IMF Working Paper - Taxing Cryptocurrencies

Compilation: Katherine Baer et al., TaxDAO

Cryptocurrency and Tax Design

This section explores key policy issues that arise when developing and assessing the tax treatment of cryptocurrencies, deferring related regulatory issues until later. Following the chain of events for cryptocurrency transactions and creation (Figure 1), issues related to income tax and VAT/sales tax arise; there may also be purely corrective taxation. taxation). Existing national practices in these areas are diverse, require further clarification in many cases and are generally in flux.

In dealing with these design issues, externalities aside, the natural principle that currently applies is neutrality: tax cryptocurrencies in the same way as comparable traditional instruments. For example, there seems to be no reason for miners to treat income from fees and new token generation differently from other business income, unless there is some specific (non-)incentive. However, due to the dual nature of cryptocurrencies: both an investment asset and a medium of exchange, it is difficult to apply the principle of neutrality when dealing with cryptocurrencies.

A. Income Tax

Corresponding to these two functions, cryptocurrencies are classified in two main ways for income tax purposes: as property (such as stocks or bonds) or as (foreign) currency. The impact of this distinction depends on domestic regulations, but can be significant. For example, many countries exempt individuals from taxation of foreign currency capital gains (Cnossen and Jacobs, 2022). Classification as property will generally result in capital gains tax, but important details about losses, allowances and tax rates that change over the holding period will be crucial. For example, in the United States, characterization of cryptocurrencies as property means that in principle all capital gains from transactions must be declared, and if held for more than one year, a tax rate lower than ordinary income tax applies; Taxed as ordinary income, but only on gains over $200. Similar difficulties exist elsewhere, and treating cryptocurrencies as property requires calculating gains or losses on each transaction. The obligations this places on small users can be overwhelming, and a major barrier to everyday purchases of goods and services using cryptocurrencies.

Perhaps there is a third possibility. Some draw an analogy between holding cryptocurrencies and gambling, with the obvious implication that they should be taxed in the same way: e.g. Panetta (2023). This has implications not only for income tax, but also for value-added and sales taxes (acquisitions are treated as bets), which treat gambling in a complex and varied manner. However, it is unclear whether this analogy is appropriate: in HMRC (2022a), about half of respondents said they held cryptocurrencies “just for fun”, but Hoopes et al. (2022) found that cryptocurrency sellers reported Gambling revenue is similar to others.

In practice, the most common approach seems to be to tax cryptocurrencies as property, subject to the corresponding capital gains tax rules. This still leaves room for a variety of different approaches. Some countries, including Europe, Malaysia and Singapore, either do not tax capital gains on financial assets or exempt gains from taxation after a short holding period. Portugal, which has been trying to position itself as a crypto-friendly country, explicitly exempts gains from holding cryptocurrencies, though now only for holdings longer than a year; El Salvador remains fully tax-exempt.

A notable exception is India. There, cryptoassets are on the fringes of regulation: neither illegal nor strictly speaking legal. Nonetheless, the Indian government has implemented a dedicated tax regime aimed at imposing a 30% tax on gains and/or income from transactions of “virtual digital assets” (VDAs), which refers to cryptocurrencies, NFTs and Similar tokens, and other assets that may be designated by the government. There is also an additional tax of 1% on any transfer of VDA.

B. VAT and Sales Tax

The use of cryptocurrencies should not present too much of a principled difficulty with the core structure of these taxes, which are usually expressed in terms of supply not for fiat currency but for “consideration”, the term given to barter transactions The scope is broad enough to cover crypto assets. (However, there are likely to be practical difficulties in applying the term, some of which are mentioned below, such as price volatility (which can place particular pressure on precisely verifying when a transaction occurred), scope for fraud, and into cross-border rules, etc.). To ensure that fiat currency purchases of cryptocurrencies themselves are not subject to VAT, some countries, including Australia, Japan, and South Africa, have specified VAT exemptions; in the European Union, a court ruled in 2015 that VAT should not apply to such transactions.

