Written by: TaxDAO-Ray, TaxDAO-Leslie
In October 2018, the encryption platform Oyster Protocol encountered a serious crisis. Its founder Bruno Block (real name Amir Bruno Elmaani) exploited a loophole in the smart contract to privately mint a large number of new Oyster Pearl (PRL) tokens. and sold off in the market, causing the price of PRL tokens to plummet. Elmaani was subsequently charged with tax evasion and fraud and was sentenced to four years in prison on October 31 this year.
This article will outline the facts and background of the Bruno Block fraud and tax evasion case, analyze the legal basis for the U.S. government to charge him with tax evasion, and on this basis, analyze the supervision and compliance of the U.S. government and the IRS on cryptocurrency issuance. requirements, with a view to providing reference for the industry.
1. Facts and Background of the Case
1.1 Oyster Protocol and its business model
Oyster Protocol was launched in September 2017 by an anonymous founder named Bruno Block. It is a blockchain-based data storage platform that uses IOTA and Ethereum technology to provide websites with a decentralized, privacy-preserving and low-cost data storage and transmission solution. Oyster Protocol aims to provide decentralized storage and encryption services for websites by utilizing the idle storage space and CPU of user browsers, while providing a new source of income for website owners.
The native token of Oyster Protocol is Pearl (PRL), an Ethereum-based ERC20 token that can be used to buy and sell data on Oyster Protocol. PRL can also be used to incentivize nodes in the network and maintain the security and stability of the network.
The reason for the issuance of PRL is to enable the operation and monetization of the data storage platform. Oyster Protocol enables their users to store and retrieve files through a decentralized, anonymous and secure system. On the one hand, as long as the Internet accesses the website using Oyster Protocol, they can contribute a small part of their computing power for other users to store data in the distributed ledger. At the same time, users who need to use cloud storage can use PRL tokens to pay for data storage, and can also get PRL token rewards by participating in network maintenance. On the other hand, website owners and content publishers can also earn income by using Oyster Protocol. They only need to add a line of code to the website to use the computing resources provided by users to store their content and get a certain percentage of the PRL tokens paid by users. In this way, they do not need to rely on the traditional advertising model, nor do they need to worry about problems such as ad blockers or malware. Oyster Protocol claims that the issuance of PRL is to create a win-win ecosystem where both websites and users can benefit from data storage and realize value exchange and incentive mechanisms through PRL tokens.
1.2 Development History of Oyster Protocol
In October 2017, Oyster Protocol conducted its initial coin offering (ICO), raising approximately $3 million.
In January 2018, Oyster Protocol released its testnet, demonstrating its data storage and retrieval capabilities. In April of the same year, Oyster Protocol released its mainnet, officially launching its data storage service. The mainnet also introduced a new token, Shell (SHL), which is used to pay for network connections and decentralized application (Dapp) operation fees; the token is distributed to PRL holders through airdrops. The launch of the mainnet marks the transformation of Oyster Protocol from an idea to a usable product, and also opens up more possibilities for its future development.
In October 2018, Oyster Protocol encountered a serious crisis when its founder Amir Bruno Elmaani (also known as Bruno Block) exploited a loophole in the smart contract to privately mint a large number of new PRL tokens and sell them on the market, causing the price of PRL tokens to plummet. Elmaani was subsequently charged with tax evasion and fraud and sentenced to four years in prison.
In November 2018, Oyster Protocol announced its name change to Opacity and launched a new token, OPQ, to replace the PRL token. Opacity inherited the technology and vision of Oyster Protocol, but cut off all ties with Elmaani. Opacity is still running and has a certain user base and community support.
2 Analysis of Elmaani Tax Evasion and Fraud Case
In addition to being criminally charged by the U.S. government for his actions of privately minting PRL and cashing it out, Elmaani is also facing a civil lawsuit filed by the U.S. Securities and Exchange Commission (SEC). The SEC sued: Elmaani sold and issued PRL through false promises and deception, violating the corresponding provisions of the Securities Act and the Exchange Act prohibiting fraud, and asked the court to confiscate his illegal gains and impose civil penalties. According to existing U.S. legal precedents, [1] fraudulent gains are also subject to taxation, so the judgment of the civil lawsuit filed by the SEC does not affect the determination of whether Elmaani has taxable income. Therefore, this article will mainly analyze the criminal lawsuit filed by the U.S. government.
