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Gaps and Confusion in Cryptocurrency Taxation

Posted on Oct. 12, 2020

Venezuela is hoping that cryptocurrency will deliver the nation from its punishing hyperinflation and the effects of U.S. sanctions that have stifled trade and rendered the Venezuelan currency nearly worthless.

Since 2018 the government has experimented with different crypto projects, but so far none have succeeded. In February 2018 the government released a national cryptocurrency, the petro, that President Nicolás Maduro said would be backed by the nation’s mineral wealth. But details about the offering — or even its level of adoption — have been slim. Local merchants reportedly won’t accept it, and global analysts have called it a scam. Bitcoin seems to be doing much better as an alternative to the Venezuelan bolivar soberano, as everyday Venezuelans are increasingly using bitcoin for routine purchases. The government is now planning to adopt that strategy on a more global scale.

At the end of September, the Venezuelan government announced it will use cryptocurrency for global trading, as a sort of end run around U.S. sanctions. As part of the strategy, it is planning to run a 90-day decentralized, global crypto stock exchange pilot program.

Few countries have embraced cryptocurrency in the manner Venezuela has. But many are eyeing the crypto industry through a much more traditional lens: as a stable growth industry.

Meanwhile, taxation of cryptocurrency poses considerable confusion and uncertainty for global investors because taxing authorities are adopting different approaches. In many cases, regulators are folding cryptocurrency into existing tax rules and treating it as property subject to capital gains rates upon disposition. A minority of jurisdictions are treating cryptocurrency as a separate class of assets. Beyond that, updates on existing legislation and regulations have been slow.

There are no global standards for cryptocurrency taxation. Perhaps there should be. That’s the take-away from PwC’s latest review of cryptocurrency taxation. The firm’s Global Crypto Tax Report 2020 surveyed tax rules in 30 jurisdictions that have released cryptocurrency tax guidelines, finding a jumbled landscape. The situation matters for cryptocurrency exchanges and investors moving forward because there are several cryptocurrency areas, like decentralized finance (DeFi) and the VAT, GST, or sales tax treatment of staking income, that have little to no specific tax guidance, especially cross-border. Nevertheless, they are expected to grow within the coming years.  

PwC Finds Gaps

Tax legislation and regulations in the countries PwC surveyed are generally failing to keep up with new cryptocurrency assets as they are introduced, according to the report. The first tranche of crypto tax regulations came out in 2014, five years after Bitcoin, the first cryptocurrency. Seven countries released guidance that year, including the United States, the United Kingdom, Australia, France, and Denmark. The next wave of regulations and legislation came between 2017 and 2018 when 11 countries, including Japan, Germany, Ireland, South Africa, Thailand, and Argentina, issued cryptocurrency guidance. From the beginning, there has been division over how countries characterize digital asset payment tokens like bitcoin for tax purposes. The differences have persisted as other countries gradually introduced their own crypto regulations and legislation. Many treat them as property subject to capital gains tax, but other options include treatment as foreign currency, or as their own asset class.

In this year’s report, PwC created a crypto tax index ranking jurisdictions on 20 different types of cryptocurrency tax guidance. Three things are notable about their findings.

First, there are three types of rules that have been adopted by roughly 50 to 60 percent of the surveyed countries. The rules address how individuals should calculate capital gains on crypto transactions, how businesses should calculate capital gains on crypto transactions, and how mining income should be taxed.

Within these areas, there are notable differences, particularly when crypto-to-crypto or crypto-to-fiat disposals are concerned. For example, Malta does not apply capital gains tax on long-held bitcoin transactions or exchanges. Portugal does not apply capital gains tax on bitcoin transactions by individuals. France does not tax capital gains on crypto-to-crypto exchanges, but does apply tax if a cryptocurrency is exchanged for a fiat currency.

Second, none of the jurisdictions surveyed has issued tax guidance on three newer cryptocurrency activities and products: crypto borrowing, lending, and DeFi; non-fungible tokens and tokenized assets; and the VAT, goods and services tax, or sales tax treatment of staking income.

Third, although there is a variety of rules, adoption is shallow. The 14 other types of guidance, mainly involving initial coin offerings, taxation of hard forks, airdrops, and VAT/GST treatment of various crypto assets, have been adopted by only a small handful of jurisdictions.

Additionally, most jurisdictions have not created crypto-specific withholding rules. General principles apply for all but five of the jurisdictions surveyed. PwC says this could be problematic because it’s not always clear if withholding is required under current rules. But the United States could lead the way on this because the IRS is expected to release crypto-specific information reporting and withholding rules targeting gross proceeds reporting.

Liechtenstein, Malta, Australia, and Switzerland have the most comprehensive crypto tax guidance, according to the report. It’s no coincidence that these jurisdictions are also promoting cryptocurrency as a growth sector. But economic growth appears to be a main reason for robust guidance, more than a desire to clear up taxpayer confusion. In Europe, an Alpine crypto corridor is forming in Switzerland and Liechtenstein, with both jurisdictions adopting rather wide-sweeping cryptocurrency rules. Last October the Liechtenstein Parliament approved a new Token and Trusted Technology Service Provider Act, also known as the Blockchain Act. It went into effect on January 1. Switzerland’s parliament on September 25 updated its blockchain laws, establishing a legal basis for DeFi trading and the legal requirements for operating crypto trading exchanges, among other rules.

In Israel, several lawmakers in the Knesset introduced legislation at the end of September to treat cryptocurrency as currency instead of as an asset subject to capital gains rates, according to media reports. The main rationale is that Israel needs to support digital currency as a growth sector.

