The Canadian Revenue Agency recently stated in section 233.3 of the Income Tax Act that bitcoin and other digital currencies are considered “specific foreign properties” and are to be treated as foreign funds or intangible properties.
The rules of the Income Tax Act document states that foreign properties including bitcoin that exceeds the value of $100,000 CDN should be reported with a tax form called T11135 to notify the amount of bitcoin held by an individual or an organization.
In the Canadian Revenue Agency Document No. 2014-0561061E5 “Specified Foreign Property,” the CRA states that digital currencies including bitcoin and other cryptocurrencies are considered as foreign funds if they are held or deposited outside of Canada and if they are not used in an active business.
Furthermore, the CRA explained in the document that a partnership which holds digital currencies are classified as a foreign property if “the total of all non-resident members’ shares of the income or loss of the partnership for the fiscal period is less than 90% of the total income or loss of the partnership for the period.”
Such partnership would be specified as a foreign property of the Canadian corporate owner and the digital currencies used in its operation will be also classified as foreign properties or funds of the partnership.
Bitcoin Association Switzerland reports that, according to the Swiss Federal Tax Administration, no VAT applies to bitcoin in Switzerland. The transfer of bitcoin doesn’t constitute delivery of goods or services, and therefore it’s not subject to VAT.
“This is the most reasonable way to classify bitcoins in the context of VAT, and we are fortunate that the tax administration agrees with our view,” says Luzius Meisser, president of Bitcoin Association Switzerland. “Bitcoin is a currency, and thus should also be treated like a currency.”
In February 2014, a group of three Swiss Bitcoin organizations jointly wrote a formal inquiry to the Swiss Federal Tax Administration to clarify the legal situation of bitcoin with regards to VAT. The tax authority replied that bitcoin is to be treated just like any other payment option – trading bitcoin for Swiss francs is seen as similar to trading euros for Swiss francs. Furthermore, the transaction fees charged by bitcoin exchanges are VAT-free.
“This is excellent news for bitcoin in Switzerland as it provides the legal certainty we need to professionally operate our business,” says Niklas Nikolajsen, CEO of Swiss bitcoin exchange and service provider Bitcoin Suisse AG.
Other European nations have made similar decisions. Recently, the Spanish tax office confirmed that, under Spanish law, bitcoin has been recognized as a financial service, and therefore the cryptocurrency isn’t subject to the nation’s 21 percent VAT.
In the European Union, which Switzerland is not part of, there is not yet clarity on the VAT status of bitcoin. In June, however, the European Court of Justice in Luxembourg is expected to hold a hearing on the matter, Handelszeitungreports.
“We hope that the Swiss decision can serve as an inspiration for Europe,” said Mathieu Buffenoir, vice-president of Bitcoin Association Switzerland.
Bitcoin is now confirmed to be exempt from VAT in Switzerland, but other regulations apply. Switzerland considers digital currencies such as bitcoin equivalent to any other foreign currency. This means that the professional operation of bitcoin trading platforms constitutes financial intermediation with the requirement to comply with both the Banking Act and the Anti Money Laundering (AML) Act. Recently ECUREX, a digital finance marketplace for professional traders and financial institutions headquartered in Zurich, announced that it has become the first digital currency exchange platform to be fully compliant with both.
Switzerland, a modern country in the middle in Europe with a world-class financial system, a stable regulatory environment, and a thriving economy unencumbered by the often lengthy and ineffectual bureaucratic procedures of the European Union, is emerging as a good location for bitcoin businesses.
In related news reported by Handelszeitung, preparations are under way for the establishment of the first bitcoin bank in Switzerland, according to multiple sources in the financial sector. The bitcoin bank would be set up as a normal commercial bank connected to the banking network and compliant with the Banking and AML Acts, and able to offer all standard banking services. Bitcoin Magazine is following the story and will report in detail once more information is available.
The burden of managing a tax calculation every time you buy something with bitcoin creates adoption friction that’s counterintuitive to the frictionless nature of bitcoin that we all know and love. (More on this in my article titled, “A Gift from the IRS and the Coffee Problem.”) So what if there was a better way to align the tax rules with the uses and benefits of bitcoin, to naturally accelerate adoption? How about eliminating short-term capital gains rules for bitcoin and other digital currencies?
Old world ways
Most folks generally understand the tax implications of using bitcoin by now, which includes having to track bitcoin to calculate a gain or loss whenever you buy a cup of coffee. Bitcoin may have become a victim of its own volatility when the IRS, during its decision-making process, was perhaps looking at the rise of bitcoin without considering price drops. Nonetheless, the application of property rules with short-and long-term capital gains is consistent with the taxation of any other assets going up and down in value. Bitcoin, however, deserves an exception, one that will take us into warp-speed and mass adoption.
