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Are Cryptocurrency Exchanges and Other Intermediaries Subject to FATCA?

Author: Lisa Zarlenga, Lauren Azebu; Steptoe

This article is presented for general information only and may not be relied upon as legal or tax advice.  Interested persons should seek advice from legal counsel in applying the considerations discussed to their own  situations.

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This article is presented for general information only and may not be relied upon as legal or tax advice. Interested persons should seek advice from legal counsel in applying the considerations discussed to their own situations.
The Foreign Account Tax Compliance Act (“FATCA”) was enacted in 20101 to target tax evasion by discouraging U.S. taxpayers from using foreign banks and other financial institutions to avoid proper reporting and paying U.S. tax on income from assets held in such financial institutions. Among other things, FATCA generally requires foreign financial institutions (“FFIs”) to register with the Internal Revenue Service (“IRS”) and to comply with certain information reporting, withholding, and due diligence requirements with respect to “financial accounts” maintained by U.S. persons.

Although there is currently no guidance as to how FATCA should be applied in the cryptocurrency context, many cryptocurrency exchanges and other types of intermediaries, such as wallet providers, ATM operators, and investment funds, are foreign and thus potentially are subject to the information reporting, withholding, and due diligence requirements under FATCA if (i) the intermediary is an FFI with (ii) financial accounts maintained by U.S. persons. This article discusses these requirements and whether cryptocurrency intermediaries may be subject to them.2

I. Overview of FATCA

The U.S. Treasury Department has released extensive regulations under FATCA, describing the information reporting, withholding, and due diligence obligations of FFIs in detail. Treasury also has negotiated intergovernmental agreements (“IGAs”) with many other countries to implement FATCA.3  These countries  have incorporated the FATCA requirements into their local laws and may apply their own penalties for  noncompliance.  In some cases, an IGA or local law may define terms in a manner slightly different from those  in the FATCA Treasury regulations.  For simplicity, the discussion below focuses on the definitions in the  FATCA regulations, which are generally similar to the definitions in the IGAs. 

Failure to meet the reporting, withholding, and due diligence requirements results in the FFI being subject to a  30-percent withholding tax on certain U.S.-source payments made to the FFI.  As part of its due diligence  obligations, an FFI is required to obtain self-certifications (generally on IRS Forms W-8 or W-9) from each  account holder indicating whether or not the account holder is a U.S. person for tax purposes.   

As a result of the unique web of Treasury, intergovernmental, and local jurisdiction guidance under FATCA, the  determination of whether an entity is an FFI requires a case-by-case analysis.  The IRS has not issued any  guidance as to how FATCA should be applied in the cryptocurrency context, nor are the authors aware of any  guidance on this issue in the IGAs or in local guidance issued by the jurisdictions that have an IGA in effect.4  As  a result, there is significant uncertainty as to whether a cryptocurrency exchange or other intermediary should  be treated as an FFI, and the circumstances under which cryptocurrency investments should be treated as  reportable financial accounts are unclear.   

That said, as discussed below, the definitions of FFI and financial account under FATCA are broad enough to  potentially cover cryptocurrency intermediaries, depending on their activities.  In the absence of current  guidance, a conservative approach would be for an intermediary to require account and wallet holders to  provide self-certifications at the time the accounts or wallets are opened to facilitate compliance with the  FATCA requirements should the IRS take the position that cryptocurrency intermediaries are FFIs in future  guidance.  Of course, this approach could have significant operational implications.  In any event,  cryptocurrency intermediaries should discuss their activities in detail with tax counsel to determine whether  they could be treated as an FFI, and, if so, how best to comply with the FATCA requirements.

II. What Is an FFI? 

The determination of whether an entity is an FFI is fact-intensive, and depends in part on whether the entity is  subject to the requirements of an IGA under local law.  Generally, however, an FFI includes any non-U.S. entity

that is a custodial institution, an investment entity, or a depository institution.5  As discussed below, a key  question in this analysis, which has not been answered by the IRS, is whether cryptocurrency would qualify as  a “financial asset.”  The only guidance issued by the IRS classifies convertible virtual currency as “property,”  and not currency, for tax purposes,6 though the guidance does not elaborate on what type of property.

