Bitcoin has been shrouded in mystery since its launch in 2009. From the intrigue about inventor ‘Satoshi Nakamoto’ to its links to the now-outlawed Silk Road (the ‘dark web’ marketplace infamous for selling drugs and firearms) the cryptocurrency is rarely out of the headlines. But more recently it has begun to shed its associations with the underworld and now presents a new challenge for the authorities – how should it be treated for tax purposes?
Bitcoins are attractive because they function like cash – they provide anonymity and can be transferred to others without the need for a commercial middleman. They are now accepted by thousands of e-commerce sites – and some bricks-and-mortar stores – and can be bought with hard currency at exchanges and ‘cashpoints’ from London to Vancouver. But after recent stories of exchanges being hacked, raided by the authorities or entering bankruptcy proceedings, it remains uncertain whether Bitcoin will break through and become a generally accepted form of payment with the public.
Is it legal tender?
The US Library of Congress published a survey this year which revealed that in most jurisdictions, Bitcoin isn’t classed as legal tender or electronic money. This raises questions particularly around VAT, and to date, only Singapore and the UK have clearly defined the tax treatment of Bitcoin transactions in that area. It is possible to provide some general guidance based on statements by the authorities and accepted principles, but without specific regulations or case law the exact situation remains uncertain.
Are Bitcoins taxable?
Bitcoins have a market value, and it’s likely that profits from active ‘mining’ and trading them are taxable (although not in the UK). Bitcoin speculators may also, in some countries, be taxed on their gains.
Retailers face tax issues when they accept payments in bitcoins for goods or services, when they use those bitcoins to pay for goods or services from others, and when they use a Bitcoin exchange facility to convert them into regular currency.
Some have suggested that because bitcoins are not legal tender they should be considered vouchers. But an EU proposal to harmonise the tax treatment of vouchers (which differs across member states) contains wording that appears to exclude bitcoins from this definition. Although the situation is still uncertain, the fact that they’re for unrestricted use also suggests they shouldn’t be classified as vouchers for VAT purposes.
Another way of categorising Bitcoin from a tax perspective is as a ‘digital good’ – the provision of which is considered for VAT purposes as a service. In this situation, buying something with bitcoins could be regarded as a ‘barter trade’, which involves an exchange of goods or services (although again, not in the UK). If both parties are entrepreneurs for VAT purposes, they each provide a service or delivery of goods to each other that would in principle incur VAT.
Retailers need also to consider how they apply VAT on sales of goods when accepting payments in bitcoins, given the often dramatic fluctuations in exchange rates. If retailers exchange bitcoins for regular currency, the transaction may also qualify for as a VAT-able service for the retailer. And Bitcoin exchange service providers (often used to process Bitcoin payments into regular currency) may have to pay VAT on any commission they earn. Similar issues are likely to arise under sales tax and GST systems.
What is ‘Bitcoin mining’?
Bitcoin mining is the process by which bitcoins are generated. Every time a Bitcoin transaction is made, it’s broadcast to all members on the network who check a ledger of past transactions (called the blockchain) to ensure that users aren’t trying to spend the same coins multiple times. This ledger also details who owns every bitcoin in circulation. In order to add to the blockchain, Bitcoin miners use specialised hardware and software to solve complex maths problems. Once they’ve done so, they collect records of verified Bitcoin transactions, package them together into a ‘block’ (containing coded proof of how the transaction was confirmed) and add them to the blockchain. Every time they add a block, miners are paid any transaction fees along with a ‘subsidy’ of newly minted coins.
Will the situation change?
The tax treatment of Bitcoins is not yet clear. The key for businesses appears to be the VAT treatment of exchanging Bitcoins for regular currency, and the use of Bitcoins by entrepreneurs to purchase goods and services. Britain’s provisional (and somewhat opportunistic) VAT guidance, which treats Bitcoins as a quasi-currency and means that no specific VAT issues should arise, could eventually be implemented across the EU. Whether this will happen in the short team is doubtful, given that authorities are suspicious of an unregulated payment form that has anonymity as one of its selling points. But regulators cannot continue to close their eyes if serious businesses continue to accept Bitcoins from their customers. From a personal income and corporate tax perspective some practical clarification and formal changes to tax laws may be required in some countries. But until that happens, the Bitcoin mystery continues.