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Taxing Bitcoin: A Cryptic Challenge

August 1, 2018
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Taxing Bitcoin: A Cryptic Challenge

In the murky bitcoin market, regulators are still figuring out the accounting and tax implications.

By Abdul Razak Rahman

Bitcoin is an internet-based cryptocurrency or virtual money that allows anyone to transact with anyone else, anywhere at any time, instantaneously at marginal cost, with confidence and privacy, without friction nor censorship. It has no central authority and no intermediaries and is a USD120 billion global ecosystem of users, developers, exchangers, traders and merchants.

Colbert Low, Vice-Secretary of Access Blockchain Association (Malaysia) said that bitcoin is very much a volatile and speculative market. Bitcoin values leaped 1,600% between May to December 2017 but dipped by 60% from January to April 2018. He hopes that “The volatility will bring maturity to the ecosystem as there is a need for mainstream adoption in Malaysia as well as the Asean region.”

Global Regulatory Developments

Even in the developed markets, bitcoin and its ilk are not yet mainstream and regulators are still studying the implications. At the time of writing, the US Securities and Exchange Commission (SEC) had not approved any exchange-traded products such as exchange-traded funds (ETF) backed by cryptocurrencies or assets related to cryptocurrencies for listing or trading. Neither had the SEC registered any initial coin offerings although in March 2018, the SEC had started the process to approve or disapprove a change in its rules that will allow two bitcoin ETFs to be listed on the NYSE Arca Exchange. In another blow to cryptocurrency legitimacy, the US Treasury also declared that virtual currency does not have legal tender status in any jurisdiction. Although the general perception is that bitcoin is a virtual currency, the US Commodity Futures Trading Commission treats bitcoin as commodity similar to gold or oil.

From the taxation perspective, the US Internal Revenue Service declared that bitcoin must be treated as property for tax purposes which will result in capital gain or loss if there is an exchange. If held for resale, it should be treated as inventory and will give rise to ordinary gain or loss. If it is used as payment, it should be treated like currency and must be converted, with its fair market value checked on an exchange. “These different interpretations and treatments from the regulators lack guidance and clarity and may hinder healthy innovation brought about by new technology,” said Colbert.

Local Regulation

On the home front, mainstream adoption of cryptocurrencies similarly require clarity on regulation, accounting and tax matters. Whether bitcoin should be categorised as a currency or a commodity is the first question that comes to mind as this will dictate the corresponding accounting and tax treatments. If bitcoin is regarded as an asset, then there is the classification matter, whether as an inventory or as a property. The occurrence of taxable events and the corresponding tax treatments also require clarity in the case of exchange of one cryptocurrency with another i.e. crypto-crypto or crypto-fiat where the cryptocurrency is exchanged with normal currency. Another important area is assigning the fair market value to bitcoin.

Malaysia mainstream adopters are also facing practical challenges, primarily difficulty in securing the services of experienced accountants and auditors as well as integration with local ERP (enterprise resource planning) suites. Therefore, this is an area of opportunity for professional accountants and tax agents due to the huge potential of the cryptocurrency market, said panellists at the recent discussion on Bitcoin: What is the Tax Reality at the MIA Malaysian Tax Conference 2018. A volatile balance sheet is another issue to consider as matching the Ringgit liability against bitcoin assets creates extra risk. Finally, the cost of tracking and compliance are high, especially for the SMEs.

Global Tax Guidance for Cryptocurrencies

“Not many countries have come up with special or new tax rules to tax cryptocurrency but many countries have come up with guidance or policy decisions on how the existing tax rules deal with cryptocurrency,” explained Anil Kumar Puri, International Tax Leader, Ernst & Young. The UK is the first country that came up with the policy notes on the treatment of cryptocurrency from the capital gains tax and indirect tax perspectives. This was closely followed by the United States IRS in the form of FAQs on tax treatments relating to cryptocurrency. Closer to home, Japan, South Korea and Thailand have issued rules or initiated processes to tax cryptocurrency.

With regards to classification, Anil noted that many countries are treating cryptocurrency as either a property or an asset, and not a currency since it is not issued or backed by the central banks or governments. Since cryptocurrency is categorised as a property or asset, there are challenges on how to apply the various tax rules on the unique cryptocurrency transactions. The US IRS and Canada, for example, deemed bitcoin mining as a taxable transaction. Similarly, the sale of bitcoin is considered a taxable event in countries such as the UK, US, Canada and Australia and therefore will be subject to capital gains tax (CGT) or income tax, depending on the tax laws of the country. Most countries are also treating exchange of bitcoin as two separate transactions of buying and selling, which will then attract capital gains tax as well as GST or VAT.

“As far as Malaysia is concerned, the IRBM has not issued any guidelines in dealing with tax issues of cryptocurrency as comprehensive study is required to fully understand the subject matter,” explained Mohamad Fauzi Saat, Director, International Tax Department, IRB Malaysia. However, as a member of the Inclusive Framework on BEPS (Base Erosion Profit Shifting), Malaysia is committed to work towards achieving consensus-based solutions on the tax treatments by 2020, said Fauzi.

Regulators also need to understand the business model for cryptocurrencies before formulating and implementing regulations that encourage business and tax compliance. “Running a cryptocurrency mining business is almost equivalent to running big data centres. With tax implication on cryptocurrency still a grey area, the feasibility of the cryptocurrency business in Malaysia is largely dependent on its economic model,” said Eric Ong of Trio ADS Sdn Bhd. “Although bitcoin mining primarily involves solving mathematical problems using machines, the overall costs have to include other costs such as the equipment cost, electricity, Internet, security and manpower. If bitcoin profits or gains are to be taxed, what are the reliefs available to the miners to cover the costs?”

Cryptocurrency regulations should also work to encourage foreign investment and diversify tax revenue sources. “Regulating the cryptocurrency through an exchange is actually beneficial to the business as evidenced by the success story in Japan, which has seen a 40% to 50% increase in the take-up of cryptocurrency business upon implementation of the regulated cryptocurrency framework by the authority. It is also beneficial to the government as the exchange creates an additional tax source to the government, in addition to the tax imposed on cryptocurrency users,” recommended Fakhrul-Razi Abu Bakar, founder of Pinkexc Sdn Bhd, the only locally-owned cryptocurrency exchange in Malaysia.

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