On December 5, 2014, the New York Department of Taxation and Finance (Department) released TSB-M-14(5)C, (7)I, (17)S. This (relatively short) bulletin sets forth the treatment of convertible virtual currency for sales, corporation and personal income tax purposes. The bulletin follows on a notice released by the Internal Revenue Service (IRS) in March of this year, Notice 2014-21.
The IRS Notice indicates that, for federal tax purposes, the IRS will treat virtual currency as property, and will not treat it as currency for purposes of foreign currency gains or losses. Taxpayers must convert virtual currency into U.S. dollars when determining whether there has been a gain or loss on transactions involving the currency. When receiving virtual currency as payment, either for goods and services or as compensation, the virtual currency is converted into U.S. dollars (based on the fair market value of the virtual currency at the time of receipt) to determine the value of the payment.
The IRS Notice only relates to “convertible virtual currency.” Virtual currency is defined as a “digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value.” Convertible virtual currency is virtual currency that “has an equivalent value in real currency, or that acts as a substitute for real currency.”
The Department’s bulletin also addresses only convertible virtual currency, and uses a definition identical to the IRS definition. The Department indicates that it will follow the federal treatment of virtual currency for purposes of the corporation tax and personal income tax.
For sales and use tax purposes, the bulletin states that convertible virtual currency is intangible property and therefore not subject to tax. Thus, the transfer of virtual currency itself is not subject to tax. However, the exchange of virtual currency for products and services will be treated as a barter transaction, and the amount of tax due is calculated based on the fair market value of the virtual currency at the time of the exchange.
The Department should be applauded for issuing guidance on virtual currency. It appears that these types of currencies will be used more and more in the future, and may present difficult tax issues.
However, the Department’s guidance is incomplete. There are a couple of unanswered questions that taxpayers will still need to ponder.
First, the definition of convertible virtual currency is somewhat broad and unclear. The Department and the IRS define “convertible” virtual currency as currency that has an “equivalent” value in real currency, but equivalent is not defined in either the IRS Notice or the bulletin. Many digital products and services use virtual currency or points that cannot be legally exchanged for currency to reward users, and the IRS and the Department should be clearer about the tax treatment of those currencies.
Second, although the Department will follow the federal treatment for characterization and income recognition purposes, the bulletin does not discuss apportionment. This is likely a very small issue at this point in time, but the Department will, some day, need to address how receipts from gains in the exchange of virtual convertible currencies are apportioned.
Virtual currencies will create issues not only in the tax world, but also in the unclaimed property world. The Uniform Law Commission has begun its efforts to rewrite the Uniform Unclaimed Property Act, and the treatment of virtual currency will be an issue discussed during the rewrite. Companies that use virtual currencies, convertible or not, should follow the rewriting process to make sure the drafters are informed of all of the issues these companies will face.