Tax Issues of Crypto Currency. Guideline for Tax on Digital Funds
Crypto currencies are on the rise. The Bitcoin Dollar Forex is sky high and the blockchain technology has the potential to knock banks out of the game. This article highlights the challenges that Bitcoins, Ethereum, Litecoins and other crypto currencies trigger from a tax perspective, by Tilmar W. Goos, LL.M
Bitcoin (BTC) the name of a digital money unit which is a global decentralized payment system. The market value of BTC 1 = USD$ 4.332,12 and fluctuates between -1.59% and +1.39% daily according to Coin Stats Mobile App for iOS. There are several digital currencies, another noteworthy crypto currency is Ethereum (ETH), which has a market price of ETH 1 = USD$ 307,03 as by today and a daily fluctuation of +1.72% and Litecoin (LTC) LTC 1 = USD$ 51.76 with a daily fluctuation -1.43%.
Transaction are handled via internet by a group of computers with special peer-to-peer application which means that unlike traditional banking, no central processing point is required. In order to manage the digital currency a personal digital wallet by the means of a software or hardware is used as an access tool for your own bitcoins. Cryptographic techniques ensure that transactions with Bitcoins are only made by the respective owner and the credit units and cannot be issued more than once.
The identification is made using the public key (“PUK”, from which a kind of address or account number is derived) and the corresponding authorization by the private key (“PIK”, similar to a personal password). A Bitcoin is defined as a chain of signatures, which can only be passed on with a valid PIK. If you want to transfer a Bitcoin, you take your own PIK and the PUK of the receiver and sign the Bitcoin so that only the receiver can sign the next transaction with his own PIK. A Bitcoin is therefore also referred to as an encryption. Although the term ‘currency’ is usually used by states, but this is not the case with Bitcoins. The conversion rate of a Bitcoin into other traditional payment means (so-called “Fiat Money”) is determined by a limited supply and a corresponding demand. The maximum amount of money is fixed by the network protocol to 21 million Bitcoin units and cannot be influenced by individual subscribers.
“Bitcoin and other crypto currencies, the concepts behind them and the way the blockchain works, have the potential to knock banks out of the game.”
Tax Treatment of Bitcoins and digital currency
Several jurisdictions treat the ownership of a digital information unit as a taxpayer’s right to a property and its tax treatment is determined by domestic law. In analogy to traditional cash, small amounts of a few hundred Euros are used for regular payment transaction may be neglected in the tax declaration of a taxpayer. From a tax perspective the question is where the Bitcoins are to be declared for tax purposes. Some jurisdictions include digital currency to securities which then may be affected in terms of tax treatment. However, even though the tax payer is obliged by domestic law to submit all enclosures regarding securities and credit balances with corresponding counter parties are to be recorded. Whereas monetary rights to a ‘thing’ are not listed under securities rather under section ‘other assets’ such as art or jewelry at the respective daily closing price.
The tax payer has to everything in his power to make a complete and correct assessment in accordance with domestic tax legislation. The arising problem is that there is no third party which would be subject to a certificate requirement and could confirm the end-of-year stock. Thus this triggers two main concerns, (i) first the third parties will be annulled and (ii) secondly the tax authorities are solely dependent on the data of the taxpayer similar to the case of jewelry or cash. It may be possible to print the end-of-year stocks of the digital wallet. However, a disclosure of the PUK and thus of the individual transactions open to the public does not appear to be proportionate since the payment details are subject to the protection of privacy and are not necessary for the correct assessment by the tax authorities. Furthermore, the PUK alone is not suitable for detecting the property of the corresponding bitcoins since this can only be done in combination with the respective PIK.
“Bitcoin and other cryptographic currencies are — unlike the Euro — not yet legal means of payment”
Evaluation of Digital Currency
Problems also arise in the evaluation of digital currency. Some jurisdictions treat Bitcoins as foreign currency and calculate a value for assets by the average of the prices published in the end of the year. This certainly does not do justice to the decentralized charter of Bitcoins because there are not only a few trading platforms but thousands which makes a fair declaration of the average almost impossible. It would be appropriate to base the valuation on the basis of average price of the most common exchanges which are e.g. coinmarketcap.com or another technique is to choose the price of the trading platform the taxpayer regularly uses. However, the high volatility which digital currencies such as Bitcoins are exposed within the same day makes it difficult to determine an official closing price and must be taken into consideration.
Digital Tax Evasion?
Every taxpayer must be able to ascertain whether an assessment is wrongly omitted or that a legally binding assessment is incomplete which triggers penalties imposed under domestic legislation. It is therefore advisable, especially in the case of larger amounts, to declare the digital currency in the pure state in a complete and true manner. If the person has neglected this step in the past, there is still the possibility of a punishable self-disclosure. If the taxpayer has a evaded tax for the first time, the prosecution will be dispensed. Self-report is worthwhile to reduce penalties because if tax authorities discover that taxes have been evaded it is too late to reduce fines through legal prosecution.
Finally, the taxation of digital currency is among others a challenging topic among tax experts and many questions remain unanswered. Whilst the bubble of digital funds grows through massive media coverage, the Big 4 accountancy firms lead the trend and accept crypto currency payments and offer crypto ATMs. This shows that this technology must be taken seriously. However, difficulties in legal definition, tax treatment and disclosure of crypto currency, tokens and other digital funds remain which offers taxpayers several loopholes and challenge tax authorities.
If you have question regarding the taxation of crypto currency or how to set up and ICO do not hesitate to contact me. My team and I are on the forefront of this topic and assist our clients throughout the start of an ICO, buying, investing and trading crypto currencies as well as consult on software and hardware wallet solutions.
by Tilmar W. Goos, LL.M, published 7th October 2017, Sønderborg, Denmark
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