David Deputy is the director of strategic development and emerging markets and George Salis is a principal senior tax economist at Vertex, a tax software firm.
The following article is an exclusive contribution to CoinDesk's Crypto and Taxes 2018 series.
Currency has three primary functions: a store of wealth, a unit of account and a means of exchange. Most would argue that cryptocurrencies today only serve the first of these.
Therefore, whenever taxation of cryptocurrency is discussed, it's almost always about taxing changes in realized wealth, i.e. income tax.
But that could soon change.
As we weather the great crypto winter of 2018, many believe the space could emerge stronger than before, as regulators grow more comfortable with the risks and become more committed to global cooperation on the issues. With concurrent work by core developers pushing scalability and fee-reducing upgrades into the tech stacks, cryptos may finally be poised to begin gaining acceptance as a means of exchange and a unit of account – in other words, ready for use in daily transactions.
While certainly a long-anticipated and welcome milestone, it's also sure to raise the ire of national and state regulators hungry for revenue – revenue from sales taxes, value-added taxes (VAT) and goods and services taxes (GST). On a global basis, these taxes raise more revenue for governments than income tax.
As with income taxes, failure to comply can lead to dramatic consequences for those who are unaware or fail to follow regulations. And these taxes can bite, with Finland charging 24 percent, France 20 percent and Germany 19 percent.
So, how do we start the conversation, and what do businesses, decentralized or otherwise, need to know? What about issuing or holding tokens: how does the classification of the token determine which taxes apply? With many token issuers hoping (or perhaps praying) for a "utility" rather than security classification, does a utility designation result in transaction tax liability and if so where?
Unfortunately, it not an easy picture to paint. Just as there is a lack of consistency and global uniformity when it comes to securities regulations for cryptocurrencies, the same byzantine quilt of regulatory morass exists for transaction tax regulations.
Here are three cryptocurrency transaction tax trends that businesses, and to some extent individuals, need to be aware of.
Different countries, different rules
As in nearly every other aspect of tax, different countries have different regulations and guidelines. If your company does business in more than one country, this can be nearly impossible to manage without a full-time staff of experts or advisors.
In cases where goods or services are purchased using crypto, and the crypto is considered an asset or property, first the gain is computed as income subject to tax for the purchaser, then the total value of the transaction is subject to transaction tax, which the merchant/seller/vendor must then collect and remit.
This is all calculated in local fiat currency converted with the appropriate timing. Individual nations (and even some states within countries like the U.S.) impose their own set of tax rates and often their own definitions for the different categories of goods and services.
In several countries there are multiple layers of taxation: think city, state, and federal, all at the same time but with different rates. In short, it's a real mess for small businesses going global.
But wait, there's more! If you thought calculating rates was difficult, determining which jurisdictions have the right to tax is even more complicated.
In a typical transaction, there's a relatively complex set of required factual determinations involving "bill to," "ship to," "ship from" and "consumer resident jurisdiction." Of course, exactly how these facts apply varies by jurisdiction.
The taxman goes online
With digital goods, which most emerging crypto tokens presently represent, the rules have only just started to emerge in the last few years.
These rules are in constant flux, with efforts by the EU and the Organisation for Economic Co-operation and Development (OECD) hot and heavy as we write this (search "OECD BEPS Action 1 interim report" for 300 pages of recently published, potentially mind-numbing details).
The clear trend points toward taxing digital transactions (no more tax-free internet). Taxing is based upon where the consumer resides. Collection is done via holding platforms collecting and remitting on merchants' behalf and/or the withholding of taxes on payments sent to offshore merchants.
So it's complicated. In the crypto space, should we care?
One can argue that today the pseudonymous nature of crypto means little is typically known about the sender or receiver of a transaction. Consequently, all these new "digital economy" rules simply cannot be enforced.
However, with government tax and other administrators leaning on the exchanges to introduce know-your-client (KYC) guidelines, and then requesting these records, unidentified accounts may dwindle over time. Further, we may also eventually expect some type of global default rule requiring crypto-based businesses to accumulate and then distribute these taxes based upon some kind of allocation to jurisdictions.
Think about a set of "white blockchains" emerging which enforce tax, securities, AML/KYC and other rules. These would be in-demand platforms as businesses and investors seek to de-risk their crypto space operations.
Taxing the intermediary
The third trend relates to who is responsible for paying a tax.
The digital economy (by which we mean just the internet, not yet the blockchain) arose far faster than regulators were prepared for. So now, they are struggling to find a way to tax transactions that present a rapid erosion to their transaction tax base.
One emerging idea is to make intermediaries, such as Amazon and Alibaba, responsible for tax collection. This is not yet a widely accepted solution, but discussions within the OECD and the EU are occurring, and the U.S. has legislative and judicial actions already pending.
If this method were to catch on, it may be easy to see a distributed blockchain-based business, or even the underlying distributed blockchain itself, as an intermediary that is responsible for collection of transaction taxes.
This much is clear: Given the projected revenue loss from internet transactions, governments are not delaying.
Australia, India, Singapore, the U.K. and others are introducing regulations to tax digital transactions that take place within their borders. Regulators are unlikely to view blockchain-based transactions as anything other than a new form of digital-economy "internet" transaction for which they are launching rules today.
Tokens for taxable goods or services
Further, depending on the country, any companies or individuals, having issued tokens redeemable for goods or services, should consider both their corporate tax risk and the peril to their individual freedom.
First we have to acknowledge that this is a fuzzy area, given that the basic concept of what a token represents is still unclear. Governments are struggling to draw bright lines between what is a security or property or an asset or a commodity or something with utility (prepaid goods or services). The ability for a token to morph over time further complicates the matter as we have seen with the shifting fortunes of the SAFT approach.
But complexity and lack of expertise is not often a valid or effective defense – just do a quick search under the term "dawn tax raid" and you will see first-hand the cold, hard reality of misinterpreting or ignorance of tax rules.
Pay special attention to South Korea, both a crypto hot-spot and the jurisdiction most active in "dawn raids." Further, our Korean friends have an interesting law, whereby a business alone cannot be indicted as a natural person – a human must also be charged.
Consequently, beware of that early morning knock on your hotel door when you attend that conference in Seoul. As usual, caveat emptor.
Tax calculator image via Shutterstock.