FATF has adopted international standards that would level the playing field for virtual asset service providers, including cryptocurrency providers, and traditional financial institutions. In response to heightened Money Laundering (ML)/Terrorism Financing (TF)/Proliferation Financing (PF) risks related to virtual assets, the FATF amended its Recommendation 15 – New Technologies to clarify that the FATF Anti-Money Laundering (AML)/Counter Terrorist Financing (CFT) Standards apply to virtual asset (VA) activities and virtual asset service providers (VASPs), including cryptocurrency providers. Despite the exit of the FATF Grey list and EU Black list, MIPA has continued its supervisory plan and ensured that the Accountancy sector is complying with its AML/CFT Obligations. Now that Mauritius is ‘Compliant’ or ‘Largely Compliant’ with 39 out of the 40 FATF Recommendations, we are leaving no stone unturned to be ‘Compliant’ with Recommendation 15.
As the use of digital assets proliferates and regulatory bodies continue to chart that new territory, auditing and accounting for those assets present fresh challenges. Many cases involving distributed ledgers and cryptocurrencies require thoughtful examination of basic considerations within traditional audit and accounting frameworks, while other instances call for new standards and practices. At this relatively early stage, uncertainty lingers around some elemental issues, such as which rules to follow, the jurisdiction of regulators and even the nomenclature by which to refer to such assets. With the presence of a new legislation englobing Virtual Assets in Mauritius and questions about auditing, accounting and taxation of digital assets, asking the right questions are helpful to understanding these new challenges and adapting to them. The ecosystem of digital assets is evolving, and so are the questions and challenges within.
A research paper on “Accounting for and auditing of digital assets” by the Association of International Certified Professional Accountants clarified that entities will classify digital assets as indefinite-life intangibles. This means that they are going to be recorded at their initial fair value but not adjusted to fair value thereafter. Instead, the assets will be tested for impairment. Thus, the assets will be measured as of the contract inception date. That value will be used to record the revenue upon transfer of the good.
Whilst the accounting bodies have been slow to issue authoritative guidance, the IRS has been more vocal as to how it wants individuals and companies to treat digital assets for tax purposes. In 2014, the IRS published Notice 2014-21, which stated that, “[f]or federal tax purposes, virtual currency is treated as property. General tax principles applicable to property transactions apply to transactions using virtual currency.” In October 2019, the IRS published Revenue Ruling 2019-24 and an updated FAQ on virtual currency transactions. The new guidance provided explanations on the taxation of hard forks and airdrops, and provided details on the accounting and calculation of gains and losses on virtual currency transactions.
The IRS’ classification of digital assets as general property creates multiple potentials for a capital gain, or loss, for a taxpayer. Whether a digital asset is exchanged for a durable good, contributed to a partnership, or used to pay network fees, the taxpayer must generally calculate capital gain on each transaction.
Considering the continued uncertainty surrounding the taxation of digital assets, many taxpayers are taking a conservative approach to digital asset tax reporting. Those transacting in digital currency should consult the proper professionals to ensure they understand the tax outcome of conducting or participating in an offering.
An auditor, on the other side, will need to carry out certain procedures to determine an entity’s rights and obligations over a wallet address keeping in mind that some wallets are anonymous. If an accountant thinks about it from a fraud perspective, nothing prevents anyone from booking the balances within that wallet on multiple statement entities and providing that wallet address to every auditor who is looking at the separate financial statements.
If, for example, a company purchased a product by moving bitcoin, the bitcoin transfer could be seen on the blockchain. But that does not necessarily provide audit evidence about the purchased product, including whether the product was delivered. One needs to understand if there is a manual process between information that’s flowing from the blockchain into the financial statements, and what does that process look like. And whether that would be subject to human error or fraud.
ML risks associated to VA/VASPs in the Accountancy Sector
Before on-boarding a client associated with crypto-assets, it is necessary to understand how actors may utilise crypto-assets and tokens to commit acts of crime. Examples of criminal actors include:
- Individual actors: for instance, an individual who buys or sells illegal goods on the dark web in return for crypto-assets;
- Small groups: for instance, individuals who are part of a small hacking group, or individuals who buy and/or sell illegal goods on the dark web with links to a larger criminal network;
- Large and/or sophisticated organisations: for instance, a group who launders crypto-asset proceeds of crime in exchange for fiat on behalf of smaller criminal organisations.
- Many Initial Coin Offerings (ICOs) for example appear to be legitimate, with the boards of directors comprising of personnel with impressive backgrounds. Such ICOs may be organised by individual actors, small groups or much larger sophisticated groups.
Despite crypto-assets often being described as highly disruptive and risky, when considering the AML risks associated with them it is important to remember that there are many similarities with traditional assets, e.g. cash. Whilst crypto-assets may allow greater anonymity than traditional payment methods they are, because of Distributed Ledger Technology (DLT), often inherently more transparent than cash. Basic risk assessment questions remain the same regardless of the presence or otherwise of crypto-assets in a transaction or business relationship.
- Client risk: “Does the client or its beneficial owners have attributes known to be frequently used by money launderers or terrorist financiers?”
- Service risk: Do any of our products or services have attributes known to be used by money launderers or terrorist financiers?”
- Geographic risk: “Is the client established in countries that are known to be used by money launderers or terrorist financiers?”
- Sector risk: “Does the client have substantial operations in sectors that are favoured by money launderers or terrorist financiers?”
- Channel risk: “Does the fact that I am not dealing with the client face to face pose a greater ML/TF risk?”
It may be helpful to consider the capacity in which the potential client is approaching the accountant, and the relevance of crypto-assets to the work. When dealing with persons who hold crypto-assets, the primary questions will be around source of wealth and funds. Given the widespread popularity of crypto-assets, the mere presence of it in a client’s portfolio does not necessarily make it a high ML risk.
Accountants should seek to understand how to reconcile existing accounting and finance concepts with new value transactions; equally they should seek to understand how the growth in new financial technologies brings with it a potential corresponding increase in ways to evade the law. Consequently, it pays dividends to familiarise yourselves with crypto-assets if only to ensure that we protect ourselves and our clients against risks, while capitalising on the rewards.
They should bear in mind that, despite allegations of criminality concerning participants in crypto-asset markets, there are many participants in such markets who are legitimate. These legitimate participants are entitled to accounting, auditing, insolvency and tax services.