It should be noted that, although according to relevant news reports, Elmaani pleaded guilty to the judge on April 5, 2023, and the judge made a formal judgment on October 31 of that year, [2] as of the time of this article, the author has not been able to retrieve the original text of the judgment. The latest relevant legal document that the author can retrieve is a "slip copy" signed by the presiding judge on April 4, 2023, updated by West Law, which is a draft judgment that has not been officially released. [3] Considering that Elmaani pleaded guilty to the judge the day after the draft was released, and according to the statement of the draft judgment, Elmaani did not object to the main facts of the case, this article will sort out the court's judgment ideas based on the draft judgment.
2.1 Prosecutor’s investigation and testimony against Elmaani
According to the indictment filed by prosecutors (on behalf of the U.S. government), prosecutors have evidence that Elmaani committed the following acts of tax evasion and fraud:
First, between 2017 and 2018, Elmaani sold his PRL for U.S. dollars through a series of intermediate steps. Elmaani exchanged a large amount of PRL he held on the first cryptocurrency exchange ("Exchange-1") for other cryptocurrencies. Afterwards, Elmaani transferred the new coins to the second cryptocurrency platform ("Exchange-2") and exchanged them for U.S. dollars.
Second, in October 2018, Elmaani secretly issued millions of PRLs, sold them, and kept the proceeds (the “Exit Scam”). Elmaani created millions of new Pearl tokens for himself for free by modifying PRL’s smart contract. At the same time, Elmaani converted PRLs into U.S. dollars using the same method as in the first step. In the process, Elmaani used cryptocurrency services called “mixers, or tumblers” to combine transactions from multiple customers, making individual transactions difficult to track; he also transferred cryptocurrency and U.S. dollars through the accounts of his friends and family (including his spouse), all of which had the effect of concealing the movement of cryptocurrency.
Third, Elmaani took other steps to conceal his income, including trading precious metals.
The fallout from Elmaani’s series of trades caused PRL to become nearly worthless. When Exchange-1 discovered the exit scam, it halted all trading in PRL and delisted PRL from its exchange two weeks later; the scam caused investors to lose a significant amount of money. Two days after launching the exit scam, Elmaani said that part of the reason he executed the exit scam was that “taxes are really nasty.”
2.2 Prosecution’s charges against Elmaani
The U.S. government alleges that in 2017 and 2018, defendant Amir Elmaani earned millions of dollars in income, including from a new cryptocurrency he created called Pearl Token, and he did not pay taxes on nearly all of that income. The U.S. government indictment alleges that Elmaani evaded paying most of his income taxes for those two years through various means, including:
(a) filed a false income tax return for the 2017 reporting year and failed to report significant amounts of income to the IRS;
(b) in 2018, used a nominee to receive part of his/her unreported income and transferred that income to him/her;
(c) in 2017 and 2018, earned income that he did not report by operating his business under a false name and concealing his true identity;
(d) owned assets through anonymous entities and in the names of others in 2017 and 2018;
(e) received additional unreported income from an October 2018 cryptocurrency exit scam while attempting to conceal his involvement in the scam; and,
and (f) engaged in extensive trading in cryptocurrencies, cash, and precious metals in 2017 and 2018 to conceal its unreported income.
2.3 Elmaani’s Defense
Elmaani did not deny that he had committed several of the actions listed by the prosecution, and even admitted that he knew he had tax obligations, but he still raised three points of defense. First, Elmaani claimed that he did not commit the aforementioned actions to evade taxes, but only to avoid the scrutiny and tracking of Pearl investors, company members and Pearl community members. Second, Elmaani claimed that he did not receive the tax bill sent by Exchange-2, so he did not know how much tax he had to pay, and therefore could not pay taxes. Third, Elmaani proposed that he suffered from mental illness (insanity) during the period of committing the aforementioned actions, so he did not have the intention to evade taxes, let alone take the relevant actions for the purpose of evading taxes. Interestingly, his explanation for this mental illness is that after setting up the relevant scam, he began to worry about the collapse of the world's financial system, so he wanted to renovate the yacht he bought after making a profit to provide financial security for his family after the financial crisis.
