While more and more people all around the world are being bitten by the bitcoin bug, tax authorities are subjecting transactions executed with the cryptocurrency to ever closer scrutiny. Meanwhile, it is increasingly obvious that the world of bitcoin is starting to give shape to a new form of tax haven - comments Ákos Baráti, tax advisor at Jalsovszky Law Firm. Bitcoin and offshore
Since 2008, the Western World has been more and more assertive in taking steps to reduce the damage caused by international tax avoidance. Various international treaties, including European Union rules, treaties on international information exchange, and even the USA’s FATCA system, all aim to curtail the efforts of taxable persons to hide their wealth in offshore companies. The pressure exerted on tax havens is visibly yielding better results all the time.
All these efforts could be undermined, however, by the mass adoption of bitcoin and similar means of payment. Owing to the nature of the blockchain technology on which bitcoin is based, these transactions involve no central clearing house between the parties (such as the financial institution in the case of a bank transfer). Instead, due to the use of a public register, they are supervised by the whole community. But unlike conventional transactions, in the blockchain system the participants in individual transactions are protected by encryption and anonymity. The absence of central supervision, and the encryption, can facilitate the movements of whole fortunes between individual players in the economy, without the authorities finding out.
At the moment, cash is one of the mainstays of the black economy because on the one hand it’s an internationally accepted means of payment, and on the other its movements are essentially untraceable. It isn’t too much of an exaggeration to say that bitcoin is like cash, but can be mobilised more easily and in greater quantities: unlike cash, huge amounts can be shifted in bitcoin with an anonymous transfer over the internet, or on a USB drive. And what’s more, while in the past bitcoin was used to pay for illegal services, today there is a growing number of legal and everyday places that accept it - even in Hungary, in some places you can now use bitcoin to pay for a haircut, or even for legal services. And because bitcoin and other cryptocurrencies are perfect for hiding transactions from the state authorities, it’s also well-suited for tax avoidance and the accumulation of large fortunes. Tax havens, therefore, could be replaced by cryptocurrencies in a few years. What’s in a name?
Naturally, none of this takes away from the fact that the taxation of transparent bitcoin transactions is an increasingly hot topic. But the authorities are divided about how bitcoin should be treated. Bitcoin is a payment instrument, or at least that was the conclusion reached by the European Court of Justice, when it examined the nature of the cryptocurrency from a VAT perspective, and decided that transactions carried out with bitcoin are VAT-exempt. The court’s judgment is of great import, because it was the first public position statement on the nature of bitcoin from a taxation perspective.
Meanwhile, member states are falling over themselves to declare that bitcoin’s classification as a payment instrument only determines the VAT implications, and this has no effect on other tax types. With regard to income taxes, the individual member states usually treat bitcoin as a promise of payment, or a receivable, and determine the consequences of its mining, sale or use as a payment instrument accordingly.
The Hungarian tax authority takes a similar line: in its practice, within the corporate tax system, the tax authority classifies gains generated from bitcoin as income from financial transactions and taxes them accordingly. The personal income tax treatment of income generated from bitcoin throws up a number of dilemmas. But because income of this type cannot be treated as either a trading gain (as bitcoin isn’t a security) or as the income from a regulated capital market transaction, it is taxed as other income, so in addition to the personal income tax liability a healthcare contribution of 19.5% is also payable. What does the future hold?
It’s a safe bet that cryptocurrencies will soon come under strict regulation all around the world, and this will probably also settle the taxation issues, and attempt to eliminate the anonymity and prevent its use as a means of digital tax avoidance. The ball is currently in the court of domestic and European decision makers. Some, however, believe that any restriction or ban will be as ineffective as prohibition in 1920s America. This would result in cryptocurrency trading being "forced underground" rather than ceasing, and continuing to provide a fertile ground for tax avoidance.