A. Custodial Institution 

A custodial institution is an entity that holds financial assets for the account of others as a substantial portion  of its business—i.e., the entity’s gross income attributable to holding such financial assets and related services  equals or exceeds 20 percent of the entity’s gross income during the shorter of the three-year period ending on  December 31 of the year preceding the year in which the determination is made, or the period during which  the entity has been in existence.7    

         1. Holding for the Account of Others 

It seems that many cryptocurrency exchanges, certain wallet providers, and even investment funds could be  treated as “holding” cryptocurrency for the account of others as a substantial portion of their business.   However, decentralized, or peer-to-peer exchanges, facilitate transfers of cryptocurrency directly between  participants without the participation of a centralized third party.  These exchanges arguably do not hold cryptocurrency for the account of any participant.   

Cryptocurrency wallets that store private keys to access cryptocurrency can be hot (i.e., software connected to  the internet) or cold (i.e., hardware or paper that is not connected to the internet).  Wallets can be further  divided into custodial wallets (also referred to as “hosted”), in which the wallet provider controls the private  keys, and noncustodial wallets (also referred to as “unhosted”), in which the user stores the keys.  Many  cryptocurrency exchanges provide custodial wallet services and thus could be treated as holding  cryptocurrency for the account of others.  Noncustodial wallet providers may be viewed as simply selling the  user software or hardware—the cryptocurrency is held directly by the user—and thus arguably should not be  viewed as holding cryptocurrency for the account of others.

        2. Financial Assets 

Once it is determined that a cryptocurrency intermediary is holding cryptocurrency for the account of others, it  must be determined whether the cryptocurrency is a “financial asset.”  The FATCA regulations provide that the  term “financial asset” means a security, partnership interest, commodity, notional principal contract, insurance contract or annuity contract, or any interest (including a futures or forward contract or option) in such  financial assets.8    

One of the difficulties in classifying cryptocurrency as one of the enumerated categories of financial assets is  that there is a tension between how different regulatory agencies have classified cryptocurrency.  The  Commodity Futures Trading Commission (“CFTC”) has taken the position that cryptocurrencies are  commodities,9 and the Securities and Exchange Commission (“SEC”) has taken the position that certain  cryptocurrency investments are securities.10  However, there is continued uncertainty regarding whether  cryptocurrency falls into the tax law definition of these terms, and the IRS has not indicated a view on these  questions.   

For purposes of FATCA’s definition of financial assets, securities and commodities are defined by reference to  section 475.  Specifically, a security includes (i) stock in a corporation; (ii) an interest in a partnership or trust;  (iii) a note, bond, debenture, or other evidence of indebtedness; (iv) an interest rate, currency, or equity  notional principal contract; (v) any evidence of an interest in, or a derivative financial instrument in, any  security described in (i) through (iv) or in any currency, including any option, forward contract, short position,  and any similar financial instrument in such a security or currency; and (vi) a hedge with respect to any  security described in (i) through (v).11  Although it is possible that certain altcoins could fall within this  definition depending on their terms, it is unlikely that cryptocurrencies such as bitcoin, ether, and litecoin  would fall within the definition of security.   

A commodity includes (i) any commodity that is actively traded (within the meaning of section 1092(d)(1),  which generally looks to whether there is an established market);12 (ii) any notional principal contract with  respect to any commodity described in (i); any evidence of an interest in, or a derivative instrument in, any  

commodity described in (i) or (ii), including any option, forward contract, futures contract, short position, and  any similar instrument in such a commodity; and (iii) a hedge with respect to any commodity described in (i)  through (iii).13 It is possible that the IRS would conclude that cryptocurrency exchanges constitute an established market for this purpose and, thus, cryptocurrency is a commodity within the meaning of section 475.   

If cryptocurrency is indeed treated as a “financial asset,” some cryptocurrency exchanges and custodial wallet  providers likely would be treated as custodial institutions and therefore FFIs under FATCA.   

B. Investment Entity 

Under FATCA, an investment entity is broadly defined as an entity that is engaged (or holding itself out as  being engaged) primarily in the business of investing, reinvesting, or trading in securities, partnership  interests, commodities, or any interest (including a futures or forward contract or option) in such securities,  partnership interests, or commodities.14   

The FATCA regulations unpack this definition and provide that an investment entity is one of the following:  (i)  an entity that primarily conducts as a business trading, investing, administering, or managing funds, money, or  financial assets on behalf of other persons; (ii) an entity whose gross income is primarily attributable to  investing, reinvesting, or trading in financial assets and the entity is managed by another FFI; or (iii) an entity  that functions or holds itself out as an investment vehicle established with an investment strategy of investing,  reinvesting, or trading in financial assets.15

It is possible that cryptocurrency investment funds could fall within the definition of an investment entity,  provided that similar to a custodial institution, cryptocurrency is properly considered a “financial asset.” 

