Crypto-Taxation: Imperfect, Imposing, Imperative?

Cryptocurrencies are any digital currency with no central issuing, regulating authority, one that exists only on a decentralized ledger called blockchain. Sounds clear enough, right? Well, not quite, if you consider how differently they are treated by tax agencies around the world.

Nothing is better evidence of the global crypto-confusion than an examination of how members of the J5, the Joint Chiefs of Global Tax Enforcement, view cryptocurrencies. On one hand, in the United States and Australia, cryptocurrencies are classified as property and incur capital gains taxes. On the other hand, the Netherlands considers cryptocurrencies as goods, while countries such as the U.K and Germany rule on it on a case-by-case basis.

Consider this – The member states of an international task force that aims to combat the growing threat to tax administrations posed by cryptocurrencies and cybercrime are themselves undecided on how to treat cryptocurrencies. The inability of the J5 to do its job was articulated by Wendy Walker, Solutions Principal at Sovos Compliance, who told AMBCrypto that “the lack of coherent tax policy from J5 countries is unsurprising, considering the level of uncertainty investors are facing in the U.S.”

In fact, such examples are emblematic of the fact that “with occasional exceptions, such as tax treaties, there is rarely an attempt made to harmonize taxation throughout the world,” according to Practus LLP’s Robert Elwood.

Cryptocurrency: More of an investment asset, than a currency

It is now easy to forget that in the early days, Bitcoin was considered by many to be a currency and a medium of exchange until processing speeds and scalability proved otherwise. However, it continues to impress many as an investment asset.

The United States’ IRS dictating that cryptocurrency was a form of ‘property’ way back in 2014 was perhaps the best recognition of Bitcoin and cryptocurrencies’ evolution.

Bitcoin’s rise with respect to Futures and Options trade has been significant, something evidenced by the astronomical rise in open interest and volume and the fact that Binance launched its own dedicated Futures platform.

ICE’s Bakkt was also launched in September after a slow start, with Bakkt’s BTC contracts registering high daily volumes as well. Such institutional involvement has contributed to crypto’s financial utility, with Bitcoin’s credentials in the derivatives industry undeniably successful.

The aforementioned case makes it extremely difficult for Bitcoin to be treated any different than the likes of stocks, bonds, ETFs and other commodities.

Too late to the party?

Another possible reason behind governments being slow with crypto-tax regulations is that they didn’t expect this emerging asset class to last as long as it has, or be as popular as it is, which is why tax authorities across the world were perhaps, caught off-guard.

Another reason for the same was highlighted by Sovos’ Wendy Walker who said,

“They [IRS, other global tax agencies] aren’t technologically advanced, and they often rely on old-fashioned mail, which does not correlate well with digital assets.”

However, recognition doesn’t necessarily equal acceptance as many central banks and government representatives around the world continue to claim that cryptocurrencies are a significant threat to the government’s financial hegemony.

How then did countries deal with it? While some just banned cryptocurrencies altogether, others began wielding an instrument more powerful than any – Taxes. Think about it – cryptocurrencies are meant to assert an individual’s control over his/her assets, without the participation of any intermediary or government. Alas, governments are now using taxation policies to re-impose and re-assert the financial control they were expected to lose with the dawn of cryptocurrencies.

Ryan Losi, Public Accountant and President of PIASCIK accounting firm, said it best when he told CNBC,

“For Americans, there is no free lunch. If you’re richer tomorrow than you were today, it is likely you have some tax burden associated with that.”

A question of freedom

The case of San Francisco-based Coinbase is a case in point. Exchanges and entities providing cryptocurrency transactions services are not specifically mandated to provide tax reports to users, but the likes of Coinbase had to provide a “cost basis for taxes” report to users after the IRS ordered it to turn over the data of over 13,000 customers.

Most arguments against the taxation of cryptocurrencies come from two parties – Libertarians and crypto-anarchists. While the latter oppose crypto-taxation on the basis of the argument that it re-imposes state control, Libertarians argue that taxation should be a voluntary exchange and not coercion.

However, it can also be argued that both Libertarians and crypto-anarchists are overstating how bad crypto-taxation is. Just because traded and invested crypto-assets are being taxed doesn’t necessarily mean that the government is attempting to clamp down on individual liberty.

Taxation is good?

Crypto-taxation could be an expression of the government’s recognition of crypto-assets as something legitimate, however, it defines its nature and status. Crypto-taxation, one can argue, highlights not just the state’s acceptance of this emerging class, but also underlines its confidence in the long-term stability and sustainability of such assets.

The fact that governments and regulators around the world continue to caution against crypto-assets shouldn’t take anything away from the fact that the asset class has come a long way since the days of the Silk Road. In the larger scheme of things, taxation may, in fact, be imperative. This was the belief of John Carr, CCO at Sophisticated Investor, when he spoke to AMBCrypto,

  “…if the asset wants to achieve mass adoption and legitimacy as an asset class, taxation is imperative. By adhering to regulators, cryptocurrency gains credence in the eyes of more investors, rather than simply being regarded as something tantamount to a passing trend.”

