Nearly three years ago the U.S. took a major step in the battle against cryptocurrency tax evasion by requesting user data from one of the largest digital asset exchanges.
Now other countries are following suit.
“What you’re seeing are some efforts from J5 partner countries and other countries to maybe follow similar techniques that have been used in the U.S.,” said Don Fort, chief of the Criminal Investigation Division at the Internal Revenue Service.
The J5, or Joint Chiefs of Global Tax Enforcement, is a collaboration among tax agencies in Australia, Canada, the Netherlands, the United Kingdom, and the U.S. to crack down on transnational tax crime by gathering and sharing intelligence, conducting joint operations, and cross-training enforcement officials.
Earlier this month, Her Majesty’s Revenue and Customs—the U.K.’s tax authority— started seeking user data from several cryptocurrency exchanges, including Coinbase Inc., for the period from April 2017 to April 2019. The time frame captures the Bitcoin boom at the end of 2017 when many customers would have seen enormous profits and should have paid corresponding tax bills.
The U.K. request is reminiscent of a summons a federal judge allowed the IRS to serve on Coinbase in 2017 to get information on the exchange’s U.S. customers. Since then the U.S. has continued to ramp up its enforcement efforts, most recently by sending letters to more than 10,000 cryptocurrency users warning of potential civil and criminal action if the users don’t report their digital assets to the IRS.
Canada and Australia have also taken significant action during the past year to gather more information about cryptocurrency users, either from the individuals themselves or from third parties.
The increased gathering and sharing of data across countries means it will get harder for individuals to keep their transactions secret from tax agencies.
“The days of trading in cryptocurrencies with minimal detection risk are passed,” said Alexander Demner, a partner at Thorsteinssons LLP in Vancouver.
More Training, Data Sharing
The IRS Criminal Investigation Division has for years focused on the ways in which cryptocurrencies have been used to commit non-tax crimes, such as money laundering and narcotics trafficking, according to Fort. But for the last year or so the division has become especially focused on the threat cryptocurrency poses to tax administration.
“No longer do you have to get on a plane to go to a tax haven country to open up an account at a brick-and-mortar bank,” Fort said. “If you know what you’re doing and you have these apps and private and public keys, you can transfer money around the world.”
IRS CI agents have become experts in tracking and tracing cryptocurrencies because of past efforts to combat identity theft, Fort said.
The IRS has been sharing that expertise with J5 partners and other countries over the last year, he said. These efforts emphasize showing foreign partners what to look for and explaining the capabilities and potential threats of cryptocurrency, he said.
IRS CI in June hosted an event on cyber crime at the World Bank headquarters in Washington, with participants from approximately 20 foreign countries, including J5 members.
The event covered virtual currency, blockchain, and the dark web, according to Dany Morin, a spokesperson for the Canada Revenue Agency.
And it isn’t just training. Morin said the J5 is working on more than 50 investigations of international tax evasion—20 of which the CRA is directly involved in. The countries have also exchanged more data in the last year than the previous 10 years combined, he said.
Most countries begin their efforts to crack down on cryptocurrency tax evasion with extensive information-gathering efforts—obtaining as much data as possible from cryptocurrency exchanges and individual users.
The IRS’s successful summons on Coinbase enabled the U.S. to discover the identities and addresses of domestic customers who bought or sold at least $20,000 in cryptocurrency from 2013 to 2015. The U.K. request seeks similar information, but the time period is more recent and the country has contacted more exchanges.
More countries may be seeking user data from exchanges but the requests aren’t usually made public unless an exchange challenges it in court, practitioners said.
There are also other ways countries are gathering intelligence. The CRA has developed an extensive questionnaire for auditors to use when interviewing individuals with digital assets.
The agency wants to find out whether cryptocurrencies are business income or capital gains, which determines how the assets are taxed under Canada’s Income Tax Act, said Jason Rosen, founding partner at Rosen Kirshen Tax Law in Toronto. One hundred percent of proceeds categorized as business income are taxable, while only 50% of capitals gains are taxable.
The ATO is on a similar fact-finding mission. Earlier this year, the agency announced it was collecting bulk records from Australian cryptocurrency designated service providers as part of a data-matching program to ensure people trading in cryptocurrency pay the correct amount of tax.
De Nederlandsche Bank, the central bank for the Netherlands, is backing a proposal for a bill to register cryptocurrencies. The registration system would apply to all parties that within or from the Netherlands offer services for exchanging virtual and fiduciary currencies and provide wallets for storing cryptocurrencies, a bank spokesperson said.
Some countries have gone past the information-gathering stage into actual audits and investigations.
Fort said IRS CI will likely make some of the cryptocurrency tax cases it’s been working on public in the next six months.
Morin said the CRA has 90 audits concerning cryptocurrency underway, as well as two further investigations with a cryptocurrency component. The agency also has several open tax evasion investigations where virtual assets have either been discovered during searches or are the primary focus of the investigation, he added.
The ATO is “copying and pasting” methods used by the U.S. to hunt down and audit cryptocurrency tax evaders, according to Stuart Reynolds, a partner at specialist cryptocurrency accounting firm Fullstack Advisory in Sydney.
Reynolds said he expects Australia to increase the number of cryptocurrency audits in the coming years.
The ATO would likely engage a third-party contractor with artificial intelligence expertise to accelerate its crypto auditing activities, he said. This would be similar to the IRS’s contract with Chainalysis Inc. The agency for several years has been using software developed by the company to trace bitcoin transactions.
But even the IRS has a long way to go when it comes to curbing tax abuse in the cryptocurrency space.
“While the IRS might be leading the charge to some extent, everybody is very far behind the curve,” said Dashiell C. Shapiro, counsel at Shartsis Friese LLP in San Francisco.