2.4 Summary of Court Decisions
Section 7201 of the Internal Revenue Code (IRC) of the United States (IRC § 7201) provides for the federal crime of tax evasion, which is a felony in the United States and carries a maximum sentence of five years in prison and a fine of $100,000 (a company can be fined up to $500,000 for this crime). The presiding judge in the Elmaani case pointed out that if the prosecution wanted to prove that Elmaani committed the crime of tax evasion, it should follow the precedent of the United States v. Josephberg case [4] and prove that Elmaani's behavior met the following three elements at the same time: (1) a large amount of tax debt; (2) the intention to evade taxes; and (3) active actions. As mentioned above, Elmaani has admitted that element (1) is established, and although he denied his intention to evade taxes, he still decided not to object to element (2). Therefore, the focus of the case ultimately fell on element (3), that is, whether Elmaani took active actions to evade taxes, which was mainly related to Elmaani’s third defense.
The prosecution refuted Elmaani's defense in the form of a motion. The prosecution believed that mental health evidence should be strictly limited, and the mental illness evidence presented by Elmaani was "impermissible evidence that seeks to 'excuse' the crime", that is, "impermissible evidence that seeks to 'excuse' the crime". The reason is that even if Elmaani does have fantasies and fears about the financial crisis and the end of the world, such mental problems will not conflict with paying income tax, that is, Elmaani can have such mental illness and the intention to evade taxes at the same time. The prosecution's rebuttal was recognized by the court, and Elmaani's defense was excluded by the court. In the end, the court believed that there was no evidence or explanation that could help Elmaani get rid of the charge of tax evasion. Of course, this draft did not contain the specific trial results, and the detailed reasoning and argumentation will be published after the official judgment document is issued.
In general, there was no fierce confrontation of opinions during the trial of the Elmaani case, nor were there any difficult theoretical problems to resolve, nor were there any ambiguous facts of the case. The focus of the dispute was on the traditional judgment of the elements of crime, and it did not directly reflect the characteristics of cryptocurrency tax crimes and the tendency of judicial trials. However, considering that the Elmaani case occurred when the ICO boom was beginning to decline, and there were few cryptocurrency tax-related criminal cases, the case is indeed cutting-edge and representative in the field of cryptocurrency cases in the United States and even the world. The following article will try to explore the U.S. cryptocurrency tax system involved and conduct appropriate extended analysis.
3. Analysis of tax-related content in this case
3.1 US Cryptocurrency Tax System
The premise of taxing cryptocurrencies is to clarify the legal nature of cryptocurrencies. Different organizations and institutions in the United States hold different views on this. For example, the SEC believes that cryptocurrencies are securities, while the Commodity Futures Trading Commission (CFTC) defines cryptocurrencies as commodities by interpreting the nature of cryptocurrency derivatives, and the IRS defines cryptocurrencies as property. Since the IRS is the tax authority, the IRS's characterization and regulations should prevail in the cryptocurrency tax system.
The US cryptocurrency tax system mainly revolves around income tax and capital gains tax. Of course, in a broad sense, capital gains tax is also a type of income tax, but it is often established separately due to legislative policy considerations. As early as 2014, the IRS stipulated the tax calculation rules for cryptocurrencies in the "Investor Guide and Rules" (Notice 2014-21), requiring that cryptocurrencies be subject to the same tax system as property. Specifically, there is no tax on the purchase and holding of cryptocurrencies; in terms of income tax, income from airdrops (AirDrop), decentralized financial lending (DeFi), mining, and receiving cryptocurrencies as wages and remuneration are all subject to income tax, and the fair market value is used to calculate the income; in terms of capital gains tax, converting cryptocurrencies into legal tender, giving away cryptocurrencies, using cryptocurrencies to purchase goods and services, and exchanging cryptocurrencies are all subject to capital gains tax, and different tax rates are applied based on the length of holding time after deducting the cost. [5]
However, there is something special about Elmaani’s behavior in this case, because he minted Pearl tokens before selling them. It goes without saying that capital gains tax should be paid on the proceeds from the sale of tokens, but the IRS has not yet reached a conclusion on whether the minting of tokens should be taxed. In this regard, some people believe that both minting and mining create new digital assets through calculations, so the income from minting tokens should also be taxed. This article believes that whether the minted tokens are taxable income should depend on their market liquidity. In the absence of liquidity, the true value of the tokens is difficult to determine, and naturally the income cannot be determined. Elmaani minted tokens illegally after the tokens were issued for a period of time. Since the token market already had a certain degree of liquidity at the time, the value of these newly minted tokens was relatively clear, and they belonged to Elmaani’s income and should be taxed.
