Cryptocurrencies and Other Digital Assets Take Center Stage in 2022—Part 3

Part 1 of this series discussed the basics of cryptocurrencies and the challenges tax authorities face as they attempt to construct a tax and regulatory framework for them. Part 2 considered how some of the world’s major economies are rising to meet this challenge. Part 3 now examines the OECD’s recommended solutions for taxing digital currencies and contemplates the way forward for crypto regulation and taxation.

OECD’s Outlook and Recommendations

In October 2020, the Organization for Economic Cooperation and Development (OECD) issued a report entitled “Taxing Virtual Currencies: An Overview of Tax Treatments and Emerging Tax Policy Issues,” suggesting a framework that regulators can use to develop effective tax rules for cryptocurrency transactions.

According to the OECD report, regulators find it challenging to develop a robust cryptocurrency tax policy due to a lack of centralized control, pseudo-anonymity, valuation difficulties, hybrid characteristics, and rapid evolution of the technology. As a result, countries treat cryptocurrency-related transactions in different ways: There is no uniformity in applying tax rules, resulting in low compliance rates and lost tax revenue.

The report addresses the following areas across more than 50 jurisdictions (based on responses to questionnaires supplemented with publicly available materials):

• characterization and legality of virtual currencies;
• domestic tax treatment across the different stages of a virtual currency’s lifecycle, from creation to disposal;
• common tax policy challenges and emerging issues; and
• considerations for policymakers.

Characterization and Legality of Virtual Currencies

Crypto assets can broadly be classified into three main categories based on their economic function:

• payment tokens (or virtual currencies) represent an asset that can be used for the exchange of goods and services;
• utility tokens are primarily used for accessing certain services or infrastructure—the tokens can represent prepayments, vouchers or licensing of specific rights;
• security tokens are tradeable in nature and are often held for investment purposes.

There are variations within each of these three categories (in addition to the fact that some tokens may have “hybrid” features covering more than one category). Tokens also may change over time due to their multi-layered nature, similar to multi-layered derivatives contracts.

Virtual currencies or payment tokens are the tokens that are mainly addressed in the jurisdictions covered by the report. Less guidance is currently provided on utility and security tokens, although they may follow the same treatment as payment tokens.

Tax Treatment of Virtual Currencies

Some key takeaways from the report on the domestic tax treatment of virtual currencies related to income tax, property tax, and value-added tax (VAT) are set out below.

Income Tax

The report describes several different approaches that have been taken in determining when the first taxable event occurs for income tax purposes for mined cryptocurrencies, and in determining which kinds of exchanges of virtual currencies (e.g., crypto–to–fiat, crypto–to–crypto, crypto–to–goods–and–services) generate a taxable event.

In most of the countries, virtual currencies are considered a form of property, most often as intangible assets other than goodwill. Income tax is common upon disposal or exchange of a virtual currency, although some jurisdictions allow individuals to exchange virtual currencies for fiat currency without the transaction representing a taxable event. Further, exchange of virtual currencies for services, goods or wages typically qualifies as a taxable event.

There can be differences in the tax treatment of transactions in virtual currencies depending on the status of the parties involved. Some jurisdictions, such as Australia, Canada, the Netherlands, Switzerland, and the U.K., adopt different approaches for businesses/regular traders and individuals/investors.

Property Tax

Virtual currencies are treated as property in most jurisdictions and are likely to be subject to gift, inheritance, or wealth taxes. There can be different property taxation for resident and nonresident companies, which affects the tax rate or method of calculation. In Switzerland, there is a regime under which virtual currencies must be converted to Swiss francs for tax assessments, provided by the Federal Tax Administration.

However, transfer taxes typically do not apply to virtual currencies as they do not fall within the scope of such taxes, which generally only apply to real estate or securities transactions.

VAT

The VAT treatment of virtual currencies is more uniform than the income tax treatment. Most EU countries have a consensus that the exchange to or from virtual currencies is not subject to VAT. The same applies for using virtual currencies to buy goods or services. Thus, no VAT should be charged on the use of virtual currencies itself. However, on the opposite side of the same transaction, the supply of taxable goods and services that is paid for with virtual currencies is considered subject to VAT.

Many other jurisdictions have adopted the EU’s approach, with the OECD report identifying New Zealand as a notable outlier.

Further, not all types of virtual currency services are treated consistently among EU member states or other countries. For example, some differences remain in the treatment of mining income, related services, and other crypto assets. The trading and handling of virtual currencies, including the creative process of mining, may all have VAT consequences.

