As Jersey, the British Crown Dependency and offshore financial centre, becomes the first jurisdiction in the world to establish a regulator-approved Bitcoin investment fund, this month we chart developments over the past year in the taxation and regulation of this mysterious “cryptocurrency”.
Bitcoin: The Basics
Developed by the elusive Satoshi Nakamoto (believed to be a pseudonym) and introduced in 2008, Bitcoins are traded over peer-to-peer computer networks. No banks or middlemen are involved with bitcoin transactions, and the currency is not controlled by any central bank or other jurisdictional or multilateral authority. Not yet at any rate. So, put simply, Bitcoins are a form of internet cash.
Bitcoins can be acquired in a number of ways. The most common ways of obtaining Bitcoins are: buying them from a friend or another individual; accepting payment for the sale of goods and services in Bitcoins; and buying them from a Bitcoin exchange by converting money in your bank account into Bitcoins. Popular exchanges include Blockchain, Bitbargain and Quickbitcoin, and Bitcoins can of course be converted back into “real” money in the currency of your choice.
Another way of obtaining Bitcoins is to earn them by becoming a “miner”. “Mining” is actually fundamental to the Bitcoin economy and is how Bitcoins are created. By donating a portion of your computer’s processing power to solving Bitcoin transactions and securing the network, known as the “blockchain”, Bitcoins can be earned. However, the Bitcoin mining industry is becoming increasingly competitive; the rate at which new Bitcoins are created each year is automatically reduced, and will continue to fall until 21m Bitcoins are in circulation. It is expected that this point will be reached by 2040.
Tax and Regulatory Issues With Bitcoin
Bitcoin is unregulated, and the situation in most countries remains that, while Bitcoin trading is not illegal, it is not expressly legal either. Still, by not acting, governments across the world seem to have given their tacit acceptance of the virtual currency. Except Thailand that is, which has banned its use. The Thai authorities do not consider Bitcoin to be a real currency, and have made it illegal to both buy and sell Bitcoins and trade in goods and services using Bitcoins.
The regulatory vacuum in which Bitcoin exists, coupled with the fact that most tax authorities are struggling to come to terms with the growth of the internet and e-commerce, makes trading in Bitcoin – and other virtual currencies for that matter (for Bitcoin is not the only one) – an uncertain business. Will we see more countries follow Thailand’s lead and ban crypto currencies? Or will national and supranational regulators and central banks get together and decide to control crypto currencies as conventional fiat currencies? And what of the tax implications of using Bitcoin and similar virtual currencies? Judging by the increasingly regular pronouncements and guidance by tax and regulatory authorities across the world, Bitcoin is slowly become an accepted medium of exchange. These jurisdictional developments are summarised next.
In April 2014, Bulgaria's tax authority said that virtual currencies such as Bitcoin are to be treated as financial assets for tax purposes, in a statement issued ahead of this month's 2013 tax-filing deadline.
According to a statement from the country's National Revenue Agency, gains from digital currency trading will be taxed at 10 percent, and taxpayers should enter details on this income minus losses into existing fields in tax returns.
The announcement comes days after the US Internal Revenue Service (IRS) issued more comprehensive guidance in which it explained that digital currencies should be regarded generally as property for federal tax purposes, and in some cases as a capital asset when sold or exchanged.
In April 2013, Brazil revealed that it will treat Bitcoin as a security rather than a currency for tax purposes, thereby introducing capital gains tax on speculative trading.
Claudemir Malaquias, Chief of Tax and Customs at the Brazilian Revenue Service, said in a recent interview published by Brazilian newspaper Folha de São Paulo that investors in Bitcoin will be required to file information on gains from digital cryptocurrency holdings in their tax returns. Taxes will apply to holdings worth BRL1,000 (USD450 at the time of writing) or more, and amounts exceeding BRL35,000 will be taxed at a 15 percent rate.
In August 2013, Germany's Ministry of Finance announced that it is to recognize Bitcoin as a "unit of account", introducing value-added tax on the sale of goods and services for a consideration of Bitcoins.
The decision marks a part-reversal of the nation's earlier treatment of the Bitcoin as an alternative asset class. In June, the Government announced that gains derived from the appreciation of Bitcoin holdings would be subject to capital gains tax at Germany's 25 percent rate.
Instead, under the new rules, Bitcoins held for more than one year will be exempt from capital gains tax (CGT). The exemption is aimed at preventing the double taxation of persons using Bitcoins to pay for goods and services instead of conventional currency, but retains CGT for speculative short-term investments. VAT is charged on Bitcoin-"denominated" transactions between taxable persons, at the rates applicable to those goods or services, and profits are treated as income for income tax purposes.
Companies wishing to transact in Bitcoins are required to register with the Federal Financial Supervision Authority.
In March 2014, Hong Kong's Financial Services and the Treasury Bureau warned investors that caution should be exercised when trading in virtual currencies, such as Bitcoin. The Bureau is responsible for providing advice to the Government and regulators on financial sector policies and oversight.