3.2 US federal tax evasion
The previous article has mentioned the three basic elements of the crime of federal tax evasion in the United States. These three elements seem simple, but in fact, after being supplemented and improved by numerous judicial precedents, these three elements have relatively rich connotations. Some of the contents are not mentioned in the draft judgment of the court in this case, but are crucial to understanding this case.
Element (1) requires a substantial tax debt, that is, the amount of tax actually paid by the taxpayer is far less than what it should have paid. There are three points to note about this. First, the U.S. income tax liability is based on an annual unit, that is, the tax liability for each year is independent. If a taxpayer has taxable income in three tax years and commits tax evasion, then the taxpayer will be charged with three crimes instead of one, and the amount of tax evasion for three years cannot be combined. From this perspective, Elmaani may have committed federal tax evasion once in 2017 and once in 2018. Second, the prosecutor of a federal tax evasion crime (usually the U.S. federal government) does not need to prove the exact amount of tax evasion of the defendant, because the purpose of imposing penalties for tax evasion is not to recover a specific amount of tax, but to punish tax evasion and violation of the tax system. As for how to determine whether an imprecise amount is "substantial", U.S. case law has not established an absolute standard or used a specific formula. Instead, it is often up to the jury to decide whether the amount of tax evasion is "substantial" based on the specific circumstances. [6] Understanding this point well, we can also understand why in the aforementioned draft judgment, the judge, prosecutors or Elmaani did not investigate or refute the amount of tax. Third, as mentioned above, the source of income does not affect its taxability, and illegal income such as fraud is also subject to income tax. [7] Therefore, no matter what the verdict of the SEC v. Elmaani securities fraud case is, Elmaani's tax evasion case will not be affected.
Element (2) requires that the defendant has the intent to commit tax evasion, and there are multiple criteria for determining intent. First, a good motive cannot be used as a defense for intent, and the prosecution does not have to prove that there is some evil or negative motive behind intent. Intention only needs to be a voluntary and intentional violation of a known legal obligation. [8] Second, willful ignorance should also be considered intent. Willful ignorance means that the taxpayer knows that he is not aware of the relevant tax regulations, but still files a tax return in this state of ignorance. However, there are exceptions to this situation. In the case of unclear and ambiguous tax laws, ignorance and misunderstanding of the law can be a valid defense. [9] Finally, a decline or loss of willpower can also be a valid defense, provided that such willpower problems are directly related to the criminal behavior. Otherwise, as the prosecution argued in this case, some mental illness unrelated to taxation cannot be used as a reason to exempt from the crime of tax evasion.
Element (3) requires active conduct for the purpose of tax evasion, which can be manifested in two broad forms: evasion of assessment and evasion of payment. The former refers to the omission, underreporting of income, or overreporting of deductions, and the latter refers to the concealment of property after the tax assessment is completed in order to avoid taxes. The simple act of not paying taxes is not subject to federal tax evasion. Elmaani's behavior was evasion of assessment, which is also the most common tax evasion behavior. If Elmaani did not file false tax returns, operate anonymously, and trade after selling tokens, but simply refused to pay taxes, then he would at most be punished for the misdemeanor of willful failure to pay taxes under IRC Section 2703, rather than the felony of federal tax evasion.
