntary Disclosures Program will accept your
disclosure but also lays the groundwork for a judicial-review
application to the Federal Court should the CRA unfairly deny your
disclosure.
To determine whether you qualify for the Voluntary Disclosures
Program, schedule a confidential and privileged consultation with
one of our expert Canadian tax lawyers. Solicitor-client privilege
prevents the Canada Revenue Agency from learning about the legal
advice that you received from your Canadian tax lawyer. Yet your
communications with an accountant remain unprotected. So, if you
seek tax advice but want to keep that information away from the
CRA, you should first approach a Canadian tax lawyer. If an
accountant is needed, your Canadian tax lawyer can retain the
accountant on your behalf and extend legal privilege.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.