Bitcoin simultaneously encompasses two wonderful traits of money, serving as both a store of value as well as a medium of exchange. The frictionless, almost instant transfer of value speaks for itself by transforming the Stone-Age model full of fees and headaches we’ve come to expect. Bitcoin has a magical store of value component because it’s a self-contained system combining a currency, a protocol and a network into something useful and scarce. The IRS short-term capital gains rules, as pointed out in the coffee reference, erroneously add friction to bitcoin’s otherwise frictionless medium of exchange. Ironically, the very same rules are like a gift from the IRS when applied to bitcoin’s store of value. Long-term holds of bitcoin or any other asset have the lowest possible tax rates — 15 percent in some cases — compared to ordinary income as high as 39.6 percent.
Exploring a new frontier
A few IRS rule changes could easily transform this strange dichotomy into a slam-dunk for bitcoin. My assertion is simple: The cost of supporting the rules is greater than the benefit. The aggregate cost of compliance for taxpayers, combined with the IRS costs to administer the rules, outweighs the benefits to the U.S. Treasury.
Here are just a few of the most obvious costs:
IRS staff training on understanding digital currencies
IRS staff training on how to field bitcoin-related questions
IRS resources spent on processing tax returns with pages and pages of bitcoin transactions (an effort that diverts resources away from areas that produce a higher return)
To illustrate this wasted use of resources further, let’s take data sets from individuals and businesses, while assuming the transactions were in an all-bitcoin world, and calculate the net gain or loss at the end of a year. An analysis of 2014 would likely result in a net gain close enough to zero to justify eliminating the short-term capital gains rules for bitcoin and other digital currencies. For bitcoin to become a truly frictionless medium of exchange, these rules need to be eliminated. Meanwhile, long-term gains for bitcoin held longer than one year would remain intact because larger, infrequent transaction amounts are easy to track. It’s also consistent with taxation of asset appreciation related to bitcoin’s store of value property.
A long-term relationship
The modification I’m proposing creates the perfect dance between store of value and medium of exchange while making things easier for the IRS and the taxpayer. If a business or individual holds bitcoin for 10 months, the question they will ask is: Do I want to continue holding bitcoin into the long-term capital gain zone or use it now for things I need anyway? Those in the game for a long-term play won’t flinch and those who are not will spend the bitcoin and get it flowing again.
In addition, the IRS “wash sale rules” would apply, essentially prohibiting a repurchase of the same cryptocurrency within 60 days of a sale. The wash sale rules normally prohibit sales and repurchase of securities within 30 days so taxpayers can’t recognize a loss. In this context, however, it would extend the 30-day period to 60 days to thwart the game of resetting the clock on a long-term hold. The wash rules would not apply if bitcoin was used to purchase goods or services. It applies only when bitcoin is sold for USD. For example, if you use bitcoin to buy office supplies, you can’t turn around and use office supplies to buy back bitcoin. On the other hand, if you sell bitcoin for USD you can use the USD to buy back bitcoin, which is why I’m proposing a modified wash sale rule.
If you don’t like the above example, consider these alternatives:
Increase long-term capital gains to 22.5 percent
If the IRS were to eliminate short-term gains, then let’s increase the long-term rate to 22.5 percent to offset the revenue that would have been gained from short-term gains, while still remaining a bargain for the taxpayer. Within the current system, collectibles, such as paintings, antiques and baseball cards, have a special tax rate of 28 percent; therefore, bitcoin and other digital currencies should be able to have a special tax rate.
Implement de minimis transaction relief
Transactions for purchases of goods or services less than $100 would not be subject to short-term capital gains (for individuals). Similarly, transactions less than $250 would not be subject to short-term capital gains (for businesses). Long-term term capital gains rates would still apply to bitcoin held longer than one year.
Establish a volatility threshold
Both individual and business taxpayers would be exempt from short-term capital gains when the price of bitcoin fluctuates within a volatility threshold. As long as the highest price at any point during the year is less than 150 percent of the lowest price during the year, then no transactions will be subject to short-term capital gains tax. For example, if the lowest price was $400 and the highest price was $595 then no capital gains would apply because 150 percent of $400 is $600 and $595 is less than $600. In this case as well, long-term term capital gains rates would still apply to bitcoin held longer than one year.
