Crypto-Taxes

Feb 19, 2018

Sunday Business Post, 18 February 2018
There are some technological innovations which genuinely change the way we think about things.  Spreadsheets, ATMs, live pausing of television, streaming music services, satnav.  Everyone has their own view on what those markers of change might be.  

Bitcoin is such an innovation, or perhaps more correctly, crypto currencies are of which Bitcoin is only one.  On Monday last, South Dublin County Council considered a motion to approve Bitcoin as a legitimate way for the public to pay for council services.  That the motion was rejected is in one sense neither here nor there.  The significance is that it was on the agenda in the first place.

It seems to me that the essence of Bitcoin and what makes it radically different from other types of currency, is that it dispenses with the need for an independent institution to verify its issue and use.  Bitcoin is for all the world like a bearer document for the digital age.  The euro note is the bearer document we are all familiar with.  It has value because a bank has issued it, and its value is attributable to the person holding it.  If you lose the banknote, you lose the value.  If you lose digital access to the Bitcoins you own, you lose their value too.

The Block-Chain

With Bitcoin the risk of fraud is reduced by the block-chain, an anonymised digital trail showing how often it is changed hands and to whom its value should currently be attributed.  Block-chain works like a bank, regulating Bitcoin issuance and uniqueness, but is not bricks or mortar nor ATM halls, but digital code. 

Once we cut through the digital mystique, Bitcoin is much like any foreign currency.  At least for tax purposes, that is.  When you use euros to buy foreign currency, say US dollars, you are acquiring an asset.  You can gain or lose on that asset depending on the relative value of euros to dollars when you go to sell it.  On the first principles of tax, that gain is taxable.    

When Bitcoin is received as payment in commercial transactions, the same rules in place for payments received in other foreign currencies should also apply.  Payment by Bitcoin doesn't exempt goods or services from VAT, nor allow imports to escape customs duty.  It doesn't mean that a business shouldn't have to pay tax on its income paid by Bitcoin.  Much about Bitcoin is routine.  Nevertheless, the use of Bitcoin and indeed other similar crypto currencies represent a headache for Revenue authorities the world over. 

Because Bitcoin operates via a network independent of any central authority or bank, all functions such as issue, transaction processing and verification are managed collectively across a network of computing platforms.  That makes it tricky for Revenue authorities to trace, certainly far harder than tracing euros, sterling or dollars which tend to end up somewhere in some bank account to which a tax man or woman can request access.  There is no comparable “holding ground” for Bitcoin savings, whether from taxed income or otherwise.  They exist in a computer file to which their owner has access, while the record of their validity contained in the block-chain is distributed across multiple platforms on the World Wide Web. 

A Digital Mattress

Bitcoin can be hidden by tax evaders under a virtual digital mattress.  Fortune magazine is reporting US research which suggests that only a tiny percentage of individuals who may have gained from transactions in crypto currency are reporting those gains to the Internal Revenue Service.  That may be a by-product of the relative novelty of crypto currencies.  I'm told the Canadian Revenue Service, rather than just change the tax rules, has signalled plans to develop an education and enforcement program so that their taxpayers know how to deal with Bitcoin properly. 

When the Bitcoin issue was raised in the Dail sometime ago the then Minister for Finance Michael Noonan suggested that Bitcoin may present a cash substitute for some tax evaders.  He noted that it was probable that it represents a new opportunity for existing non-compliance, rather than a new form of evasion.  That observation was probably correct in 2013 but the issue may need re-examination now.  As with all forms of tax evasion, it is not just sufficient to be able to counter evasion as it is happening, but to detect it after the event. 

Leaving no Trace

There is of course still a chance that Bitcoin might crash and burn, and the recent surge and almost as rapid devaluation of the crypto currency makes this a real possibility.  It could turn out to be the Betamax format of online payments, technologically excellent but never attaining critical mass in the marketplace and finally superseded.  Just in case, we need to dispense with the myth that if a transaction is in a crypto-currency it is in some way tax-free.  

Revenue authorities may have to think about the ways of tracing Bitcoin derived activity, for example, by regulating businesses which convert Bitcoin to the more traditional currencies.  Because even if Bitcoin itself is superseded, the challenge it poses remains: how to enforce tax collection on transactions using currencies that leave no physical trace.

Brian Keegan is Director of Public Policy and Taxation at Chartered Accountants Ireland