Contrast these approaches with that of New Zealand, which does not have a particularly robust cryptocurrency sector. At the beginning of September, New Zealand’s Inland Revenue Department issued guidance on how crypto assets will be taxed, and said that regular income tax rules apply. New Zealand does not have special cryptocurrency tax rules, but it treats crypto assets as property for tax purposes.

What is missing from the library of crypto guidance? PwC flags a few areas in which comprehensive guidance is lacking:

  • the tax treatment of income earned from crypto staking and transaction validation;

  • the VAT implications of selling different utility tokens;

  • the tax treatment of DeFi, particularly how the recipient’s income is taxed and whether source payments should be taxed;

  • the taxation of security and asset-backed tokens;

  • the tax reporting obligations and responsibilities of digital asset exchanges; and

  • the taxation of cross-border decentralized autonomous organizations, which either operate with no or little human intervention.

ICOs Get Some Attention

Within the past three years, initial coin offerings (ICO) have become increasingly popular. But taxing authorities have been slow to warm up to this development. Only six jurisdictions in the survey — France, Switzerland, Germany, Malta, Hong Kong, and Singapore — have released guidance.

U.S. experience with ICO treatment indicates how complex the issue can be. The SEC treats ICOs as securities, although the IRS treats virtual currency as property under Notice 2014-21,
2014-16 IRB 938, and legislation to reconcile the issue has been introduced but not adopted. IRS guidance on the issue has also been silent.

Staking Issues

Some cryptocurrencies like Bitcoin allow users to validate mining transactions for new tokens, also known as staking. In exchange for staking, the users receive income. The benefit of staking is that it is less resource-intensive than traditional crypto mining. But there isn’t much guidance on how staking should be taxed, according to the report, and four tax issues remain to be resolved:

  • Is staking income payment for services or should it be considered passive income?

  • Should staking income be taxed when tokens are received or disposed of?

  • If a cross-border transaction is validated, where does the taxing right lie?

  • How does VAT apply to staking income?

In the United States, there are increasing calls for more guidance. In July a bipartisan group of members of Congress — Reps. David Schweikert, R-Ariz.; Tom Emmer, R-Minn.; Darren Soto, D-Fla.; and Bill Foster, D-Ill. — wrote to the IRS, suggesting that staking tokens should be taxed when sold, just like other forms of property.

“We believe that taxpayers’ true gains from these tokens should indeed be taxed. However, it is possible the taxation of ‘staking’ rewards as income may overstate taxpayers’ actual gains from participating in this new technology,” the letter said. “It could also result in a reporting and compliance nightmare, for taxpayers and the Service alike.”

Taxation of staking-related returns is another issue. Cryptocurrency stakers normally receive some sort of annual return, called an “inflation payment,” as an incentive to keep staking. It is unclear how those inflation payments should be taxed, according to the New York State Bar Association Tax Section. Those payments could be an accession to wealth and treated as gross income, although valuing extremely new coins may be difficult. But NYSBA Tax Section also points out that the payments could be similar to stock dividends and not be taxable, because staking tokens increases the coin supply and could drive down their value.

Authorities Take a Closer Look

Amid this backdrop, taxing authorities are gradually collecting more information about cryptocurrency accounts from crypto exchanges. The IRS was the first to seek information, sending a John Doe summons to Coinbase in 2016 seeking information on over 13,000 users. That request spurred various litigation challenges, including a lawsuit from a taxpayer who held an account with Coinbase, received a compliance letter from the IRS, and claims the IRS violated his constitutional due process rights and conducted an unlawful search and seizure of his private financial information by obtaining his account information Harper v. IRS, 1:20-cv-00771 (D.N.H. 2020). None of that has blocked the IRS from accessing account information, and it has propelled other taxing authorities recently looking to do the same.

In the United Kingdom, HM Revenue & Customs will be receiving account information from Coinbase users. On October 2 the exchange told its users that it will start to share account information with HMRC for users with a U.K. address who received more than £5,000 during the 2019-2020 tax year.

New Zealand’s Inland Revenue and Customs is also seeking user account information from exchanges, and Australia recently announced it is using data matching to locate Australian taxpayers who have held cryptocurrency assets over the past six years.

Russia is reportedly taking a harder stance on crypto disclosures. The Ministry of Finance wants to impose fines or jail time on Russian account holders who fail to report cryptocurrency income. The proposed amounts that would trigger this liability are surprisingly small, starting at RUB 100,000 (about $1,300), according to several local news reports.

International Coordination

PwC notes there’s a lot of room for policy coordination between taxing authorities. The report points out that international tax reform efforts at the OECD could considerably shape crypto taxation. Cryptocurrency by design is faceless and highly automated. Newer DeFi operations are built on public blockchains — no physical presence is needed — and it’s possible that cryptocurrency operations could fall under pillar 1 of the OECD’s base erosion and profit-shifting project 2.0 unified approach, which looks at economic activity instead of physical presence. The implications should become clearer after the OECD releases blueprints for its reform plan.

We are already seeing some international coordination in the area of enforcement. The Joint Chiefs of Global Tax Enforcement (J5), an alliance among the United States, the United Kingdom, Canada, Australia, and the Netherlands, is sharing information on cryptocurrency activity. In the wake of the coronavirus pandemic, the group has been scrutinizing that activity more closely. In July the J5 brought down an alleged $722 million scheme involving unregistered securities.

On a more global scale, the OECD is evaluating the taxation of blockchain, and that activity calls into question whether there is room — or appetite — for the OECD to generate a broad, crypto taxation framework, much like it did in 1998 when it developed a cross-border ecommerce taxation framework, the Ottawa Taxation Framework Conditions.

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