Capital vs Income as the defining factor in taxing cryptocurrency transactions

The brave new world of cryptocurrency is surrounded by a number of questions and ambiguities. This is only to be expected given its relative infancy and the breakneck speed with which it is evolving and gaining ground. However, it would appear in 2018 that certain parameters are now being established and ground rules acknowledged, as various jurisdictions are setting out clearer rules of engagement with this sector.

The G20 Summit held in Argentina last March issued a clear statement that cryptocurrency is a priority, with many leaders and industry experts agreeing that effective regulation is needed sooner rather than later to prevent money-laundering, tax evasion and other financial crimes. Beyond this consensus, however, countries are taking a decentralised approach to the issue and views on cryptocurrency regulation can differ from state to state. The coming months will tell whether common strands will begin to emerge, particularly among the EU member states.

A central issue in this unfolding debate, crucial in terms of exactly how regulation is to be established and enforced, is how our current tax regimes should factor in cryptocurrencies. Do these need to be radically reinvented or are there fundamental tenets and concepts in tax law that can, without being stretched too far, be applied pragmatically to the crypto space?

Many jurisdictions are using the working principle that cryptocurrencies can ultimately be treated as “intangible property” and that therefore general tax principles applicable to property transactions could also be applied to cryptocurrency exchanges. If such a transaction results in gain or profit, then how are taxation rules, particularly Maltese tax law in this case, best applied?

The first aspect that must be established is whether the gain resulting from a crypto exchange is of a capital or income nature. Although we have no actual differentiation between the two in Malta’s Income Tax Act, there is a significant body of case law that provides a basis on which to classify a gain as capital or income with some confidence.

A rather cliched but extremely effective analogy that is often used is that of a tree bearing fruit, where the tree represents the capital property while the fruit is the business income resulting from that asset. However, it is well known in tax circles that some ambiguity can arise when seeking these classifications and very often specific cases are not clear-cut. This is where the question of intent becomes all-important, that is, the intention at the time the transaction took place, and this remains one of the leading tests used by regulators and courts to decide whether any form of revenue is income or capital in nature.

In general terms, proceeds will be income in nature if the assets were acquired with the intention of selling it on at a profit. However, if the asset is acquired and held with the intention of producing further income from that asset then it is treated as capital in nature.

The “badges of trade” are widely accepted indicators to help determine the intention and nature of a transaction. These include the quantity and nature of the goods; the incidence of transactions; supplementary work on the asset being sold; the interval of time between when the asset was acquired to when the asset was sold and the method of acquisition and disposal (an asset acquired through inheritance or as a gift is less likely to be the subject of trade).

As with any other transaction, this framework can be applied to gain resulting from cryptocurrency transactions to classify this as income or capital and it is this assessment that will determine the applicable tax rules.

Just like trading in bonds, company shares or commodities, cryptocurrency transactions considered to be of an income nature are taxable in terms of the Income Tax Act, which includes a blanket provision requiring gains or profits derived from transaction of an income nature to be taxed, irrespective of the type of asset. On the other hand, if the gain is derived from a capital transaction this would only be taxed if it arises from an asset listed in Article 5 of the Income Tax Act. This list, however, is clearly specified in the Act and is limited to transfers of immovable property, securities, intellectual property, beneficial interest in a trust and partnership. Therefore, if the capital gain in question is derived from an asset that is not listed in Article 5 then no tax will apply.

As we now set to work examining the new crypto legislative framework just published by government, I believe that this brief overview of the tax implications of trading in cryptocurrencies clarifies that, until new models are presented, the current “income vs. profit” rules for determining the taxability of gains in this sphere remain the determining factor. This awareness should guide any individual or business entering the crypto space and inform their decisions in this regard.

This article provided by NewsEdge.