The EU DAC8 Directive on taxation of crypto assets will legally oblige exchanges and other crypto asset service providers to report their customers’ transactions to EU member states’ authorities. What might sound like a hassle, could prove to be a major step to bringing crypto to mass adoption.
Crypto holds a great promise in times of negative interest rates, hurdles to investment access for private persons and galloping inflation. Every human being can wield greater financial freedom with crypto, they can participate in wealth generation. Crypto gives retail investors financial instruments that in traditional finance are only available to the very rich and selected institutions.
However, freedom comes with responsibility. For crypto to become mainstream it needs to be regulated and taxes are a vital part of it. This is where DAC8 comes into play. The EU DAC8 directive is the eight amendment of the “Directive on Administrative Cooperation” and aims to better regulate the tax aspects of crypto assets within the EU.
For law aficionados, Directives lay down certain results that must be achieved but each Member State is free to decide how to transpose directives into national law within these legal barriers.
How to do crypto taxes
Understanding the EU DAC8 Directive begins with a look at crypto tax liability. Every crypto asset holder must pay taxes for the gains made. It can be variable income tax or fixed capital gains tax, depending on the country the holder is tax resident in. There can be a holding period after which gains are tax-free. The regulations vary greatly among the EU Member States but they all have one thing in common: the crypto holder must report gains to the tax authorities, just as they have with every other asset.
Traditional finance has additional reporting obligations. Here, not only the individual owners must report their gains but also the financial institutions storing the assets. Banks even collect the capital gains tax from the holdings of their clients and deliver them to the tax authorities.
Why double reporting makes sense
“Double reporting – from both the individuals and the institutions – makes sense,” says Dr. Max Bernt, Chief Legal Officer of Blockpit. “Until now, the obligation to report taxes in crypto rested on the asset holder to volunteer that information. Making the institutions report tax-relevant data of their customers creates a clever system of checks and balances.”
One key element of the DAC8 Directive will be to add institutional reporting to the regulation of the EU Member States.
Who is reporting and why it isn’t at all easy in crypto?
The coming reporting obligation concerns so-called “Crypto-Asset-Service-Providers” (CASP). These are organizations that service customers by processing crypto transactions. The most widely known type are crypto exchanges, in Europe that would be for instance Coinbase, Bitpanda or Bitstamp. It also affects Hong Kong-based Binance, as they have a European license in France. It would not affect an exchange that has no license in the EU. The reporting obligation also includes broker intermediaries and crypto ATMs.
Unlike in traditional finance, crypto transactions can be facilitated by every unregulated project. But not every crypto company is a crypto service provider. Decentralized organizations (DAO) for instance usually have no entity in a regulated country.
DAC 8’s purpose
“The main purpose is catching tax evaders,” says Bernt. With the enactment of the DAC8 Directive, the service providers must send their client’s data to the respective authorities. In particular, they will send KYC data (Know-Your-Customer, personal identity information) and all relevant transaction data of their customers.
“The tax authorities in your country can then use this information to compare it to what you declared in your tax report and figure out if your self-reporting was accurate.”
The catch with crypto
The decentralized structure of crypto makes it nearly impossible to achieve a single record of truth. Recalling that only gains are taxable one must know the value of an asset when it was received, how long it was held and the value when it was sold. In crypto, however, an asset can be bought on one exchange, transferred to a few self-hosted wallets, transferred again to another exchange, and then sold. Both exchanges will report their data to the tax authorities (when they are EU licensed). The self-hosted wallets or non-EU exchanges however will not report – the chain is broken.
While it is technically possible to trace the asset in most cases, the effort to do so most likely exceeds the means of national revenue service. “One must keep in mind how diverse crypto assets are – there are hundreds of exchanges, some decentralized ones don’t keep records, there are millions of privately hosted wallets, thousands of blockchain protocols, many more projects building on those protocols,” says Florian Wimmer, founder, and CEO of Blockpit. “As a company whose customers ask us to provide them with a full record of their taxable events, I can say that it is extremely challenging to keep up with the constant innovations in crypto.”
Apart from the impossibility to create a single source of truth, it will also be a challenge for the tax authorities to make sense of the data they will be receiving. This needs a completely new data infrastructure which begs the question: what are the benefits of the DAC8 Directive when it is not perfect?
“It is a step-by-step process. We are still at the beginning of widespread crypto use where many users have never declared their holdings,” explains legal expert Max Bernt. “While we can’t know all the considerations of the Commission, we can see one big advantage – the authorities will learn which of their citizens hold crypto. Those who have never reported these assets in their tax filing have been flying under the radar. They might now get a friendly letter, asking for an explanation.”
When DAC8 will be implemented
From DAC8 proposal to implementation.
“The time frame for DAC8 right now is still up to discussion, we expect it to be concluded until November 2022 at the latest. We can then expect DAC8 to kick in 2024,” explains Bernt.
In that case, the tax year 2024 which has to be reported by mid-2025 in most countries would be the most likely start.
The EU DAC8 Directive is bullish for crypto
The United States has a similar directive in place and is a few steps ahead of Europe. The DAC8 directive will surely have consequences on Europe as a marketplace. Not so much versus the United States but rather versus world regions with weaker regulation. The question is: will it be good or bad?
“I’m very bullish on this, because crypto needs to be regulated to gain the necessary trust”, says Blockpit CEO Florian Wimmer. “For mass adoption, institutional and retail investors alike need legal certainty.”
“For example, banks need to go through their compliance department to be able to invest into certain volatile assets like crypto. And if there’s no legal certainty or legal clarity, they are not even allowed to invest into assets like Bitcoin or Ethereum,” adds Bernt.
If this prediction holds true, we might come another step further towards universal access to finance via crypto. “We pay for liberty with our taxes,” concludes Florian Wimmer. “I wish that we all have to pay a lot as that would mean that we had realized even greater gains.”