Paying your Bit-Tax
The question of how to tax bitcoin has been complicated by the fact that regulators are still not entirely sure what bitcoin is. Is it a commodity? If so, income gained as a result of trading bitcoin would most likely be treated as capital gains. Is it a currency? If so, trading profit might be treated as ordinary income. And when/how are taxes applied? Is it upon actual sale? If so, does grocery shopping with bitcoin become a taxable event? And what about merchants? When is VAT applicable? When Bitcoin is accepted as a currency, is it taxed both as income and again for capital gain purposes when exchanged?
This guide briefly outlines the current tax debate in the US, EU and UK. However, our armchair punditry should not be confused with actual tax advice – consult with a professional as required.
Bitcoin Taxation in the US
A March 25th 2015 IRS statement provided notice that “the character of gain or loss from the sale or exchange of virtual currency depends on whether the virtual currency is a capital asset in the hands of the taxpayer”. In the event that bitcoin is a capital asset – similar to a stock or bond, for instance – it should be treated as property for the purposes of tax calculation – meaning taxes should be calculated at the time of sale.
On the plus side, this means that bitcoin gains are taxed at capital gains rate, well lower than income tax rates. On the other hand, losses can only be claimed up to $3,000 per year, meaning that big losses would need to be carried forward from year to year to claim tax credit.
For purposes of determining these capital gains or losses, the bitcoin owner must calculate the value in USD of his bitcoin on the day it was received. This can be an extremely difficult task considering that most bitcoin buyers and sellers, particularly those active for a long while, are unlikely to have documentation as to how and when each and every bitcoin was received. However, the IRS allows for some common sense in determining fair-market value, provided it is done in “a reasonable manner that is consistently applied.”
However, as Ryan Selkis writes in his investopedia series on the subject, if bitcoin is considered property buying a cup of coffee would theoretically be a taxable event. This, at the very least, would discourage greatly retail use. When pushed on this specific topic by the Wall Street Journal, document co-writer Keith Acqui admitted that the policy was indeed “cumbersome”, but went on to say that the bill has been written in that way, and the “policy would apply to all transactions”. This cumbersome policy is already giving rise to automated bitcoin taxation calculation services, offered directly from exchanges or wallets or from third-party accounting tools like libratax.
All things considered, the IRS ruling is beneficial to bitcoin holders, who enjoy a lower taxation rate on capital-gains.
Taxation in the EU
There is currently no proper guidance from the European Union as to how cryptocurrencies should be considered from a taxation perspective. This has led to a fragmentation of policy, serving to perhaps stunt the growth of the market.
Some member states, such as the UK, have taken the view that bitcoin (though this could be applied to any digital currency) is best categorized as a currency, and thus exchanging it for other currencies or services should not be subject to value added tax. France and Germany more or less share the UK position. Poland and Estonia on the other hand have argued that bitcoin is not a currency, and thus cannot be exempt from normal VAT taxation. Their arguments more or less boil down to a common theme in which bitcoin, as it has no issuer or supervisional institution, cannot be considered legal tender, a necessary component of the traditional definition of currency. There is selective application of VAT – for instance, Poland has imposed a 23% tax on mining profit, while Estonia requires a 20% tax on bitcoin exchanges’ already small margin. There are another dozen or so EU countries that have not yet determined their approach to cryptocurrency taxation.
The issue was flagged by the Swedish high court to the European Court of Justice in June 2014, asking for a directive on whether cryptocurrency exchanges must charge VAT on service fees. While EU directives are not binding on member states, they do provide serious influence over how member states craft their own laws. Additionally, in the case that a member state’s policy is in obvious contradiction to EU directives, it might be challenged in Brussels.
It usually takes a while for the ECJ to deliver a decision – meanwhile the bitcoin community will be holding its collective breath. The ruling could influence countries to change their policy to the benefit or detriment of bitcoin, or it might even prompt the EU to pass specific legislation. Depending on the outcome, it could represent a watershed moment for European-based exchanges, merchants and miners.
Bitcoin taxation in the UK
To the delight of UK-based bitcoin lobbyists, in February 2014 HMRC backed off a previous directive that had labeled bitcoin as a “taxable voucher” which would have required a 20% VAT on any bitcoin purchase, instead recognizing bitcoin as a currency. This means that, while VAT will be due from anyone accepting bitcoin as payment according to the same rules governing normal GBP transactions, the exchange of bitcoin and GBP will not be VAT-applicable.
Income and capital gains taxes will be applied only in certain circumstances. In highly speculative transactions there will be no taxes received, nor losses retrievable – which is a similar position to that taken vis a vis gambling. Essentially, bitcoin in particular, and cryptocurrency in general, are treated almost exactly as fiat currencies, which is great from both a regulatory perspective as well as from the perspective of wider adoption.
Thankfully, a fantastic little accounting and tax compliance product called LibraTax has automated the calculation of tax liability. Libra automatically calculates taxable and non-taxable events, maximizes user losses generated from currency depreciation, and minimizes gains to avoid overpayment. Libra automatically generates a completed tax form that can be attached to tax returns, basically automating the whole tax process from start to finish.