In a landmark decision, the European Court of Justice held that bitcoin virtual currency transactions are VAT exempt as they are treated like real currency. 

This a guest post by our DLA Piper tax colleagues, Giovanni Iaselli and Alberto Sandalo.

What is bitcoin under a tax perspective?

In a context of crisis and mistrust towards financial institutions, virtual cryptocurrencies have been standing as an alternative means for saving and investment. Virtual currencies are defined by the OECD as

digital units of exchange that are not backed by government-issued legal tender

Bitcoin is more specifically a virtual cryptocurrency in that it relies on cryptography and peer-to-peer verification to secure and verify transactions. Bitcoin operates through a peer-to-peer network, on a completely decentralized basis and without any institutional intermediary. Each investor’s account is identified by a code number, with an encryption system granting transactions security. As long as no personally identifying information is required to be provided to acquire or transact in bitcoins, this ensures anonymity.

The production of bitcoin (so-called “mining“) is nothing but the contribution of software (and hardware) capacity from a “miner” (usually in a pool) to the bitcoin platform. In exchange, the miner receives a certain number of bitcoins as commission. Indeed, the more the miners gather and add capacity to the system, the more the encryption algorithm becomes complex.

Are bitcoins taxed?

Bitcoin operators have started wondering whether all of this could eventually be taxed and, if so, how. The main problem regards the VAT/GST treatment for transactions which involve the exchange of cryptocurrencies for legal tender or vice versa. Many start-up companies involved in this business have spread so far: if a private investor wants to convert an amount of legal tender in bitcoins, a company provides this service by applying a predetermined exchange rate and retaining a percentage as commission. But the question is whether such bitcoin transactions are covered by VAT!

In Europe, only few governments have enacted provisions specifically stating that bitcoin transactions should be VAT exempt, namely Belgium, the UK and Spain. As regards non-EU countries, the US and Switzerland have done the same. On the contrary, EU Member States like Poland and Estonia have expressed an opposite view.

The position of the European Court of Justice

The European Court of Justice gave its view on the matter in its decision delivered on 22 October in Case C-264/14. The appellant in the proceedings was Mr. Hedqvist, a Swedish bitcoin operator whose company provides exchange services from bitcoins to Swedish crowns and vice versa.

The Court investigated on whether such services (yes, the Court concluded that it could not be qualified as a “supply of goods” for VAT perspective) could be taxed at all for VAT purposes. In doing so, it determined the nature of bitcoins as pure means of payments, whose function simply being to facilitate trade in goods and services. Therefore, even if not (yet) regulated by law, cryptocurrencies perform the same function of legal currencies. However, as long as Mr. Hedqvist’s company provides exchange services for consideration, this amounts to a provision of service which falls under the scope of VAT.

However, the VAT Directive sets out a list of exemptions which rule out the application of VAT for peculiar transactions otherwise taxable. One of those exemptions covers transactions involving, inter alia, currency, bank notes and coins “used as a legal tender“. At first sight, the provision seems to exclude bitcoins transactions. However, the Court held it must not be interpreted in the sole textual meaning (which, besides, highly varies among the versions in all the languages of the EU).

In the view of the court, consideration should be paid on the purpose of the exemption. Such purpose consists in not to impede the convertibility of pure means of payments by the levy of VAT. The reasoning is set as follows. An efficient single market is made by frequent cross-border services. This implies the need to exchange currencies. Levying VAT on such exchange transactions would mean render cross-border services more expensive than domestic ones. Therefore, the rationale of the exemption

is to ensure that, in the interest of the smooth flow of payment, the conversion of currencies is as unencumbered as possible“.

In this respect, the ECJ found that there is no material difference between bitcoins and legal currencies, in that they both perform the same function of pure means of payment. Therefore, they should enjoy the same treatment and be VAT exempt.

The consequences of the decision on bitcoin

The judgment has the effect to bind all EU member States to consider the exchange of legal tender currencies for virtual currencies with bi-directional flow as VAT exempt transactions, even those States which had not expressed their position yet (like Italy).

But what is really worth noting is that the Court, in Hedqvist case, has laid down a principle of utmost importance capable of implications going also beyond VAT, which can be summarized as follows:

as far as virtual currencies and legal tender share the same function of pure means of payment, the applicable tax treatment must be the same.

Such approach is totally consistent with the view expressed by the OECD in the context of the BEPS project. The digital economy is not a ring-fenced area which should be subject to special and differentiated rules for the simple reason that the digital economy is becoming the economy itself.
The ECJ judgment in Hedqvist is nothing but a witness of that.

Unfortunately, we must conclude by playing the troublemaker role. Indeed, if bitcoins exchange transactions are VAT exempt, it means that the service provider has no right to deduct VAT paid on purchases.

But the most important news is still the good one: the non-applicability of VAT to customers!