C. Depository Institution 

A depository institution is an entity that accepts deposits in the ordinary course of a banking or similar  business.16  An entity is considered to be engaged in a banking or similar business if the entity accepts deposits  or other similar investments of funds and regularly engages in one or more of the following activities:  (i)  makes personal, mortgage, industrial, or other loans or provides other extensions of credit; (ii) purchases, sells,  discounts, or negotiates accounts receivable, installment obligations, notes, drafts, checks, bills of exchange,  acceptances, or other evidences of indebtedness; (iii) issues letters of credit and negotiates drafts drawn  thereunder; (iv) provides trust or fiduciary services; (v) finances foreign exchange transactions; or (vi) enters  into, purchases, or disposes of finance leases or leased assets.17    

Some cryptocurrency exchanges may be treated as accepting deposits, particularly if the exchange allows users  to deposit fiat currency with the exchange and use such amounts to purchase cryptocurrency.  Similarly, cryptocurrency ATMs operate like an exchange kiosk where users can anonymously exchange fiat for  cryptocurrencies.  “One-way” ATMs only allow users to buy cryptocurrencies, while “two-way” ATMs also offer  the option to sell cryptocurrencies directly at the ATM.  It is doubtful, however, that cryptocurrency could be  considered a “deposit” in this context since it is treated as property for tax purposes.  In addition, the second

part of the definition will serve to further limit the number of cryptocurrency intermediaries that could be  treated as depository institutions, though some exchanges now offer margin trading and other loan products. 

III. What Is a Financial Account? 

If a cryptocurrency exchange is treated as an FFI, it must identify and report certain information regarding its  “financial accounts” maintained by U.S. persons.  A “financial account” includes any depository or custodial  account maintained by an FFI as well as any equity or debt interest in an FFI (other than interests that are  regularly traded on an established securities market).18   

A “depository account” includes, for example, a commercial checking, savings, time, or thrift account, or any  other instrument for placing money in the custody of an entity engaged in a banking or similar business for  which such institution is obligated to give credit.19   

A “custodial account” is an arrangement for holding a financial instrument, contract, or investment (including,  but not limited to, a share of stock in a corporation, a note, bond, debenture, or other evidence of indebtedness,  a currency or commodity transaction, and any option or other derivative instrument) for the benefit of another  person.20  “Financial instrument, contract, or investment” is likely broad enough to include cryptocurrency  either through reference to a commodity transaction (for the reasons discussed above), or through the phrase  “but not limited to,” which may provide the IRS sufficient flexibility to include cryptocurrency investments.   

Noncustodial wallets or decentralized exchanges arguably should not be viewed as financial accounts for  purposes of FATCA, because in such cases, the owner holds the private keys and hence directly controls the  assets.

IV. Conclusion 

Foreign cryptocurrency exchanges and other types of intermediaries, such as wallet providers, ATM operators,  and investment funds could be subject to certain information reporting, withholding, and due diligence  obligations under FATCA if (i) the intermediary is an FFI with (ii) financial accounts maintained by U.S.  persons.  The IRS has not released any guidance on the circumstances under which a cryptocurrency  intermediary would be treated as an FFI or a cryptocurrency investment would be treated as a “financial  account.”  Nonetheless, applying the current definitions in the regulations, it is possible to conclude, depending  on their activities, that centralized cryptocurrency exchanges taking custody of private keys, custodial wallet  providers, and cryptocurrency investment funds could be viewed as FFIs providing financial accounts to their  customers.     

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1 “FATCA” is the common name used to refer to Internal Revenue Code sections 1471 through 1474,  enacted in the Hiring Incentives to Restore Employment Act of 2010, Pub. L. No. 111-147 §§ 501-541 (2010).   

