“In this world nothing can be said to be certain, except death and taxes”Benjamin Franklin
Cryptocurrency is a digital asset designed to work as a medium of exchange that uses strong cryptography to secure financial transactions, control the creation of additional units and verify the transfer of assets. The ‘coin’ carries value which can be transferred, although since that value is purely speculative and not supported by underlying assets or a central authority such as a bank, it can be very unstable. It is for this reason that it is often referred to as a digital or crypto asset rather than a currency.
In this season of cryptocurrency investment, the market can seem like a gold rush; offering promise, but at the expense of predictability. The taxation of cryptocurrencies has been the biggest change for Bitcoin traders. In almost all jurisdictions, there are no specific tax laws on the taxation of cryptocurrencies, therefore, tax treatment is based on general principles and guidance issued by Tax authorities. However, is cryptocurrency a digital currency or a taxable commodity? As a result of its unstable nature, most countries have failed to recognize cryptocurrency as a form of domestic legal tender. This might change in the nearest future.
United States of America
In the United States, IRS Notice 2014-21 defines virtual currencies as property. What this means is that anything purchased using a digital currency is liable to be taxed as a capital gain whether short or long term, depending on how long the asset was held. To illustrate this, if you buy a cup of coffee with Bitcoin that you purchased when it was worth $1,000, you must also account for the price of Bitcoin at the time of the coffee purchase. If Bitcoin is trading at $1,200 when you buy the coffee, you have purchased a dollar-denominated good with another asset that is now worth more in dollars than it used to be. That means the amount of Bitcoin you spent on the coffee will be taxed according to capital gains rules.
It is noteworthy to state that buying and holding cryptocurrency is not a taxable event but if you use digital coins to buy anything, even just a cup of coffee, after your holdings have increased in value, you have experienced a gain and that is taxable. Thus, for every purchase, you must report the amount you spent and the difference between the currency’s value when you spent it and the value when you first got it.
To the keen eye, these principles expose some gray areas. As the cofounder of CoinTracker, Chandan Lodha observed:
“the more devoted a cryptocurrency user you are, the more complicated it is to track everything the IRS needs”
What this implies is that you have to do a bunch of work in accounting and record keeping in order to have any real hope in getting your taxes right.
Furthermore, some traders have successfully managed to avoid paying taxes on cryptocurrency-for-cryptocurrency trades by appealing to something called the ‘like-kind exception’ which allows people defer tax payments when trading one property for another similar property. To illustrate, if you trade your house for another one, which then gains in value, you don’t have to pay taxes on that gain until you have the cash for it since the increase in value or gain is in fact tied up in the house itself. However, section of the 2017 tax bill limits this exception to real estate, meaning cryptocurrency traders must pay taxes on crypto-for-crypto trades made after December 31, 2017. What about trades before that? That’s a bit foggy.
In Germany, Bitcoin sales do not incur capital gains tax. That is, Germany won’t tax you for buying coffee with Bitcoin. However, if the investment is held for less than one-year, German Income Taxes apply. That is if you are selling your Bitcoins after a period of 12 months/ a year or more, then those capital gains are totally exempt. To illustrate, let’s say you bought 1 Bitcoin on the 1st of August 2016 and bought another 1 Bitcoin on the 1st of September 2018. On the 2nd of September 2018, you sold your 1 Bitcoin you bought on the 1st of August 2016. In such a case, you aren’t required to pay any capital tax gains after you cash out your 1st Bitcoin in Fiat. It is for this reason most tax experts believe Germany is a tax-free haven for mid-term and long term crypto holders. Income taxes in Germany are more progressive and can be up to 45%. So far, no country has taken such an open and ambitious step towards accepting cryptocurrencies in their tax laws.
However, in Australia, the Australian Taxation Office (ATO) has certain guidelines about cryptocurrency taxation on their official website and it is available to the public. In Australia, Bitcoin is neither considered money nor Australian currency or any other foreign currency which makes things a bit more twisted. It is considered an asset and is subject to Capital Gains Tax (CGT) except when used as a personal asset (cryptocurrency is not a personal asset if it is acquired, kept or used as an investment, in profit making scheme, or in the course of carrying on a business). This applies to all other cryptocurrencies like Bitcoin.
According to the Australian Taxation Office, a CGT is applicable when you sell your cryptocurrency. However, all your holdings must be mentioned in tax filing to avoid any issues. In essence, you pay tax only when you sell and not just buy and hold.
As earlier alluded above, crypto-to-crypto transactions is one of the biggest questions in taxation space. In Australia, such transaction is taxable. The Australian Taxation Office has specifically mentioned that while exchanging one cryptocurrency to earn another one, it means that you are selling first cryptocurrency and buying a second one.
In 2013, the Canada Revenue Agency (CRA) took the position that Bitcoin and other cryptocurrencies are not currencies and should instead be viewed as commodities. In essence, 50% of the gains are taxable and added to your income for that year. To illustrate this, if you bought a cryptocurrency for $1,000 and subsequently sold it for $3,000, you would have to report a capital gain of $1,000 (50% of $2,000) which would be added to your income and taxed at your marginal tax rate. However, let’s say you bought 1 Bitcoin for $100 but it has a current market value of $15,000 and you decide to renovate your home and the contractor agrees to trade his services which are normally worth $15,000 for 1 Bitcoin. What would be the tax treatment? In such a case both parties are liable for taxes. The original owner would pay capital gains on $7,450 (50% of $14,900) while the contractor would still need to report business income of $15,000.These kinds of transactions are known as bartered transactions which has been adequately provided for in sections 3, 6 and 69 of the Income Tax Act of Canada.
In all honesty, to say this tax treatment is a bit harsh would be an understatement.
The South African Revenue Service, being the main tax watchdog in South Africa, released a draft cryptocurrency tax legislation on April 2018. According to the legislation, digital currencies like Bitcoin will be classified as intangible assets subject to income tax. Thus, if this draft is legislated, South Africans would be mandated by law to declare income accrued from crypto transactions. However, the draft legislation also stipulates that cryptocurrency transactions are exempted from Value-Added Tax (VAT). This decision is premised on the fact that SARS views such transactions as being separate from financial services transactions. Thus, purchasing, selling, transfer, ownership, issuing and holding of digital tokens will not attract VAT under the proposed cryptocurrency taxation paradigm.
As with everything crypto, the rabbit hole goes deep, and some people are trying all kinds of tricks to cut their tax bills.
However, while many questions still remain unanswered as regards the general principles of taxing cryptocurrencies in various countries, we can only hope for more clarity in the nearest future. This lack of clarity does not tilt or shake the importance of taxation in a country’s economy. Taxation to a country’s economy is just like hinges to a door as Olukayode Ehimosan, an associate attorney at SPA Ajibade poignantly quipped in his article titled, “Improving the Nigerian Tax-titude”
“Taxation is the most viable hope for maintaining economic equilibrium and properly diversifying the economy. Its potentials are too much to quantify…”
Cryptocurrencies have entered the collective consciousness and adoption has grown worldwide. Governments are still trying to figure out a way to tax them. While some have been successful, some have encountered difficulties. Perhaps, in the nearest future, we can find more creative methods to effectively tax cryptocurrencies.