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Tax in a Virtual World: Taxing Virtual Currencies

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bitcoin_virtual_currency.jpgA growing number of companies, large and small, are now accepting bitcoins as payment for their goods and services.

Despite being almost completely unregulated, virtual currencies, of which bitcoin is the most prominent example, are being accepted as a legitimate monetary medium by an increasing number of countries.

Tax authorities however are struggling to fit virtual currencies into tax systems still largely built on the physical economy of the 20th century.

What is a Bitcoin or Virtual Currency?

Described by the developers of bitcoin as “pretty much like cash for the internet,” units of virtual currency are traded over peer-to-peer computer networks.

Unlike conventional fiat currencies they do not involve intermediaries, and are not regulated or backed by central banks or governments.

Related: Data Protection and Privacy Rights

Property Or Currency?

To date, tax authorities have had significant difficulties with determining how to go about taxing virtual currencies, mainly because there has been debate about how to classify bitcoins for tax purposes. Virtual currencies combine the properties of currencies, commodities, and payments systems, and their classification will often have implications for their legal and regulatory treatment.

A key issue is whether they should be treated as a form of property, or as a form of currency for tax purposes.

Guidance published by the United States Internal Revenue Service in 2014 suggested that cryptocurrencies should be treated as property. The agency observed that while virtual currencies are often seen to operate like fiat currency, they do not have legal tender status in any jurisdiction. It therefore confirmed that the general tax principles that apply to property transactions apply to transactions using virtual currency.

The Inland Revenue in New Zealand, however, clarified later the same year that an alternative 'currency' dollar, such as bitcoin, should be treated as a currency from a tax perspective, as transactions are assessable and deductible for income tax purposes to the same extent as other cash or credit transactions.

Related: New EU Data Protection Regulation – An Overview

VAT, GST and Sales Tax

There does seem to be more consistency with regards to tax authorities’ treatment of virtual currencies for value-added tax and sales tax purposes, with a consensus emerging that taxpayers exchanging traditional currencies for their virtual equivalent should be exempt from consumption and sales taxes.

In the European Union, it is hoped that a 2015 ruling from the Court of Justice (ECJ) will provide more clarity for virtual currency users.

In a position already taken by some EU tax authorities, including HMRC in the UK, the ECJ ruled that that the exchange of traditional currencies for units of bitcoin should be exempt from VAT.

The ECJ said that "purchases" of bitcoin should fall under provisions in the EU VAT Directive which provide that member states must exempt transactions relating to "currency, bank notes, and coins used as legal tender".

Australia is also coming round to this view. After the ATO initially decided to treat bitcoins as akin to a barter arrangement, in March 2016 it was directed by the Australian Government to issue a ruling that treats virtual currencies in the same manner as traditional currency and therefore broadly outside the scope of goods and services tax.

The Future

Some say that virtual currencies are the future, and that they will eventually replace cash and fiat currencies. While this may be the case, it is a future that looks a long way off as regulatory authorities continue to eye virtual currencies with suspicion.

It will probably also take a long time before tax authorities arrive at a consensus on how to deal with taxing virtual currencies.

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