Building Slippery Slopes – The Hidden Dangers of the Infrastructure Bill’s Crypto Provision

  • The official justifications for regulating cryptocurrencies are based on questionable assumptions
  • The reporting requirements established in the infrastructure bill bear concerning similarities with FATCA
  • The failures of FATCA should make the crypto community very wary of these latest regulations
  • The US might be surrendering its leading position in the crypto industry

Facts versus FATCA

As the proverb goes, the road to hell is paved with good intentions. Stopping criminal activity is a laudable goal. It is in the interest of the crypto community to rid itself of any and all illicit activity. The methods to achieve this goal, however, need to be properly calibrated so as to not jeopardise the industry. In the case of the infrastructure bill, an actual paved road would have been preferable to an ill-conceived reporting requirement.

The Biden Administration’s intentions regarding cryptocurrencies were laid out in the American Families Plan Tax Compliance Agenda. An in-depth reading of this report reveals some strange references and hidden dangers.

On the same page that proposes expanding reporting requirements to “crypto asset exchanges and custodians”, the report confidently mentions a “proven way to improve compliance” with regards to tax. The supporting footnote immediately scales this claim back by stating that it is “difficult to draw full conclusions given the nascency of these efforts”. The specific program, that the report is simultaneously calling proven and unproven, is FATCA. For most people in the financial services industry, this acronym is likely to send shivers down their spine. The same is true for millions of overseas Americans who found themselves in its crosshairs.

FATCA, or the Foreign Account Tax Compliance Act, is a reporting requirement passed as part of the Obama-era HIRE act in 2010. It forces financial institutions to send information to the Treasury regarding assets held by American citizens abroad. Failure to do so incurs enormous penalties. The objective of the act is to catch wealthy Americans who stash their money offshore. It arose in the wake of various tax scandals, including, most notably, the UBS scandal.

In pushing for such a measure, a 2008 US Senate report estimated that $100bn a year were lost in taxes as a result of offshore abuses. In a report in 2010, the Joint Committee on Taxation revised this figure down to $8.7bn over ten years, or $870m a year. In just two years, the number had thus become 0.87% of the original estimate. A decade on, and even with this revised figure, the actual tax revenue generated from FATCA may be even lower. Estimates claim it is closer to $300m per annum. This is separate from the money obtained from the draconian fines imposed for reporting failures. Those are fines based on misreporting what one owns and not what one owes.

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The actual objective of the legislation - catching tax evaders - thus produced negligible results. In an academic article published by the Texas A&M University School of Law, Professors William Byrnes and Robert Munro provide an explanation. They argue that it “appears that the primary purpose of FATCA was for the U.S. government to obtain otherwise private financial information and control of the global financial industry. Unlike a conventional withholding tax which actually intends to collect tax, FATCA is an interim measure intended as a highly coercive penalty regime…” They conclude that “the actual amount of tax collected by FATCA is statistically insignificant.”

In addition to failing its core objective, the heavy-handed implementation of the act has had devastating effects on Americans living abroad. There have been countless horror stories involving Americans being locked out of the banking systems of the countries in which they reside. Financial institutions became terrified of US clients and threw them out by the tens of thousands. This implied the loss of basic banking services, including cancelled mortgages and the inability to hold any form of bank account. Americans residing abroad also had to hire expensive specialised accountants. In an estimated 82% of cases, these accountants told the IRS their clients owed them nothing. As the Wall Street Journal argued in their article entitled “American Expats’ Tax Nightmare”, FATCA, as applied to Americans abroad, is “absurd.”

The high costs, time commitment and anxiety caused by FATCA led to another consequence. Since its enactment, the number of American citizens renouncing their citizenship has surged. Nearly 37,000 have done so since 2010 and, in 2020, a record number of wealthy Americans did the same. The latest numbers may be even greater than those reported as people have been struggling to get appointments at embassies because of covid restrictions.

If that wasn’t enough, according to a 2018 Treasury report, the IRS spent almost $380m in unsuccessfully implementing FATCA. In their words, “the IRS has taken limited or no action on a majority of the planned activities outlined in the FATCA Compliance Roadmap.” This, complemented by a diminishing tax base due to renunciations and reduced business for US entities, may end up making the legislation a loss-making exercise. It is hard to see any scenario in which it can be argued that FATCA is a successful piece of legislation.

Crypto assets

The tax compliance agenda specifically addresses the topic of “virtual currencies” on page 20. It states that cryptocurrencies pose “a significant detection problem by facilitating illegal activity broadly including tax evasion”. To back this forceful statement, the supporting footnote points to an academic article from 2013. The article is entitled “Are Cryptocurrencies Super Tax Havens” and was published in the Michigan Law Review.

As the title indicates, the article is speculating about the potential for tax evasion using cryptocurrencies. In the author’s own words, cryptocurrencies “could replace tax havens as the weapon-of-choice for tax-evaders”. A speculative, 8-year-old academic article seems like shaky grounds on which to conclude that there is broad tax evasion in the crypto sphere happening today.

The article goes on to suggest several ways in which to crack down on cryptocurrencies because of the risk of tax evasion. The first are “FATCA-like solutions”. The author admits such rules would only be “useful at the point of exchanges of Bitcoin to government-issued currencies”. The provision in the infrastructure bill has seemingly ignored this and widened the interpretation to include any entity handling cryptocurrencies.

The author then suggests more forceful solutions in case people decide to stay in the crypto ecosystem without ever returning to fiat. In this case, they argue, the government could “operate against Bitcoin users” and “chill the enthusiasm about Bitcoin by disallowing payments in Bitcoin.” Alternatively, “governments could theoretically eliminate Bitcoin by owning it all” through large-scale purchases and mining operations. One can only hope that these latter suggestions have not been taken into consideration by lawmakers.

Fallout

There are troubling references to FATCA in the official documents that support regulating cryptocurrencies. FATCA-like implementation of the provision laid in the infrastructure bill could prove devastating to the US crypto industry. It could drive crypto assets and innovation towards more accommodating jurisdictions and discourage American financial institutions from dealing in cryptocurrencies because of the regulatory burden. This could, in turn, slow down broader cryptocurrency adoption in the US.

Similarly to FATCA, policing obligations would shift to operators in the crypto industry which could create substantial damage in the process. As the millions of Americans abroad, those holding cryptocurrencies in the US could become the pariahs of the financial system. We already see crypto exchanges beefing up their reserves to weather new regulations, which also means smaller players will no longer be able to compete. The crypto community will have to continue its efforts in fighting back against legislation which could bring about these damaging consequences. There is still a chance to reverse them in the House of Representatives.

Conclusion
The US Senate has passed a sweeping provision regarding cryptocurrencies in an effort to strengthen tax compliance. If it is implemented in a similar fashion to FATCA, it could have a devastating impact on the role the US plays in the crypto industry. The Treasury should take its own advice in the tax compliance agenda and recognise the serious “pitfalls that can arise when reporting requirements are imprecisely designed”.

Nothing in this article constitutes professional and/or financial advice. The content is provided exclusively for informational and/or educational purposes. Nothing is to be construed as an offer or a recommendation to buy or sell any type of asset. Seek independent professional advice in regards to financial, tax, legal and other matters.

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