It pointed out that since mid-2013 the Government and financial regulators have been reminding the public of risks relating to the highly speculative nature of investing in virtual commodities, which are not regarded as legal tender in Hong Kong. Their prices are susceptible to significant fluctuation due to speculation, such that – unbacked by any physical items, issuers, or the real economy – they can cause significant monetary losses to consumers, the Bureau warned.
While Hong Kong does not regulate virtual commodities specifically in terms of their safety or soundness, it was stressed that existing laws provide sanctions against money laundering, terrorist financing, fraud and cybercrime.
Hong Kong’s Government and financial regulators are to closely monitor developments, including the use of virtual commodities in the jurisdiction and the evolving regulatory consensus at international level. They also plan to monitor regulatory and enforcement actions in comparable jurisdictions, to consider whether further action is necessary to protect the public.
Isle of Man
In June 2013, the Isle of Man's Department of Economic Development announced that the island intends to introduce measures to enhance controls on the use of digital currencies, such as Bitcoin.
Cryptocurrencies fall outside of the Isle of Man's traditional anti-money laundering legislation. The Department said the absence of regulation "leaves a window where businesses could trade from the Isle of Man [and] undertake practices which are at odds with the island's stance on anti-money laundering and crime."
The island said it is to recognize digital currency as property, rather than currency, and impose the appropriate anti-money laundering controls that apply to other designated businesses. The measures will be introduced in two stages: firstly by including digital and cryptocurrencies within the remit of the Proceeds of Crime Act 2008; and, secondly through the proposed enactment of the Designated Business (Registration and Oversight) Bill 2014.
Businesses trading in digital currencies will not need to be licensed by the island's Financial Supervision Commission, but will need to register with it, and will be subject to compliance reviews.
Following the collapse of Japanese Bitcoin exchange Mt Gox in March 2013, the Japanese authorities announced that they would review the tax treatment of cryptocurrencies such as Bitcoin to support Japan's efforts to enhance the regulation of the sector.
Previously Japanese regulators shied away from taking a position on Bitcoin, stating only that it is not considered a currency and therefore outside the sphere of regulators.
The difficulty is as to how wide Japan should cast its net, and lawmakers must consider whether any new VAT obligation is in fact enforceable. Japan may follow the UK's lead that Bitcoin should be treated in the same way as gold. Under this approach, purchases that are paid for with Bitcoins are subject to VAT in the normal way, but Bitcoin trading and "mining" activities do not face VAT.
Takuya Hirai, an IT advisor to the ruling Liberal Democratic party, told reporters: "We haven't yet thoroughly grasped the situation, but some kind of regulation is needed from the perspective of consumer protection, and we will also discuss [Bitcoin] from the perspective of imposing asset tax."
Japan has previously acknowledged that, despite its aspirations to heighten regulation on Bitcoin trades, introducing oversight of cryptocurrencies will require international efforts, not unilateral reforms.
Not only has Jersey become the first jurisdiction in the world to successfully establish a regulator-approved Bitcoin investment fund, it has also set out rules on the taxation of cryptocurrencies.
Philip Ozouf, Jersey's Assistant Chief Minister, said: "This is believed to be the first regulated Bitcoin fund in operation and Jersey is pleased to be paving the way. Fintech, which broadly defines the emerging digital industry in finance, is a sector that I believe holds significant opportunities for Jersey.”
The open-ended fund is due to launch on August 1, 2014.
However, the Jersey Financial Services Commission is of the view that an in-depth analysis of the risks posed by crypto-currencies needs to be carried out before an appropriate and proportionate anti-money laundering regime can be introduced.
The local tax authority in Lódz, central Poland, said in May 2014 that the sale of the digital currency Bitcoin should be subject to VAT in Poland, regardless of where the recipient is located.
While there is still considerable uncertainty in the absence of national guidance on the treatment of cryptocurrencies, the local tax authority said that the "mining" activity which creates Bitcoin should be taxable, and as such the supply of Bitcoins in each of the circumstances described should be subject to VAT charged at the headline rate of 23 percent.
The applicant had asked about the VAT treatment of three separate supplies, to a recipient in the state, one to a person located in another European Union member state, and one to a non-EU recipient.
In January 2014, the Inland Revenue Authority of Singapore (IRAS) issued guidance on the GST treatment of goods and services acquired in exchange for Bitcoin and Bitcoin trading.
In an email sent to Singapore-based bitcoin broker Coin Republic, IRAS clarified that, "the sale (including the exchange) of bitcoins in return for a consideration in money or in kind is a taxable supply of services subject to GST. As bitcoin does not fall within the definition of ‘money’ or ‘currency’ under the GST Act, a supply of bitcoins is not a supply of money and would not be disregarded for GST purposes. The supply of bitcoins would be treated as a supply of services as it involves the granting of the interest in or right over the bitcoins. If the seller is a GST-registered person, he would have to account for output tax on the sale of bitcoins made in the course or furtherance of his business."
