Taxing Bitcoing

 

Taxing Bitcoin:

It’s a Bit Cryptic

As Bitcoin becomes ever more mainstream, tax authorities are

struggling to keep up. In this article, we look at the intricacies of

the technology and the tax implications thereof.

 

Bitcoin: Is it a currency or another type of asset? The

answer to this question has significant implications

for how Bitcoin owners and traders are taxed. As

at the time of writing, one Bitcoin was trading at

around R124 850, having been trading at R13 837

on 1 January 2017. Bitcoin raises a number of interesting

questions, such as what drives the volatile swings in price and

is Bitcoin really the way of the future?

There is no escaping the rise in popularity of Bitcoin. The

International Monetary Fund and the European Central Bank,

among many others, have authored reports noting that serious

consideration should be given to Bitcoin and blockchain

technology because of its growing international appeal. The wide

reach of Bitcoin is assisted by the fact that it is entirely digital and

has no physical form.

Bitcoins are accepted as a means of payment across the

world by many reputable entities, such as Microsoft, Overstock

and TakeaLot. Pick n Pay recently successfully piloted the

acceptance of payments in Bitcoins.

However, there have also been instances of illegal activity using

Bitcoins. For example, a website on the so-called Dark Web,

known as Silk Road and Silk Road 2.0, accepted Bitcoins as

payments for, inter alia, purchasing drugs and commissioning

hits on individuals.

 

Control

One of the key features of Bitcoin is that it is not controlled by a

single entity, such as a central bank. This lack of central control

allows Bitcoin to circumvent exchange control regulations. So,

transfers can be made internationally without going through a

central bank or a remittance company.

It also appears as though traditional macroeconomic variables,

such as inflation and interest rates, do not have a direct impact

on Bitcoin.

Additionally, Bitcoin is limited to a total supply of 21 million,

thereby avoiding issues that could be caused by a central

bank manipulating the money supply (e.g., through quantitative

easing).

 

Public ledger

The absence of a single authority to regulate the use of Bitcoin

would have led to fraud issues (most commonly double spending)

around the use of Bitcoin. But, this problem was

solved quite elegantly by Bitcoin’s unknown designer(s) who

used the alias Satoshi Nakamoto in the White Paper entitled

Bitcoin: A Peer-to-Peer Electronic Cash System.

All transactions on Bitcoin are, thus, simultaneously stored on

a distributed public ledger that cannot be altered. This ledger

is known as the blockchain and has found application beyond

Bitcoin itself. As all transactions are publicly recorded, if a person

were to try and process a fraudulent transaction, the network

would reject it as it would not reconcile.

 

Anonymity and security

Yet, what is stored on the network is merely addresses and

Bitcoin values, not personal information. When you have

Bitcoins, you will have a wallet address and this is what is

recorded. This is akin to a bank account. What is also key here

is that this may indicate that Bitcoin is an anonymous vehicle for

transacting. This is, however, not the case. Studies by forensic

IT specialists have shown that a user can be determined with

significant investigation; hence, Bitcoin is pseudonymous. This

aspect of Bitcoin has led to concerns around Bitcoin being used

for money laundering and the financing of terrorism.

Bitcoin itself and the addresses it uses, mentioned above, are

governed and secured by a branch of mathematics known as

cryptography. Cryptography is the process and art of converting

legible information into a code which can only be read legibly

by the trusted party to the transaction. This has led to the

term “cryptocurrency”, of which Bitcoin is one of many. Other

examples include Ethereum (currently the largest cryptocurrency

by market capitalisation after Bitcoin), Litecoin, Peercoin and the

tongue-in-cheek Dogecoin. Note that this is not an exhaustive list

and the world of cryptocurrency is exceptionally vast.

 

Acquisition

Bitcoins can be acquired in various ways: Through peer-to-peer

purchases, by being purchased on an exchange or through

mining.

In the first instance, individuals can transact with others to

purchase Bitcoins or trade them for goods and services.

