Taxing Bitcoins

Because of Bitcoin skyrocket increase this past year from $17 to over $1,200, you cannot escape hearing about those cryptocurrencies and how they will change world commerce for ever. While the Federal Reserve gave tacit approval, stating “virtual currencies like bitcoin have legitimate uses and should not be banned,” and while it's been acknowledged by the Chinese authorities as a valid currency (even though Banks have yet to gain authorisation to use it) there is still a lack of guidance from the tax authorities as to how those new currencies should be treated. There are basically 2 possibilities on how Bitcoins should be treated for tax purposes: either as an intangible asset or as a foreign currency. If a Bitcoin is considered an asset, profits will be taxed as capital gains, i.e at either 18% or 28% depending on your tax band. However if it's considered a foreign currency, then profits will be taxed as income, and therefore as high as 45%.

The problem with saying that it’s a currency is that it is not issued by a government, and traditionally currencies are legal tender issued by governments. In California Bankers Assn v. Shultz, the Supreme Court stated (in a non-tax context): “‘Currency’ is defined in the Secretary’s regulations as the coin and currency of the United States or of any other country, which circulate in and are customarily used and accepted as money in the country in which issued.”

The US tax authorities have not voiced their opinion, but both Canadian and Swedish tax authorities are treating bitcoins as an asset. And the German Finance Ministry initially said that bitcoin is not classified as e-money or a foreign currency, but is rather a financial instrument under German banking rules. It seems however that Germany has been rethinking it's position on digital currencies and recognising them as "units of account" recently.

The UK is considering Bitcoins as assets too but in in a way that could jeopardize its development. Indeed, HMRC have actually managed to classify Bitcoins as 'Single Purpose Vouchers' which means that VAT is due on them. That is a serious show stopper! I suspect it's a matter of time until the UK tax authorities realise that you can't go against the tide, but until then we suggest you proceed with caution.

March 2014 update: In a new brief published this month, HMRC announced it would not charge the 20 per cent VAT tax on trades in the end. HMRC went a step further, saying it would not charge the tax on their margins either. This sidesteps the thorny question of whether to class Bitcoin as a currency, but effectively treats it as such, and bases its policy on the EU law that exempts payments and transfers of “negotiable instruments” from tax. The only caveat is that this position is contingent to the EU not deciding otherwise, so things change yet again.

Still, this brief shows a rare understanding of the platform and it's great news for Bitcoin. This further cements the UK's status as the capital for innovation in Fintech and positions the country as one of the best jurisdictions to build services for the new cryptocurrencies.