Real currency or play money?
Bitcoin is taking the world by storm due to its special character. In contrast to traditional currencies it exists only as electronic data and is kept in electronic “wallets” on electronic devices such as PCs and mobile phones. It does not have any central authority that manages or regulates its use, in the way that the Reserve Bank of Australia (RBA) regulates the Australian Dollar and uses it to pursue economic policies.
In only 4 years it has spread throughout much of the world and has become acceptable tender for many merchants in both the virtual and real world markets. In 2013 China overtook the United States in the number of downloads of Bitcoin “wallets”, while Baidu (China's equivalent of Google) began accepting Bitcoins for services (even though in December 2013 Baidu stopped facilitating Bitcoin transactions after China’s central bank barred financial institutions from Bitcoin transactions). In Australia, Bitcoin is increasingly being accepted as payment and in the last two months we even saw the introduction of a several Bitcoin ATMs in Sydney, Melbourne and Brisbane.
At the start of June 2014 there were approximately 12.8 million Bitcoins in circulation, trading at around AUD 685 to a Bitcoin. This translated to more than AUD 8.8 in Bitcoin capital available worldwide. It offers markets in 17 currencies, including the AUD, and in its USD market 86,000 Bitcoins (around USD 6.6 million) were traded every day in 2013.
In an analysis by the RBA that encompass a submission to its May 2013 meeting of its Payments System Board, the central bank concluded that the AUD 8.8 billion Bitcoin market has the “potential to pose a number of risks and concerns for policymakers…if it were to become widely adopted”.
It is the world’s first global currency and it is big business.
A virtual Switzerland?
Prior to the GFC, traditional banking systems were pillared on the principles of privacy and the sanctity of the banker/client relationship. The system’s anonymous character often provided opportunity for tax evasion.
During the GFC the many corporate and bank collapses highlighted the extent of tax avoidance worldwide, and provided momentum to efforts by regulators trying to implement measures aimed at improving transparency, accountability and tax enforcement. Measures that have since been implemented (for example the Foreign Account Tax Compliance legislation (FATCA) introduced by the USA), coupled with extensive anti-money laundering regulations implemented across many jurisdictions in the mid 2000s, work to curtail tax avoidance opportunities by imposing extensive transactional reporting obligations on commercial banks and facilitating improved cooperation between tax collectors internationally.
Bitcoin, however, is not controlled by a central bank, nor transacted via normal banking channels. Its unique character as an exclusively virtual currency means that it has the ability to be transferred on a peer to peer basis without the intervention of a commercial (and therefore, regulated) bank, thereby avoiding being reported on by commercial banks.
Its popularity with the underworld seems to prove its value as a “secret” or “veiled” currency. Last year authorities in the United States closed down the online marketplace “Silk Road”, and arrested its owner on charges of conspiracy to traffic in narcotics, to commit computer hacking and laundering money. Operating since 2011, “Silk Road” had more than 900,000 registered users who bought and sold illegal drugs using Bitcoin, and generated sales of more than 9.5 million Bitcoin (roughly equivalent to AUD 6.5 billion at the current exchange rate of AUD 688 per Bitcoin).
It is probably fair to expect that substantial profits are currently being generated exclusively in Bitcoin, and that those profits remain largely undeclared and untaxed.
Before the GFC, tax collectors and regulators struggled with the anonymity offered by bank accounts hosted in so- called “tax haven” or “secret” jurisdictions. With the popularity of these type of bank accounts in decline, following the introductions if increased regulation as referred to above, Bitcoin now seems to offer an alternative in the form of a virtual “tax haven”.
Tax position for Bitcoin?
Many jurisdictions around the world have taken positions similar to that of Canada and the US that Bitcoin is property, not a currency, for tax purposes (including France, Australia, Sweden, Norway, Finland and Denmark). Germany has labeled Bitcoin “private money” or a “unit of account,” subject to capital gains tax, while UK has recently announced that it will treat Bitcoin and other virtual currencies similarly to traditional currencies.
