Despite recent fluctuations in value, the Bitcoin phenomenon shows no sign of slowing. The meteoric rise of the cryptocurrency presents a range of issues that law enforcement agencies, legal regulators and tax authorities must consider in determining how it fits within their existing regulatory frameworks.
Given the convenience of established currency and payment systems, what is driving the ever-growing interest in Bitcoin and other virtual currencies?
One driving force is likely to be the growing interest in the potential of the technology behind modern virtual currencies. The use of block chain or other protocols can facilitate the use of a decentralised public ledger system to partially replace the traditional banking system.
The technology is thought to have the potential to lower the cost and increase the speed of transactions by reducing the number of intermediary parties (eg, banks and clearing houses). Transactions that would have taken hours or even days can potentially be cleared in seconds.
Has your jurisdiction taken steps to regulate virtual currencies? What is their current status?
Small steps have been taken towards the regulation of virtual currencies in Sweden. However, legislative measures have yet to be introduced.
The former Swedish administration supported efforts against money laundering and terrorism funding through its participation with the Financial Action Task Force. The existing administration (following September 2014 elections) has made no public statements regarding Bitcoin.
However, the government's lack of position has not prevented the authorities (eg, the Swedish Financial Supervisory Authority (SFSA) and the Tax Agency) from issuing decisions and guidelines in their respective fields. The SFSA has decided that any service provider for the exchange and sale of bitcoins must register as a financial institution in accordance with the Certain Financial Operations (Reporting Duty) Act (1996:1006), as their services can be seen as providing a payment method. This also means that a company exchanging and selling bitcoins must comply with the Act on Measures against Money Laundering.
Since June 1 2015 approximately 10 companies have registered with the SFSA due to their operations involving bitcoins. However, the SFSA believes that there is a great number of unregistered companies that supply exchange and sale services of bitcoins and other virtual currencies.
All Bitcoin companies registered with the SFSA that have been subject to SFSA review have been found to have inadequate documentation. In one instance, the inadequacies led to an injunction by the SFSA against a company in order to make it amend its violations against anti-money laundering legislation.
The Administrative Court of Appeal recently ruled that the decision to issue an injunction by the SFSA against a business to make it stop conveying money through Bitcoin was lawful. The ruling shows that the conveyance of money using Bitcoin as a medium constitutes money transfer and requires a licence according to the Payment Service Act.
The Central Bank has made statements regarding the occurrence of virtual currencies and has said that it will continue to monitor the development but that it currently cannot be seen as a threat against the Swedish payment or financial system.
How are transactions using virtual currencies as the medium of exchange taxed in your jurisdiction?
The Tax Agency considers Bitcoin and other virtual currencies as an asset. This means that it is subject to capital gains tax in Sweden. The Tax Agency does not recognise Bitcoin as a foreign currency, based on the fact that it lacks a central issuer and that it does not pertain to a certain currency area. Any gains from the sale or exchange of bitcoins are hence treated like any other sale of assets (eg, cars or paintings).
In the area of value added tax (VAT) two decisions have been given by the Council of Advance Tax Ruling (a Swedish authority giving out binding advance decisions regarding tax questions) on:
- the nature of services of sale and exchange of bitcoins; and
- the process of bitcoin mining.
Regarding the exchange or sale of bitcoins, the council decided in the first ruling that such operations were exempt from VAT. The decision was appealed by the Tax Agency and has since been referred to the European Court of Justice (ECJ) for a preliminary ruling on whether Bitcoin falls within the VAT exemption under Article 135.1 of the Council Directive on the Common System of Value Added Tax. The Bitcoin community is following the development closely and the view has been advanced that if the court rules in favour of the Tax Agency it will have a severe effect on the development and use of Bitcoin and other virtual currencies in Europe. The date of the hearing is scheduled for June 17 2015 (C-264/14).
In the second ruling, the council found that the mining process could not be seen as providing a service and was therefore exempt from VAT. The ruling was not appealed by the Tax Agency.
If virtual currencies were to become a mainstream payment system, how might this affect the ability to control inflation in your jurisdiction?
There is still a long way to go before virtual or crypto currencies can be expected to have an effect on a macroeconomic level. On May 15 2015 the SFSA estimated that approximately 20 Swedish websites or shops accept bitcoins as a method of payment. However, assuming that virtual currencies become a mainstream payment system, traditional methods for controlling the amount of currency in circulation would be ineffective.