There is truth to Carr’s assessment. For long, cryptocurrencies were associated with darknet, a tool for criminals and terrorists in the dark underbelly of the Internet. While this sentiment hasn’t worn off completely, no longer are cryptocurrencies ‘Magical Internet Money;’ it is a legitimate asset class that has everyone from the Federal Reserve Chair to Facebook’s Mark Zuckerberg talking.

Carr’s sentiments were shared by Robert Elwood, COO and Partner at Practus LLP. Calling the idea of anything being truly borderless or free from governmental oversight naïve, he told AMBCrypto,

“Simply having a philosophy of wanting to be free of government oversight is a valid concept, but that alone does not relieve one from complying with generally applicable laws.”

He  added,

“…. the hope to have anything, especially a medium of exchange escape local legal oversight is unrealistic.”

Additionally, it can be argued that crypto-taxation is crucial to ensuring institutional involvement in the crypto-industry. As Wendy Walker said,

“Taxation is just one component of the overall regulatory framework. Institutional investors are accustomed to a taxation process associated with traditional investments and they expect a similar process to be applied related to cryptocurrency investments as well.”

Finally, it may not even be a question of freedom, but of convenience, according to Todd Southwick, CEO at iTrust Capital. He told AMBCrypto,

“At some point, we (humanity) gave up all rights to privacy in exchange for convenience. The use of currency falls into one of these lost rights.”

Global crypto-tax confusion

Even in countries like the USA where there are crypto-tax guidance and regulations available, there is too much confusion among investors and tax authorities. This confusion was articulated by Perianne Boring, Chairman of the U.S Chamber of Digital Commerce when she said,

“It’s unorganized and incredibly complicated — and it’s really putting the US at risk of falling behind from an innovation and technology perspective. There are turf wars between the different regulatory agencies, and none of this is in the best interest of the US or the blockchain technology industry.”

This statement was made back in 2018, 4 years after the IRS’s last crypto-tax guidance. It wasn’t until October 2019 that the IRS issued additional guidance that “will help taxpayers and tax professionals better understand how longstanding tax principles apply in this rapidly changing environment.”

However, the additional guidance left many questions unanswered. For instance, the guidance suggested that any blockchain fork can give rise to tax obligations for anyone holding these coins and any gained by airdrops to an address someone has “dominion and control” over is also taxable. This isn’t good news for a market that has seen many forks and airdrops over the years. Casa’s Jameson Lopp was one of many to have articulated this sentiment, calling the new guidance a “hot mess.”

Today's IRS guidance is a hot mess.
1. What if you have keys but no software from which to spend the asset?
2. What if you never sell or transfer the asset and it drops 90% in value?
3. What's the value if the asset isn't even trading at the time of fork?https://t.co/jJ5SdXU72i pic.twitter.com/SpTOIOKqg0

— Jameson Lopp (@lopp) October 9, 2019

However, all is not lost. According to Coin Center, the new guidance did clarify the basis for calculating fair market value, while also helping refine accounting standards. While the pace may be slow and some of the questions unanswered, the new guidance highlights how important cryptocurrencies are in the eyes of tax agencies such as the IRS. In fact, according to Paul Miller, CPA at Miller Company LLP,  the Internal Revenue Service, today, has a “laser focus” on the taxability of cryptocurrencies.

Sovos’ Wendy Walker was also complimentary towards the new guidance, stating that it signals that “the IRS understands cryptocurrencies are being used in a variety of ways, rather than solely as an investment vehicle.”

Even the much-maligned J5 is a sign of how tax agencies, governments are trying to solve the issue of crypto-taxation, Miller claimed. He told AMBCrypto,

“I think the J5 is a sign the government recognizes the problem and is closing the loop. While not perfect. This is similar to the overseas tax avoidance issue disclose by the disgruntled UBS worker. Eventually, the IRS and related countries will have it completely under control.”

Walker also highlighted how the J5 is on the right track, claiming that it is working towards a “uniform strategy.” According to her, the member states’ recognition of cryptos as either property or commodity is the fundamental element of “building a framework for digital asset taxation.”

The Road Ahead

Cryptocurrencies are complicated. So is taxation. Cryptocurrency taxation is doubly so, which is why governments and tax agencies across the world should work more aggressively towards resolving the differences within each tax jurisdiction. Citizens across state lines must have a universal, uniform understanding of what crypto-taxation entails.

It is easy to victimize tax evaders holding cryptos by accusing them of having hidden their assets in offshore accounts based in the Cayman Islands. However, another explanation for such cases could be the fact that crypto-taxation is extensive and confusing. Yes, the IRS would argue that the latest guidance makes it easier to file taxes on cryptocurrencies, but as John Carr said, it isn’t “definitive, comprehensive legislation.”

As Walker called it, a “piecemeal” approach to tackling the issue of crypto-taxes won’t suffice. What is more prudent thus, “is that agencies formulate uniform tax laws around how the crypto is being used so they can apply those laws within the framework of their existing tax systems.”

Article written in co-authorship with Biraajmaan Tamuly