Tax Agencies Step Up Their Regulations to Stop Tax Evasion With Crypto

For a short period of time the year 2019 raised hope that stablecoins will contribute to wide adoption of cryptocurrencies. 2020, though, appears to snuff out these hopes, as tax agencies try to stop crypto tax evasion with stricter tax regulations imposed on investors and companies.

The first blow was made with the Fifth Anti-Money Laundering Directive (5AMLD) was adopted by the European Union. The law was a reaction to Panama Papers, which exposed a range of offshore companies used by Panamian law firm and corporate service provider Mossack Fonseca for illegal purposes.

This noteworthy financial scandal hinted that cryptocurrency industry should prepare for the battle for anonymity.

Lawmakers are always struggling to patch the legal holes which allow the world’s richest businesses to avoid paying their dues. However, there are small island states in the Carribean, which purposefully keep their laws not so restrictive.

Diverting funds to offshores is not illegal, however, some companies, such as the infamous Mossack Fonseca, use privacy to cover criminal activitym, such as money laundering, terrorist financing or tax evasion.

From the 5AMLD to central bank digital currencies, authorities believe that personal data of those behind anonymous transactions should be accessible for them.

In addition, even though the United Kingdom will leave the EU in a matter of days, its anti-money laundering regulations are similar to the 5AMLD, and recent events show that the measures are being tightened to prevent use of crypto to circumvent the law.

The taxman cometh

Post-Brexit Britain is criticized for possible relaxation of its financial laws in order to lure more businesses to its market. Although financial scandals indeed erupted in the country, its tax agency is seeking to eliminate the loopholes in the regulations regarding crime involving cryptocurrency, and stop crypto tax evasion.

Her Majesty’s Revenue & Customs (HMRC) stated that it will reward $130,000 to those developers who will help the tax agency create an intelligence gathering tool based on cluster analysis. This is the latest attempt of the regulators to break the defenses of both the most popular coins and privacy tokens, such as Monero (XMR), ZCash (ZEC) and Dash (DASH).

The coins are used mostly for absolutely legal purposes, however, they have potential to be used by criminals for illicit activities, like selling drugs on the darknet, money laundering and terrorist financing.

Dash Core Group Chief Marketing Officer Fernando Guitierrez is not surprised with growing pressure. He said, that regulatory changes will hinder not only companies, but also customers. Though he stated that it was bound to happen, as such large industry could not exist unnoticed.

“All these changes will make anonymity more difficult for the average consumer, as more exchanges comply and implement KYC. Those exchanges who don’t will be forced to jump from jurisdiction to jurisdiction, which will impose extra costs that only those committed to anonymity will be willing to pay. For criminals, this will change nothing because they are in that group, among many others who are not criminals, who are willing to pay more,” he added.

The HMRC reward offer signals that it seeks to increase its blockchain forensic capabilities. Rich Sanders, principal and lead investigator at the Cipherblade Ltd blockchain analytics firm, said that such reward will not influence the system significantly:

“As for this particular initiative, a £100,000 software contract for a year says something but not very much in the grand scheme of things.”

Are blockchain forensic tools effective?

Though transactions data is kept on the blockchain, this information is not sufficient for identifying individuals. Before recent law changes, blockchain analyitcs companies addressed intelligence agencies to find owners of suspicious accounts.

Although the 5AMLD will change these procedures significantly, Sanders states that analyitcs tools are not a universal solution for de-anonymizing crypto activity, as: “Blockchain analytics tools do not inherently and directly crack the anonymity,” or, more accurately, the psuedonymity, which is characteristic of blockchain. Thus, forensic tools are only one element of a comprehensive investigative toolkit. Sanders further added:

“The way, in which a blockchain analytics tool can help in linking the pseudonymous blockchain identity to an individual is by tracing cryptocurrency from/to initial/terminal destinations such as exchanges and other services, from which data can then be requested — which will often require a subpoena to be served or, at a minimum, another legally constrained form of data request.”

Sanders went on to explain that, when evaluating the capabilities of blockchain forensic tools of establishing the identities of tax evaders, a preliminary suspicion of illegal activity should be present:

“Blockchain analytics tools are likely to be brought to bear only in cases of existing and substantiated suspicion and are not themselves suited to finding potential tax evaders in the sea of cryptocurrency users. If that’s what you want to do, you’ll have a better time — as I once semi-seriously advised IRS employees — browsing through Reddit and looking at the chest-beating about tax evasion there (by accounts with poor OPSEC).”

Authorities are enthusiastic about these changes. However, not everyone is satisfied with the perspective of collaboration with state organizations. Gutierrez from Dash Core Group noted, that not all governments and intelligence agenices actually act in concordance with their duty to protect:

“This has happened even in democratic countries, so we can’t assume that everything they do is fair or well-intentioned. Only where there is a real separation of powers, and the judicial one has consented, on a case by case basis, they should have such a right, if technically possible. If that can’t be guaranteed — and it can’t — it is better if they stay away.”

Possible implications for crypto

As cryptocurrency industry is young, it faces numerous challenges on its way to financial domination. As it gets closer to the mainstream adoption, the regulatory and compliance demands are not a surprise.

Though tech giants play with the ideas of introducing their own cryptocurrencies, even some of the biggest ones can not take all the risks associated with crypto at its current stage.

The community also regards the issue differently, with some influential individuals believing that regulatory changes signal the recognition of crypto by the authorities globally, while others fearing loss of anonymity, one of the core values defining cryptocurrencies.

Gutierrez also noted, that, though being inevitable, financial regulation may throw small players out of the market and finally lead to stagnation:

“The constant introduction of new regulations is already changing the industry. Compliance costs have grown so much that only big players can afford them. This is only going to get worse. We will have fewer new projects and that will hinder innovation. I foresee a future, in which the blockchain industry resembles more and more the financial industry it proclaimed it would replace: well-funded players, slow change and lawyers everywhere.”

Though Gutierrez predicts slowdown in the nearest future, Andrew Adcock, CEO of the London-based crowdfunding platform Crowd for Angels, stated that his company has not noticed any significant changes in the investor’s behavour:

“We haven’t seen a large change in investor and consumer attitudes, however, there has been a notable increase from companies seeking to implement changes and abide by the new regulation. I believe this is positive and will provide great protection for investors.”

Although the attempts to devoid cryptocurrencies from their inherent features will stir hot discussions amid investors, industry leaders and regulators, not everyone is so pessimistic about changes.

Adcock said that many of the clients at Crowd for Angels are not interested in the topic. Despite the doomsayers of the crypto industry, Adcock maintained his view that regulation is something to be embraced and does not believe that this will alienate investors: “There will always be those who seek anonymity, and this might be challenged by regulation, but harmony between both positions can co-exist.”