Exchanges can be used in the second instance. An exchange

works, as other exchanges, where conventional currency is

used to purchase cryptocurrency. South African exchanges

include Luno and Ice3X. It is worth noting that across exchanges

globally, Bitcoin trades at different prices, indicating a lack of

price parity.

The last method of acquisition involves using computing power

to solve cryptographic hash functions, thereby generating

a reward of 12.5 Bitcoins, which halves with every 210 000

blocks generated, and is known as “mining”. This method uses

tremendous amounts of electricity and has been commercialised

globally, effectively excluding small players who have limited

computing power.

 

The regulatory environment and tax

The aforementioned characteristics and uses collectively present

interesting challenges to regulators and governments alike. At the

moment, in South Africa, there is no regulatory framework. This

is what the deputy CEO of Pick n Pay mentioned as the obstacle

to a full-store rollout of Bitcoin acceptance. Even globally, the

regulatory situation is still uncertain with very few countries

providing a comprehensive regulatory framework.

There are also challenges within the financial reporting space, as

there is no definitive policy for accounting for Bitcoin. However,

initial research by the author in this regard does exist.

Our focus here is on how tax regulators should be taxing Bitcoin,

if at all. South Africa currently does not have any guidance on

how Bitcoin should be taxed. The SARB has stated, in their

Position Paper on Virtual Currencies, that they do not “oversee,

supervise or regulate” virtual currencies, including Bitcoin.

 

BITCOIN PERSPECTIVES FROM VARIOUS COUNTRIES

 

Country Tax Treatment

USA The Internal Revenue Service has no single

treatment for Bitcoin taxable gains and losses.

What is crucial is the character of the gain or loss.

Where Bitcoins are held as a capital asset, the gain

or loss is capital in nature. But, if Bitcoins are not

held as a capital asset (i.e., income in nature), the

gain or loss will be an ordinary gain or loss.

UK Her Majesty's Revenue and Customs requires that

Bitcoin be taxed based on whether the receipt or

expenditure is revenue or capital in nature as well

as on the type of taxpayer to determine whether

income tax, capital gains tax or corporation tax is

applicable.

Australia Australia treats Bitcoin transactions as akin to

barter arrangements, and Bitcoin is treated as an

asset for capital gains tax purposes.

Japan Japan has taken steps to characterise Bitcoin

as legal tender which could lead to Bitcoin being

taxed as a currency.

 

In contrast to the South African position, some guidance has

been issued by other countries. The table above provides a brief

summary of these positions. (Note that this is not an exhaustive

list.)

Given these differing views, it is clear that there is no consensus

on how Bitcoin should be taxed. This presents challenges for

practitioners with regard to declaring Bitcoin gains and for

determining the tax implications thereof.

As the regulatory environment moves to keep pace with the

development and adoption of Bitcoin and other cryptocurrencies,

it is prudent to highlight that exchanges are slowly becoming

the nexus of regulation. As a result, information around Bitcoin

transactions could then be accessed by SARS, placing emphasis

on ethics and the principle of self-reporting in this regard.

In South Africa, Bitcoin will not be money as defined in section 1 of

the VAT Act. Consequently, it may be subject to VAT if supplied

as a good. In addition, Bitcoin may be treated as an asset and

whether it is taxed under capital gains tax or not is based on the

intention of the acquirer.

Additional dimensions that need to be explored include the

following:

  • How Bitcoins that are mined should be treated.
  • Whether fair value gains in Bitcoin should be taxed.
  • The translation rules that apply if Bitcoin is valued in a

foreign currency.

  • The tax treatment of foreign exchange gains or losses on

Bitcoin.

It is clear that, for the moment at least, the evolution of

cryptocurrencies is outpacing regulations. As a result,

practitioners should be prudent when accounting for the tax

effects of cryptocurrencies.

Last modified on Thursday, 18 January 2018 12:40
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