It should be added in this context that inflation is not a problem in the existing Swedish economy; on the contrary, the Central Bank has established that Sweden had failed to reach its inflation target of 2% and has consequently lowered interest rates to the point where the reference rate is negative. The existing economic state has, among other things, given rise to questioning of established ways to look at and measure inflation. Virtual currencies might just be one of many aspects of digitalisation and globalisation to consider when measuring and controlling (or not controlling) inflation in the future.
What are the potential risks of virtual currencies in terms of fraud? How would these be addressed in your jurisdiction? Have any specific instances emerged in which virtual currencies have been used for money-laundering or other fraudulent purposes?
There has been an increase in the use of Bitcoin for laundering proceeds from crimes such as drug transactions and fraud. The National Fraud Centre (a subdivision within the Swedish Police) addressed the topic in 2015, stating that it encounters transfers of the proceeds of fraud to Bitcoin accounts on a weekly basis.
The Economic Crime Authority (a multidisciplinary authority with the exclusive mandate to investigate and prosecute white collar crime) has also aired its concern about the use of bitcoins for money laundering purposes.
The main risk in terms of fraud and money laundering lies in the fact that users can remain anonymous. Even though the transaction itself is traceable through the block chain the receiving user's identity can remain hidden.
Criminals can further complicate the situation for law enforcement by utilising tumbler or bitlaundry services. These services consist mainly of a number of randomised transactions in order to put a distance between the transaction and the user. In the end, the user can transfer funds from its Bitcoin account to a Visa card connected to its Bitcoin account and spend the money in an ordinary fashion.
This makes it almost impossible for the police to seize any proceeds from the crimes and to this date there has been only one documented case in Sweden where criminal proceeds in bitcoins have successfully been seized.
Swedish law enforcement sees this issue as a global problem and does not believe that it can be addressed effectively on a national level, but rather that efforts should be made on a European or international level. Other than pushing for European and international cooperation, the main response from Swedish authorities has been to inform the public of the risks involved when dealing with virtual currencies.
Different EU member state authorities have thus far taken different approaches to the regulation of virtual currencies. Is this due to the different legal frameworks of the member states or (mainly) by institutional practices of the respective authorities?
It is probably a combination of both. The difference between institutional practices has been addressed by the European Banking Authority (EBA) in its opinion (EBA/Op/2014/08) regarding virtual currencies, where it addressed the need to build a common supervisory culture and practice across the European Union regarding Bitcoin and other virtual currencies.
How likely is it that the regulation of virtual currencies will be harmonised at EU level? Could a consistent regulatory approach be reached through institutional guidelines for the competent authorities in the member states?
It is likely that a certain degree of harmonisation will occur in the field of VAT when the ECJ presents its judgment in Case C-264/14. As it is about the interpretation of the Council Directive on the Common System of Value Added Tax, the verdict will be guiding for VAT in relation to Bitcoin across the European Union.
In terms of financial regulations, harmonisation is a long process. But European institutions have begun to show interest in the development and potential need for regulations.
In its opinion on virtual currencies (EBA/Op/2014/08) the EBA presented both a potential short and long-term regulatory approach. This included a recommendation that EU legislature consider virtual currency exchanges as 'obliged entities' that must comply with requirements in the EU Anti-money Laundering Directive. The EBA's opinion has also been the basis for financial supervisory authorities in different member states to issue warnings.
The European Securities and Markets Authority (ESMA) has monitored and analysed virtual currency for a six-month period and issued a call for evidence on investments using virtual currency or distributed ledger technology. It wants to investigate the use of block-chain technology in relation to securities and investment products.
On a larger scale, depending on the development of the virtual currency market, legislative efforts could be taken within the framework of creating a capital markets union.
It seems likely that legislative initiatives will be taken to harmonise the approach to virtual currencies on a European level. It is uncertain whether EBA and ESMA guidelines will be sufficient to create a consistent regulatory approach, as the competent national authorities might require new or amended legislation in order to effectively supervise Bitcoin and other virtual currencies.
For further information on this topic please contact Sara Göthlin at Advokatfirman Törngren Magnell KB by telephone (+46 8 400 283 00) or email (sara.gothlin @torngrenmagnell.com). The Törngren Magnell website can be accessed at www.torngrenmagnell.com.
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