Create a 5-year short-term capital gain exclusion
Under this exclusion, all bitcoin transactions for purchases of goods or services, for both individuals and businesses, would be exempted from short-term capital gains. This proposed five-year sunset is consistent with other sunsetting provisions that end temporary relief. Long-term term capital gains rates would still apply.
Any of these proposed changes would likely come with unintended consequences, but progress always comes with growing pains. Any new rules that stimulate bitcoin adoption, reduce taxpayer burden, and give the IRS a fair share, should be welcomed.
Recently, I gave a webcast presentation to AICPA members to help accounting professionals understand Bitcoin and how to treat it on the general ledger. If you are an AICPA member, the webcast is available for your viewing. In this article, the key points from that presentation are outlined and will help accountants fundamentally understand and approach business based Bitcoin transactions.
Bitcoin and General Ledger Treatment
There are three key processes that ultimately produce different accounting practices and general ledger treatment when Bitcoin is involved. These three processes coincide with Bitcoin’s adoption phases as follows:
Payment Method
Foreign Currency
Base Currency
Bitcoin as a type of “Payment Method”
Within the context of modern accounting systems, examples of payment methods include cash, checks and credit cards. Very simply, they define the medium used to exchange money.
Today, the most common business use for Bitcoin is to treat it as a payment method. Much of the reason for this is because a) the price is relatively volatile and b) acceptance by employees, suppliers and partners is relatively limited. Services such as BitPay or Coinbase have effectively made it easy to accept bitcoin in a business. Instead of the business actually receiving bitcoin during customer payment, these services deliver traditional government-issued (fiat) currency.
Under this method, Bitcoin acceptance is easy to understand and it follows accounting practices widely used in business today (e.g., consider payment by services such as PayPal). Traditional accounting systems should have no problem under this practice. Generally, define a new payment method in the accounting software, relate it to the bank account that the funds will settle, and then follow the procedures that the Bitcoin service provider prescribes for accepting bitcoin in the business.
Bitcoin as a type of “Foreign Currency”
The next adoption wave will happen if bitcoin price volatility stabilizes and it becomes more widely accepted. Some leading-edge businesses already work in this fashion. Under this method of accounting, bitcoin is treated as a foreign currency; just as one would treat accepting Euros in a USD-based organization. To do this well, the business accounting system will need to understand foreign currency and related exchange prices. Traditional accounting platforms are designed with “currency data types” to accommodate only two decimal places. I was one of the early advocates to logically shift the bitcoin decimal place to the right by six digits and base bitcoin in micro bitcoin (µBitcoin) thus allowing it to work in common general ledger accounting systems.
Not all accounting systems allow for new foreign currency definitions — hence, if the business software is designed only for local currency, this method of accounting will not work. In addition, some accounting systems “hard code” their foreign currency references, and accountants may find this to be a limitation in their client or internal systems.
Under foreign currency accounting, a business bases its transactions in a local currency but may denominate transactions and/or accept foreign currency to conduct business. This practice is well understood in larger organizations — especially ones that transact in international trade.
Under this method of accounting, without respect for local tax regulations that demand different regulatory reporting requirements, bitcoin transactions effectively trigger both realized and unrealized gains and losses based on changing market currency exchange rates and timing differences between when transaction obligations are recognized and ultimately settled.
Finally, when bitcoin is treated as a foreign currency, the accounting software will price every single transaction relative to the base currency. With this price information in hand, a tax accountant can reconstitute the records offline to meet regulatory reporting requirements; such as the recent IRS guidelines that demands that bitcoin be treated as a property.
Bitcoin as a type of “Base Currency”
In the final adoption wave, while it may be far off, it is conceivable to see businesses deem bitcoin as the base currency and thus treat all other currencies as foreign — even the home currency. While this is simply an enhancement of the Foreign Currency treatment previously discussed, this method may be valuable for organizations that are fundamentally global and trade with customers, employees, suppliers and partners anywhere and everywhere. While, this accounting treatment will produce a different orientation and obviously introduces interesting reporting questions, if many organizations elect this method, it does represent a way to measure whether bitcoin has indeed achieved wide global acceptance.
Is Bitcoin integrated with the General Ledger today?
Companies that run NetSuite are set up to transact globally and with BTC4ERP, they have the full range of options to configure their accounting practices based on the way they see bitcoin used in their business. I witness some companies who simply seek a bitcoin price feed into their accounting system to help them with their own manual methods of accounting. Others indeed treat Bitcoin transactions as foreign currency and rely on the automatic bookkeeping and transaction coordination provided by my service. If bitcoin gains wider acceptance, I suspect we will see these accounting treatments on a wider range of accounting systems.