Clear policy positions are also needed on the fees received by miners and the VAT treatment of newly issued cryptocurrencies. In principle, there seems to be no reason (unless a (non-)incentive is deliberately created) not to charge it with full VAT and give it a corresponding input VAT credit. While this is generally considered good practice, in practice many VAT exemptions are made for financial services. This would lead to overtaxing of cryptocurrencies for commercial use (since miners’ input VAT credits are not creditable) and undertaxing of personal use.

Figure 1: Schematic diagram of the chain of events

Note: This chart illustrates taxable events in the circulation of cryptocurrencies (in this case Bitcoin), highlighting their particular tax policy and administrative challenges. The sender uses bitcoins to purchase services from the receiver through miners, and the receiver can choose to dispose of bitcoins or use bitcoins to purchase services. “?” indicates a particular need for policy/legal clarity. What is not clearly stated here is that these transactions can be peer-to-peer (P2P) or through decentralized or centralized exchanges, which does not affect policy treatment, but will affect tax enforcement capabilities (Peer-to-peer transactions are the most difficult, followed by decentralized exchanges, and finally centralized exchanges).

C. Externalities

There are several types of externalities that can arise from the use of cryptocurrencies, and in fact this is reflected in calls for more effective regulation of cryptocurrencies in many countries, and some (including China, Egypt, Bolivia, and Bangladesh) even outright bans on cryptocurrency transactions or mining. In addition to addressing these externalities through conventional regulatory measures designed to ensure financial stability, protect consumers and fight crime, there are also externalities that may be directly related to the use of cryptocurrencies themselves.

For example, the analogy to gambling mentioned above points to possible self-control problems that could justify corrective taxation. Widespread substitution of national currencies with cryptocurrencies (“crypto”) could undermine macroeconomic management tools and significantly reduce the effectiveness of monetary policy or capital flow measures, which could have implications for the functioning of the international monetary system. Both of these problems could potentially be corrected by imposing some form of tax on cryptocurrency transactions, similar to the financial transaction tax imposed on traditional financial instruments (including to reduce excessive price volatility), which many would also associated with cryptocurrencies. There is also the possibility that, pending more effective regulation, the use of the tax system to block transactions could in principle serve as a (very) sub-optimal stopgap measure to address risks to financial stability and reduce ill-informed investment risk to the recipient. India’s 1% transfer tax may indeed be seen as a groundbreaking step towards these goals. But whatever the conceptual merits of a cryptocurrency transaction tax, and the objections to the unknown benefits of promoting innovation in cryptocurrencies, such an implementation is problematic for reasons similar to those highlighted in Section 5: A national tax on transactions made by domestic exchanges (and/or miners) might work, but that would likely only push transactions to a peer-to-peer format or offshore. Nonetheless, similar arguments may also support less drastic measures within existing structures, such as denying or limiting capital gains tax loss offsets.

However, the most compelling case for a viable corrective tax is the environment. Proof-of-work consensus mechanisms, like the one behind Bitcoin, are energy-intensive because they rely on a lot of guesswork to find solutions to complex mathematical problems. The associated carbon emissions are of great concern: for example, Hebous and Vernon (forthcoming) estimate that in 2021 Bitcoin and Ethereum will use more electricity than Bangladesh or Belgium, producing 50% of global greenhouse gas emissions. 0.28%.

Awareness of the issue is now fairly widespread, and some cryptocurrencies are explicitly advertised as “green” to reflect this. However, voluntariness alone cannot provide a complete solution. According to common wisdom, the externalities of mining-related carbon emissions are best addressed in a general carbon tax, which would automatically internalize the cost of energy-intensive proof-of-work verification mechanisms. However, in the absence of a carbon tax, there is a case for more targeted tax measures. In March, the Biden administration proposed a 30% tax on electricity used by miners, but (at least for now) there is no distinction to reflect the carbon intensity of electricity generation. Kazakhstan (an important mining location) also introduced a similar tax in 2023, but at a reduced rate for miners using renewable energy. In the absence of such an additional tax, a less efficient but still meaningful measure might be to limit or deny income tax deductions for energy costs incurred in mining activities, and/or similarly (if not exempt from VAT), not The input value-added tax amount of the cost shall be deducted.