2 To the extent that a cryptocurrency intermediary is not an FFI, the intermediary would be a  nonfinancial foreign entity (“NFFE”) under FATCA.  I.R.C. § 1472(d).  NFFEs are not subject to the information  reporting, withholding, and due diligence requirements that apply to FFIs.  Generally, withholding agents must  withhold on certain U.S.-source payments made to an NFFE, unless (1) the NFFE either certifies that it does not  have any substantial U.S. owners (generally U.S. persons meeting a 10-percent ownership threshold), or  provides the name, address, and tax identification number of each such substantial U.S. owner, or (2) the NFFE  is an “excepted NFFE.”  I.R.C. § 1472(a)-(c), Treas. Reg. § 1.1472-1(c).  Certain excepted NFFEs (i.e., direct  reporting NFFEs) elect to report information about their substantial U.S. owners directly to the IRS.  Treas. Reg.  § 1.1472-1(c)(3).

3 There are two different types of IGAs—Model 1 IGAs and Model 2 IGAs.  Under Model 1 IGAs, FFIs  report information on their U.S. account holders to their country of organization, which then provides the  information to the IRS.  FFIs subject to Model 2 IGAs and those FFIs organized in a non-IGA country are  required to enter into an FFI agreement with the IRS, under which they must report information on U.S.  account holders directly to the IRS.   

4 Such jurisdictions also have not issued guidance on the treatment of cryptocurrency under the  Common Reporting Standard (“CRS”), which was developed by the Organisation for Economic Co-operation  and Development (“OECD”) and facilitates the exchange of tax information between non-U.S. countries.  CRS  and FATCA use similar terminology, and CRS imposes information reporting and due diligence requirements  on financial institutions that are very similar to those requirements for FFIs under FATCA.  Thus, an FFI could  be subject to requirements under both FATCA and the CRS.

5 Treas. Reg. § 1.1471-5(e)(1).  Certain insurance companies, holding companies, and treasury centers  are also FFIs.  Id. 

6 Notice 2014-21, 2014-16 I.R.B. 938, § 4 Q&A 1; IRS Frequently Asked Questions on Virtual Currency  Transactions (hereinafter “FAQs”), Q&A 2.  “Virtual currency” is defined as a digital representation of value,  other than a representation of the U.S. dollar or a foreign currency (“fiat currency”), that functions as a unit of  account, a store of value, and a medium of exchange.  A virtual currency that is convertible has an equivalent  value in fiat currency or acts as a substitute for fiat currency.  Notice 2014-21, § 2; FAQs, Q&A 1. 

7 I.R.C. § 1471(d)(5)(B); Treas. Reg. § 1.1471-5(e)(1)(ii), (e)(3)(i).

8 Treas. Reg. § 1.1471-5(e)(4)(ii). 

9 See Testimony of CFTC Chairman Timothy Massad before the U.S. Senate Committee on Agriculture,  Nutrition and Forestry (Dec. 10, 2014), at https://www.cftc.gov/PressRoom/SpeechesTestimony/opamassad-6.   This position has been upheld by at least one federal court.  See Commodity Futures Trading Comm’n v.  McDonnell, No. 1:18-cv-00361 (E.D.N.Y. Mar. 6, 2018). 

10 Specifically, the SEC has said that bitcoin and ether, in their present decentralized state, are not  securities, but that certain tokens issued in initial coin offerings may be securities.  See William Hinman, Digital  Asset Transactions:  When Howey Met Gary (Plastics), Remarks at the Yahoo Finance All Markets Summit:  Crypto (June 14, 2018), at https://www.sec.gov/news/speech/speech-hinman-061418; see also SEC,  Framework for “Investment Contract” Analysis of Digital Assets, at https://www.sec.gov/corpfin/framework investment-contract-analysis-digital-assets.  

11 I.R.C. § 475(c)(2). 

12 See Treas. Reg. § 1.1092(d)-1. 

13 I.R.C. § 475(e)(2).

14  I.R.C. § 1471(d)(5)(C). 

15 Treas. Reg. § 1.1471-5(e)(4)(i). 

16 I.R.C. § 1471(d)(5)(A). 

17 Treas. Reg. § 1.1471-5(e)(1), (2).

18  Treas. Reg. § 1.1471-5(b)(1). 

19 Treas. Reg. § 1.1471-5(b)(3)(i)(A)(1). 

20 Treas. Reg. § 1.1471-5(b)(3)(ii).

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