Common Challenges and Emerging Issues

Valuation is key in the taxation of virtual currencies. The report identifies practical challenges in determining the value and cost basis of virtual currencies. Guidance on valuation is limited. Jurisdictions have adopted different approaches to determining cost basis, including specific identification of units (e.g., U.S.), deemed chronological order (such as first-in, first-out, or FIFO) (e.g., Finland), or basis pooling (e.g., U.K.).

The report focuses on several emerging issues in the virtual currency area, including:

• recommending that regulators adopt a proper policy on taxing hard forks. A hard fork occurs when there is a split in a cryptocurrency’s blockchain and the taxpayer obtains a new coin (e.g., Bitcoin cash) in addition to the original coin. Currently, only a handful of countries have issued very limited guidance on this topic. Any further guidance should clearly mention why and when hard fork income should be taxed—at the time you gain dominion and control or when you sell?
• pointing out that stablecoins and central bank digital currencies represent new forms of virtual currencies and are often backed by other assets or fiat currencies. Their unique characteristics can be key for tax purposes, and policymakers need to consider if existing rules are appropriate.

The report suggests that regulators need to create proof of stake (PoS) specific tax guidance because staking has overtaken proof of work (PoW). With Ethereum moving from PoW to PoS in the coming months, this is an important area requiring new tax guidance from regulators.

Considerations for Policymakers

Policymakers should provide specific and clear guidance covering all events in the lifecycle of a cryptocurrency, such as creation, exchange, storage, disposal, and loss/theft. Emerging developments—for example, hard forks, stable coins, India’s recently proposed bank digital currency (the digital rupee), and interest-bearing tokens—and related services, for example, exchange services and wallets, should also be covered by such guidance. It should also indicate how other forms of crypto assets (including security and utility tokens) are to be treated for tax purposes.

The report also encourages policymakers to provide a rationale for adapting certain tax rules to improve transparency and explain how cryptocurrencies fit within their existing frameworks. Additionally, policymakers should provide guidance more frequently to keep up to date with the fast-moving pace of crypto. The OECD supports introducing a de minimis rule to small crypto transactions exempting them from taxation.

Way Forward

The complex and evolutionary nature of crypto has led to differing interpretations and treatment from various regulators globally. Concerned authorities around the world are planning to design standard rules for the regulation and taxation of cryptocurrencies. There is no escape from paying tax on cryptocurrency gains.

Cryptocurrencies are here to stay. They can no longer be seen as a speculative pyramid scheme. They are a modern-day technology that needs to be embraced as part of society. Regulatory authorities across the globe must take a position on crypto regulation and create a safer, regulated environment for all stakeholders.

There is clearly a need for effective and coordinated regulation at both the domestic and international levels. Some jurisdictions treat cryptocurrencies as property, while others treat them as a separate, unique asset. Many jurisdictions have no specific tax rules at all. There are so many open tax issues—even where tax regulations are issued—that the result is a confusing patchwork of rules and guidance.

The creation and enforcement of a clear standard for how cryptocurrency is reported and taxed is much needed in the industry.

The OECD report has taken a first step in this direction by providing clarity and guidance and laying the groundwork for policy developments and greater convergence on a regional or global level. It is expected that policymakers in several OECD Inclusive Framework member countries will follow the report’s suggestions on giving more guidance on these issues, which will benefit all stakeholders with respect to virtual currencies.

Internationally, additional guidance and rules and regulations are necessary in the rapidly changing world of virtual currencies, particularly as national central banks and the European Central Bank are considering the development of their own virtual currencies.

Domestically, this is a “wake-up call” for governments to enforce the administration of taxation of cryptocurrencies. Given the growth and breadth of virtual currencies, governments also need to provide guidance and, where already issued, supplementary guidance, to address outstanding issues.

In the meantime, tax practitioners should be well-versed in the use and rise of cryptocurrencies (and their underlying technology, such as blockchain) to better advise taxpayers regarding the taxation, compliance, and reporting issues associated with crypto.

It is clear that crypto transactions will fall, or already fall, within the ambit of tax in almost all countries, irrespective of whether a country has specific regulations. In this environment, crypto users need to carefully engage in tax planning and be as compliant as possible with any relevant regulations.

I expect 2022 to be the year of crypto from the standpoint of markets, the regulatory environment, the evolution of the tax framework, customer awareness, and impact on the global economy. This will certainly change the existing system, irrespective of the pace of action taken by different governments.

This article does not necessarily reflect the opinion of The Bureau of National Affairs, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Anshu Khanna is a Partner with Nangia Andersen LLP, a member firm of Andersen Global.

The author may be contacted at: anshu.khanna@nangia-andersen.com