The EU’s encryption tax regulation is about to be implemented. What does KPMG, the top international accounting firm, think?

Description | Giles Mitchell & Jean Heavy

Originally published: April 2023

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Are the OECD’s Crypto-Asset Reporting Framework (CARF) consistent with the EU’s Directive on Administrative Cooperation (DAC) and what are the similarities and differences? How will the two work together to regulate the taxation of cryptocurrencies?

The use of alternative payment and investment methods such as crypto-assets and e-currencies has grown rapidly over the past decade. This growth has drawn widespread attention from regulators around the world, prompting them to issue various proposals and frameworks to ensure that recent advances in tax transparency keep pace with the changing financial landscape and guarantee protections against cryptoassets and e-money. The latest framework that plays a leading role is the Amendment to the Encrypted Assets Reporting Framework (CARF) and the Common Reporting Standard (CRS) issued by the Organization for Economic Cooperation and Development (OECD) in October 2022.

Like existing tax and regulatory frameworks such as the 2014 CRS and the Financial Action Tax Task Force (FATF), CARF is a global tax transparency framework for the automatic exchange of tax information on crypto asset transactions. CARF applies the due diligence requirements of CRS to reporting obligations for crypto-asset service providers (RCASPs), requiring them to make detailed reports on crypto-asset transactions. In addition to CARF, the proposed CRS amendments will also include crypto-assets in the definition of financial assets, which means that custodians and investment entities will need to comply with CRS requirements to report and record all crypto-asset users. Based on the proposed amendments to the CRS, central bank digital currencies and specific electronic currency products are also included in the definition of institutional deposits, but central bank digital currencies and specific electronic currency products are not within the reporting scope under CARF.

CARF is an independent framework consisting of rules and commentaries that can be translated into domestic law. In December 2022, the European Commission becomes the first organization to attempt to translate the CARF and CRS amendments into law. To this end, the European Commission issued the Seventh Amendment to the Directive on Administrative Cooperation (Directive 2011/16/EU, DAC for short), namely DAC8. Although DAC8 uses the definitions in the Markets in Crypto-Assets Regulation (MiCA) rather than CARF, it is generally consistent with CARF and incorporates the OECD’s proposed amendments to the CRS.

However, there are some notable differences between CARF and DAC8, which are explored below in this article.

**1. Effective date: **CARF does not currently have an effective date, and DAC8 will become effective for RCASP on January 1, 2026 (identification services will become effective from January 2025, and TIN verification will become effective from January 2027). Financial institutions/RCASPs will need to update their processes and systems to properly capture the necessary information on crypto assets.

**2. Extraterritorial impact: **DAC8 requires non-EU RCASPs that provide encryption services to the EU to register with an EU member state and comply with the due diligence and reporting requirements of the registered member state. While this does not apply to RCASPs in non-EU jurisdictions that have adopted CARF (as they will be deemed to be in qualifying non-EU jurisdictions), non-EU RCASPs in countries that have not adopted CARF may need to put processes and controls in place , to ensure its EU customers are documented and reported in accordance with DAC8.

3. Transaction Blocking: According to DAC8, if RCASP does not obtain the required information within 60 days and after 2 pursuers, a cryptoasset user (CAU) must be blocked from conducting exchange transactions. This means that RCASP will need to put in place robust control systems to track its document requests and block future exchange transactions if valid information is not received. This may be operationally challenging and may conflict with RCASP's legal and contractual agreements. In contrast, under CARF, if the RCASP does not obtain the required information within 60 days, it will be required to report the CAU as a reportable person and determine whether there are any controlling persons (if any). While this will also require RCASPs to implement new controls and processes, the impact on RCASPs and CAUs may be significantly different than DAC8's requirement to block future transactions.

**4. Notify Individual Clients of Reportable Data:**DAC8 requires RCASPs to inform individuals that the data they provide will be used for reporting purposes and then to send all reporting information to the individual before submitting the data to the tax authorities. RCASPs must also provide all information required by data controllers under the General Data Protection Regulation (GDPR), which is similar to the CRS customer notification requirements currently applicable across jurisdictions. CARF has no requirements in this regard.

5. Penalties: The proposal stipulates that if a report is not made after two valid administrative reminders, or the information provided contains incomplete, incorrect or false data and exceeds 25% of the information that should be reported, A minimum fine shall be imposed. These minimum penalties range from €50,000 (€20,000 for natural persons) to €500,000. The European Commission assesses the amount of penalties every five years. Therefore, RCASP must ensure that its controls and processes are in place to capture, store and report all relevant information and confirm its accuracy.

The European Commission has asked interested parties to submit any concerns and feedback on the proposed DAC8 by March 30, 2023, and is currently reviewing the feedback received.

KPMG Insights

Implementing CARF and DAC8 may require substantial system and process development by financial institutions/RCASPS. This is especially important for entities that were not previously on record with FATCA and CRS, as they will not have due diligence and systems infrastructure in place. Some financial institutions may also be RCASPs and may be required to report accounts under CARF and CRS. This means that financial institutions/RCASPs must not only determine which clients' assets need to be reported, but also determine under which regime reporting is required and configure their systems to select the relevant information for each regime.

That said, RCASPs and financial institutions that fall under the jurisdiction of DAC8 are likely to have more difficulty implementing and complying with the Directive than those that fall under the jurisdiction of CARF (as it currently stands). As mentioned above, the EU is the first country or organization to try to translate the CARF and CRS amendments into laws, and the current consultation period is still not over, so we expect the EU Council to make some decisions on the DAC8 directive after receiving industry feedback. Revise. Likewise, it is very likely that other countries will translate amendments to CARF and the CRS into law and include new or similar nuances in them, with significant implications for financial institutions and RCASP requirements in those jurisdictions. Therefore, entities currently meeting the RCASP or FI definitions under CARF would do well to begin preparing for the required control, process, and system improvements.