3.3 US cryptocurrency tax reporting requirements
There is no separate declaration content and declaration procedure for cryptocurrency taxes in the United States. The relevant declaration is still carried out under the framework of income tax and capital gains tax. However, the IRS's requirements for cryptocurrency tax declaration are becoming increasingly strict and sophisticated, and the enforcement and supervision efforts are also increasing, which is reflected in both direct and indirect perspectives. The so-called direct perspective refers to the IRS's increased tax collection and management efforts on cryptocurrency traders. For example, since 2020, the IRS's 1040 tax form has begun to include questions such as "Did you receive, sell, send, trade or otherwise obtain any economic benefits from any virtual currency during 2021?" For another example, the IRS has increased the relevant budget and invested more manpower and financial resources to improve the enforcement of cryptocurrency traders. For another example, with the new regulations taking effect in 2024, people who receive cryptocurrencies worth more than $10,000 in transactions or operations have the obligation to report to the IRS. From an indirect perspective, the IRS mainly obtains tax-related information through pressure from centralized exchanges (CEX) and others. Since KYC verification must be completed before trading can be carried out after registering with CEX, even if taxpayers do not actively fill in the cryptocurrency transaction tax information, CEX will indirectly provide the IRS with the user's cryptocurrency transaction information through Form 1099 when filling out its annual tax form. In addition, the IRS is already using blockchain analysis technology to track relevant transaction information. If the relevant address has interacted with some centralized exchanges, the information and tax status of its holder may also be captured.
Specifically, when filing cryptocurrency taxes, taxpayers may need to fill out the following forms:
In addition, taxpayers may also receive a 1099-K, 1099-MISC or 1099-B form from a CEX, depending on the exchange. However, the 1099-K is not used to report the tax status of personal transactions like the forms listed in the table above, but is only used for the IRS to understand transaction information, and the same is true for the 1099-MISC and 1099-B forms. However, these three forms are not completely suitable for cryptocurrency transactions, so the IRS is planning to launch the 1099-DA form, which is more in line with the actual cryptocurrency transactions.
4. Conclusion
In sharp contrast to the booming and rapid development of cryptocurrencies is the relatively backward and lacking legal system. In particular, countries around the world, including the United States, have not yet formed a sound regulatory scheme for fraud and tax issues in cryptocurrency transactions. The Elmaani case involves both civil securities fraud and criminal tax crimes. The former harms the legitimate rights and interests of the majority of investors, while the latter endangers the country's fiscal revenue. This article focuses on the U.S. federal tax evasion crime involved in the Elmaani case, and analyzes the constituent elements of tax evasion while analyzing the U.S. cryptocurrency tax system and its specific reporting requirements. However, due to the complexity of the cryptocurrency field and the professionalism of tax compliance work, this article can only select the key points to expand on. As for more theoretical and practical issues of cryptocurrency transaction taxation, they will be discussed in another article in the future.
[1] See Moore v. United States, 412 F2d 974, 978 (5th Cir. 1969). See also United States v. Wright, 798 Fed. Appx. 849, 857 (6th Cir. 2019).
[2] See IRS. (2023, October 31). Cryptocurrency founder “Bruno Block” sentenced to four years in prison. Retrieved February 4, 2024, from https://www.irs.gov/compliance/criminal-investigation/cryptocurrency-founder-bruno-block-sentenced-to-four-years-in-prison.
[3] See UNITED STATES of America, v. Amir ELMAANI, 131 A. F. T. R. 2d 2023-1308 (20 Cr. 661(CM)).
[4] See United States v. Josephberg, 562 F.3d 478, 488 (2d Cir. 2009).
[5] See Overview of the US Crypto Tax System | By TaxDAO | CoinTime. (n.d.). Cointime. https://cn.cointime.ai/news/mei-guo-jia-mi-shui-zhi-du-gai-lan-35353
[6] See United States v. Cunningham, 723 F2d 217, 230–231 (2d Cir. 1983), cert. denied, 466 US 951 (1984).
[7] See United States v. Stafoff, 260 US 477, 480 (1923). See also United States v. Mueller, 74 F3d 1152, 1155 (11th Cir. 1996).
[8] See United States v. Phipps, 595 F3d 243, 247 (5th Cir. 2010)
[9] See Connally v. General Construction Co., 269 US 385, 391 (1926); McBoyle v. US, 283 US 25, 27 (1931).
