Can Tax Authorities Identify Cryptocurrency Owners?

Capital gains from transactions in cryptocurrencies such as Bitcoin are increasingly becoming taxable in countries worldwide. Therefore taxpayers are under the obligation to include cryptocurrency transactions in their yearly tax returns. Non-compliance may lead to serious penalties. This raises the question whether tax authorities are able to adequately identify cryptocurrency owners in order to collect the liabilities.

The anonymity issue

The main concern connected to taxation of cryptocurrencies is their traceability: virtual money are often gained, spent and traded on the internet with full anonymity. Furthermore, additional techniques for anonymization, e.g. private networks for virtual trade and mixing services, provide protection of personal details making transactions virtually untraceable.

The search for solutions

Some countries are taking measures to identify cryptocurrency owners in attempt to solve the problem with anonymity. The following text discusses the actions taken by China, where most transactions in Bitcoins are concluded (95 percent of global trade for 2017).

Aiming to combat unlawful transactions in Bitcoins, the government of China has lately adopted regulations that require local exchangers and traders to follow the new policy of the National Central Bank with mandatory verification of personal account details. Thus Bitcoin users are officially required to provide particular information about their transactions, including login details, account information, description of funding sources and history of transactions. These regulations allow the Chinese authorities to collect more details about people exchanging cryptocurrencies, including Bitcoin, to determine their sources of capital and to mitigate the risk of illegitimate actions with virtual money.

Surveillance of internet traffic

Some countries do not have comprehensive strategies and policies intended to make Bitcoin traders respect the relevant tax liabilities and to stop money laundering involving virtual currencies. Thus the local authorities rely on people to report voluntarily their income from Bitcoin transactions by including it in their yearly tax returns. Such is the case with taxpayers in the USA, who are obliged to keep records of cryptocurrency transactions and report any generated income. However, up to now, the reporting level is comparatively low. For example, in the USA only 802 persons reported their income from cryptocurrency transactions in their annual tax returns for 2015.

When the expectation for voluntary reporting is not fulfilled, governmental organizations may resort to intercepting Internet traffic in order to identify Bitcoin users involved in cryptocurrency transactions. This method is working especially when users:

1) mention online personal details such as name/Bitcoin address;

2) Exchange Bitcoins for other currencies. Currency exchange often requires verification of identity, such as copies of personal identifications documents and bank statements. Therefore these transactions could be used to track Bitcoin traffic in both directions: outgoing and incoming;

3) use Bitcoins for payment. The purchase of services and goods online most often requires contact details, e.g. address for delivery (when delivery is not digital). Therefore the taxmen can identify the recipients of these goods; and

4) use Bitcoin wallets without options for masking the IP address.

Conclusion

As described above, the anonymous use of virtual money raises many issues related to tax collection. More countries are gradually adopting measures to resolve the matter. In 2017, after the government of China enforced specific regulations, the EU Parliament and Council prepared a proposal aiming to identify cryptocurrency owners. The document states that the responsible authorities need to monitor virtual currencies since anonymity is an obstacle, not an asset to the Community.

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