Coin Republic founder David Moskowitz welcomed the confirmation, stating: "The guidance which IRAS laid out is rational and well thought out. As a business owner I can clearly account for my earnings on Bitcoin trades for my clients and my own positions and pay the proper taxes."
St Kitts and Nevis
In one of the more bizarre Bitcoin developments, the St. Kitts and Nevis Government announced on July 9, 2014, that it does not, and will never, accept investments in Bitcoins into its Citizenship By Investment Program.
The statement goes on to say that the islands will be conducting an investigation with a view to revoking the licence of any practitioner promoting entry to the program via crypto-currency investment.
The Government statement said: "The Citizenship by Investment Unit would like to assure the general public that we do not recognize Bitcoins as legal investment currency for financial transactions within our Citizenship by Investment Programme. We further emphasize that we do not accept Bitcoins, have never accepted Bitcoins, and will not accept Bitcoins."
This announcement follows the widely-publicised offering by at least one company of St Kitts and Nevis passports in exchange for Bitcoins and the subsequent Caribbean Community (CARICOM) communique highlighting the need for enhanced regulation to protect the reputation of such programs.
At least one company is offering admission to the St Kitts and Nevis Citizenship by Investment Program paid for with the cryptocurrency Bitcoin.
The Citizenship Program of St. Kitts and Nevis was established in 1984 and requires applicants to make an economic contribution to the country. In exchange, they and their families are granted full citizenship.
Earlier this year, UK tax authority HM Revenue and Customs (HMRC) revised its position on the VAT treatment of cryptocurrencies, in particular Bitcoin.
In Revenue and Customs Brief 09/14, released on March 3, 2014, HMRC has said that it intends for its VAT treatment of cryptocurrencies, such as Bitcoin, to be consistent with any treatment that may eventually be implemented across the EU. Against that background, and also due to the evolving legal and regulatory environment surrounding cryptocurrencies, HMRC has emphasized that the VAT rules outlined in the Brief are provisional, pending further developments.
HMRC says that taxpayers can rely on the VAT treatment outlined in the Brief unless and until HMRC announces any changes. Any changes will not apply retrospectively, it confirmed.
The Brief states that for VAT purposes Bitcoin and similar cryptocurrencies will be treated as follows:
- Income received from Bitcoin mining activities will generally be outside the scope of VAT on the basis that the activity does not constitute an economic activity for VAT purposes. HMRC has said that this is because there is an insufficient link between any services provided and any consideration received.
- Income received by miners for other activities, such as for the provision of services in connection with the verification of specific transactions for which specific charges are made, will be exempt from VAT under Article 135(1)(d) of the EU VAT Directive as falling within the definition of "transactions, including negotiation, concerning deposit and current accounts, payments, transfers, debts, cheques and other negotiable instruments."
- When Bitcoin is exchanged for sterling or for foreign currencies, such as euros or dollars, no VAT will be due on the value of the Bitcoins themselves.
- Charges (in whatever form) made over and above the value of the Bitcoin for arranging or carrying out any transactions in Bitcoin will be exempt from VAT under Article 135(1)(d) as outlined above.
However, in all instances, VAT will be due in the normal way from suppliers of any goods or services sold in exchange for Bitcoin or other similar cryptocurrency. The value of the supply of goods or services on which VAT is due will be the sterling value of the cryptocurrency at the point the transaction takes place, HMRC has said.
The US Internal Revenue Service (IRS) issued much-needed tax guidance on March 25, 2014 to provide clarification for users of Bitcoin and other digital currencies. It has decided that cryptocurrencies should be treated as property, not currency, for US federal tax purposes.
As was noted by National Taxpayer Advocate Nina E. Olson in her 2013 annual report to Congress in January this year, Bitcoin usage increased by over 75 percent in the four months between July and December 2013 – from about 1,700 transactions per hour to over 3,000 – and, over the same period, the market value of Bitcoins in circulation rose more than ten-fold from about USD1.1bn to USD12.6bn.
With taxpayers being unsure previously of the tax rules to which they should comply, it is now hoped the provision of IRS guidance will promote tax compliance, particularly among those who want to report digital currency transactions properly, and provide tax certainty.
The IRS guidance has been issued in the form of answers to frequently asked questions, so as to provide clear and basic information on the US federal tax implications of transactions in, or transactions that use, virtual currency.
While, in some environments, virtual currencies operate like fiat currency, the IRS points out that they do not have legal tender status in any jurisdiction, and that, consequently, they should be treated as property for US federal tax purposes.
As can be seen from the above summaries of jurisdictional developments in the area of virtual currencies, tax authorities around the world are creating a patchwork of different tax treatments of Bitcoin and other virtual currencies. There seems to be some disagreement as to whether Bitcoin is a currency or “property” as the IRS decided. It seems as though tax authorities are leaning towards the latter interpretation, but the inconsistent landscape will not help Bitcoin usage to grow. Indeed, jurisdictions such as Hong Kong and the Isle of Man remain quite suspicious of virtual currencies, and it cannot be ruled out that some countries will go down the same route as Thailand.