However, despite the position of US tax authorities that Bitcoin is property, in a recent US decision, Securities Exchange Commission v Shavers 2013 WL 4028182 (2013) it was held that Bitcoin is actually an electronic form of currency although it is not backed by any real assets or issued by central governments. The court has given legal recognition to Bitcoin as one of leading brands of parallel money. The position in the US is therefore not all that clear.
The “property approach” broadly involves the application of existing tax rules when Bitcoin is used to pay for goods and services, similar to the way the rules for barter transactions apply. For example the Canadian rules require a business that sells goods or provides services in exchange for Bitcoins, to report its income from the transaction in Canadian dollars (that is, the fair market value of the Bitcoins at the time of the sale). Goods and Services Tax (GST) would be applicable on the fair market value of the Bitcoins that were used to pay for the goods or services.
The speculative trading of Bitcoins like a commodity may result in a gain or loss on account of income or capital, depending on the circumstances of each trade, and if a tax payer mines Bitcoins in a commercial manner the taxpayer’s income for the year from such mining activity will be determined as against the total value of the coins mined as at the end of the year.
While Bitcoin continues to gain traction, international tax authorities may want to consider a consistent approach to the taxation of virtual currencies. It remains to be seen which view of Bitcoin (that is, either property or currency) or perhaps a third approach, will prevail for tax purposes.
The Australian view
The Australian Taxation Office’s (ATO) approach is not clear at present, but similar to the Canadian approach it appears to prefer treating Bitcoin as a barter commodity.
In Australia net profits or gains made from barter transactions (as expressed in a real world currency) is likely to be assessable for tax purposes. In certain circumstances the value of the goods and services supplied pursuant to a barter transaction could be subject to GST, while consideration received for goods and services (whether in the form of cash or otherwise) could be subject to income tax.
Because of the ATO’s apparent preference for the “property approach”, there is some uncertainty in respect of the manner that Bitcoin transactions ought to be treated for GST purposes. If Bitcoin is not Australian or foreign currency, it then probably does not qualify as “money” as defined in section 195-1 of the A New Tax system (Goods and Services Tax) Act 1999 (Cth) (GST Act). A supply of “money” is specifically excluded from supplies which attract GST (section 9-10(4) of the GST Act), but a supply that is not “money” is generally taxable at 10% (unless another specific exemption applies). This implies that the conversion of Bitcoin into Australian currency may be a taxable supply for GST purposes.
From a tax enforcement point of view the ATO for now seems confident that it has the capability to counter fraud and tax evasion activity involving Bitcoin. In June 2013 The Australian Financial Review (online edition 24 June 2013) quoted Michael Hardy, a senior assistant commissioner for the cash economy, as saying that:
“Bitcoin is no more anonymous than physical cash and the ATO has experience in working with earlier forms of anonymous electronic money systems, and with physical cash, which are relevant for responding to new and emerging systems… Bitcoin, like many of the electronic money systems that have preceded it, has not yet raised any taxation issues that don’t exist with either physical cash or electronic payment systems…”
However, we see that Bitcoin is not only different to traditional currencies, but also distinguishes itself from other electronic money systems. It is not regulated and created by any authority, as opposed to traditional currencies that are subject to regulation by central banks and other virtual currencies that is inextricably linked to its corporate owners / managers / creators and in that way becomes indirectly regulated.
In a statement made earlier this year the ATO said that the tax office has been monitoring the growth in Bitcoin, along with other alternative payment systems, and is working to some provide certainty taxpayers before 30 June 2014.
The future according to Satoshi Nakamoto
Bitcoin’s founder, known only by the pseudonym Satoshi Nakamoto, has described his creation as purposed to:
“…..win a major battle in the arms race and gain a new territory of freedom for several years. Governments are good at cutting off the heads of centrally controlled networks like Napster, but pure P2P networks like Gnutella and Tor seem to be holding their own."
Clearly Satoshi has intended for Bitcoin to be more that just another conventional barter commodity or virtual currency that will bow to the regulators. He created it, he said, to “hold its own”. Because of the way that regulators around the world have been struggling to properly define and comprehend this new phenomenon, it would appear as if it may be holding its own for now.