What are cryptocurrencies?

While it is difficult to establish the precise origins of monetary societies, it seems that payments using some form of money were being made as early as 2200 BC. The format of money has changed considerably since then. Modern economies are normally based on ‘fiat’ currency i.e. legal tender designated and issued by a central authority, such as euro.

In recent times, there has been an increasing use of virtual currencies. A virtual currency can be defined as a type of unregulated, digital money, which is issued and usually controlled by its developers, and used and accepted among the members of a specific virtual community.

While there are numerous cryptocurrencies in existence, the first and most famous one is Bitcoin so our focus in this article is on it. If you are unsure of what Bitcoin actually is, you can take comfort in knowing that you are not alone. In 2017, the third top ‘What Is…’ Google search was ‘What is Bitcoin’. So, what actually is Bitcoin?

Bitcoin is an unregulated decentralised peer-to-peer form of digital private money, which can be exchanged for goods or services (where accepted) or traded in its own right. It qualifies as a virtual currency but is more commonly referred to as a cryptocurrency because Bitcoins are transferred through an exchange of encoded information, i.e., by making use of digital cryptography.

As a stateless digital currency outside traditional commerce and finance or supervision, its increasing popularity has given rise to significant VAT considerations.

VAT considerations

The complexity of the underlying innovative technology and the transactions involved add to the depth of taxation issues associated with the use of Bitcoin and, by extension, other cryptocurrencies that share the same characteristics. Furthermore, it has to be noted that we do not operate on a certain fact pattern due to the peer-to-peer decentralised and anonymous’ nature of the Bitcoin system.

In the absence of any legislation specifically outlining how cryptocurrency activity should be treated for Irish tax purposes, unsurprisingly, this is an area that continues to give rise to confusion and debate.

It is not uncommon to hear contrasting views that Bitcoin is simply either VAT exempt or subject to a positive rate of VAT, but we are left wondering what exactly is meant by such statements. What, if any, of the following matters are they referring to?

(i) supplies of goods and / or services remunerated by way of Bitcoin;

(ii) activity concerning the arrangement of transactions in Bitcoin;

(iii) activity concerning the verification of transactions in Bitcoin (commonly referred to as mining activities); and / or

(iv) activity concerning the exchange of Bitcoin.

All of the above issues which warrant careful consideration have been examined by the EU VAT Committee with several possible treatments tabled in its published working papers. While it is only an advisory committee without any legislative powers, it provides useful insight and guidance on the possible application of the EU VAT Directive (Council Directive 2006/112/EC) which has been transposed into the national legislation of EU Member States.

In addition, the VAT treatment of services provided by an exchange platform have previously given rise to a referral from the Swedish national courts to the Court of Justice of the European Union (CJEU).

European case-law

There is a VAT exemption contained in the EU VAT Directive in relation to currency exchange activity but, on its face, the exemption only applies to the currencies which can be used as legal tender. This specific exemption has been transposed into Irish VAT law.

In the case of Skatteverket v David Hedqvist (C-264/14), the CJEU was effectively asked to determine whether that VAT exemption extended to Bitcoin exchange activity even though it is not legal tender. On 22 October 2015, the CJEU answered this in the affirmative and held that the margin earned by the exchange on the difference between the price paid and the price sold constituted a VAT exempt service.

The CJEU does not act as a final decision-maker but instead provides answers to questions of European law posed by the referring court. However, as the CJEU pronounces on principles which must be used in interpreting the Directive, and the Directive is supposed to underlie the VAT law of all EU jurisdictions, decisions of the CJEU are relevant for each Member State. As a result, we can discount the fact that the questions in this case were posed to the CJEU by the national courts in Sweden. That being so, the same treatment should apply across the EU.

It is important to note that this case only deals with a very specific aspect of the Bitcoin sphere (services provided by an exchange platform). Accordingly, while the judgment is certainly useful, it does not offer a comprehensive solution to the VAT treatment of all Bitcoin related activity.

Irish position

On 15 May 2018, Irish Revenue published eBrief No. 88/18 which outlines its views on the taxation of cryptocurrency transactions.

Legal status of Bitcoin and similar cryptocurrencies

It is Irish Revenue’s view that Bitcoin and similar cryptocurrencies are regarded for VAT purposes as ‘negotiable instruments’ and exempt from VAT in accordance with Paragraph 6(1)(c) of Schedule 1 of the VAT Consolidation Act 2010. This was one of six possible approaches explored by the EU VAT Committee in its working paper of 29 July 2014. In that document, it was noted that some Member States supported this position.

Supplies of goods and / or services remunerated by way of cryptocurrency

Irish Revenue has stated that supplies of any goods and services subject to VAT, remunerated by way of Bitcoin or other similar cryptocurrencies, should be treated in the same way as any other supplies for VAT purposes. This is clearly a logical position to adopt and is beyond any reasonable contention.

Where consideration is expressed in cryptocurrency, the taxable amount on which VAT is levied should be the euro equivalent value at the time of the supply. However, while this may sound straightforward, there are difficulties in determining which source of exchange rates to select. For example, the peculiarities of the Bitcoin system give rise to doubt on this point for the following reasons:

(i) Existing exchange markets for Bitcoin are subject to constant change. Exchange platforms are used worldwide, and their influence extends beyond the limits of Member States. That being so, it may be difficult to determine the most representative exchange market of a Member State.

(ii) Bitcoin does not depend on a central authority and there is no foreign exchange reference rate comparable to the ones published in respect of fiat currencies, which are the ones referred to in VAT law dealing with the taxable amount of a transaction. Since Bitcoin is traded on multiple exchange platforms, its value in other currencies (such as euro) varies at any given moment, depending on the exchange platform.

Irish Revenue has acknowledged that ‘there is not always a single “exchange rate” for cryptocurrencies’ so a ‘reasonable effort should be made to use an appropriate valuation for the transaction in question.’

Exchange activity

The document confirms that Irish Revenue view the exchange of Bitcoin for fiat currency as constituting VAT exempt activity pursuant to paragraph 6(1)(d) of Schedule 1 of the VAT Consolidation Act 2010, where the business performing the exchange acts as principal (i.e. buys and sells Bitcoin acting as the owner of the virtual currency). This is consistent with the CJEU decision in the case of Skatteverket v David Hedqvist (C-264/14), as outlined above.

Mining activity

Irish Revenue has adopted the position that income received from cryptocurrency mining activities will generally be outside the scope of VAT on the basis that the activity does not constitute an economic activity for VAT purposes.

Concluding remarks

While this article has identified some of the possible VAT issues associated with cryptocurrencies, it is important to note that Corporation Tax, Income Tax, Capital Gains Tax, Stamp Duty and Capital Acquisitions Tax considerations also warrant consideration by any party engaging in cryptocurrency activity.

Furthermore, on a related note, any party considering raising capital by way of an Initial Coin Offering (otherwise referred to as a token sale or token launch) should consider the taxation implications of doing so. Parties acquiring such tokens also need to consider the associated taxation implications.

Should you have any queries on this article’s contents or would like our assistance with dealing with any taxation matter, please feel free to contact us.