Whilst there is strong encouragement to regulate the cryptocurrency world, no internationally centralised or common recommendation has been established so far. Each State therefore still has freedom to decide on the regulatory framework as well as on the overall economic concept pertaining to the qualification of cryptocurrencies. In this respect, the key question arises as to whether the existing concepts and regulations may be applicable to the cryptocurrency world or whether the creation of an entirely new regime and new qualifications should be considered.
This trend of a decentralised approach to regulate virtual currencies encourages competition between countries, some of which show an eagerness to emerge as leaders within this fast-growing market by demonstrating, in particular, that they adopt a tailored approach to the regulation of cryptocurrencies.
The tax treatment of transactions involving cryptocurrencies should also be clarified, particularly when it comes to transactions generating income. In this respect, the cryptocurrency shall be clearly defined: is it a true currency, an intangible asset or another type of asset (e.g. taking into account the nature of an underlying asset to which they would be attached, such as a rental income when rent is paid using a virtual currency)? Should a distinction be made between cryptocurrencies or one between taxpayers generating income from those transactions? Should income derived from a cryptocurrency be considered a capital gain on a financial asset or another category of income? What VAT treatment should apply to exchanges in cryptocurrencies? All these questions are relevant when it comes to defining tax regulations for the cryptocurrency market.
Luxembourg has been one of the leaders in attempting to regulate the cryptocurrency market. In 2014, the CSSF issued an official “Bitcoin Communiqué 2014” and licensed Bitstamp, the first-ever EU-licensed and the world’s longest standing cryptoexchange. Four years later, following the G20 summit, the CSSF issued two new press releases ( “warnings”) alerting investors to the lack of specific regulations that protect investors and the fact that transactions in virtual currencies (VC) as well as initial coin offerings were not counter-guaranteed by a government or a central bank. The CSSF “VC Warning 2018” states, inter alia, that cryptocurrencies are actually not currencies but rather a “means of exchange”.
More recently, the Luxembourg tax authorities also released two circulars aimed at clarifying the direct tax and VAT treatment applicable to cryptocurrencies.
The introduction of Circular of 26 July 2018 (No. 14/5 - 99/3 - 99bis/3) states that a cryptocurrency is not a currency. A cryptocurrency is not legal tender and its value is not monitored by any central bank. It is therefore an intangible asset for direct tax purposes, meaning that the Luxembourg tax authorities will not allow a company to draw up its financial statements or file its tax return in cryptocurrencies.
The circular goes on to state that when a cryptocurrency is used as a form of payment, this does not affect the nature of the income, e.g. rent paid using a cryptocurrency does not affect characterisation as “rental income”. When income is derived from disposing of the cryptocurrency itself, an assessment needs to be conducted to determine whether the derived income is commercial income or another form of income.
Commercial income: The income derived from cryptocurrencies is considered “commercial profit” if it meets the conditions laid down in Article 14 of the of the Law of 4 December 1967 on income tax (the Income Tax Law – ITL: “Any independent activity, with a profit-making intention, exercised on a permanent basis, which participates in the general economy, when said activity is neither a forestry activity nor an independent professional activity". For cryptomining companies, such qualification is rather straightforward since all income generated by a commercial company is deemed commercial in nature and taxed in this category. The distinction therefore concerns other types of entities and individuals involved in cryptocurrency transactions. In more general terms, in order to differentiate a commercial activity from a private wealth management activity, the circular contains illustrative criteria that may be used as evidence of the existence of a commercial activity, e.g. having premises used for managing cryptocurrencies using borrowed funds, the frequency of transactions/inventories involving cryptocurrencies, the management of business activities on behalf of third parties, etc. If the income is considered “commercial profit”, the net income (i.e. less related expenses) is taxable at the progressive income tax rate. Municipal business tax should also apply if the commercial enterprise is located in Luxembourg.
Other income: If income is not “commercial profit” (based on the definition in Article 14 ITL), then the income should be considered “other income”, which includes capital gains. Said income can therefore be considered a capital gain, as defined by Article 99/99bis ITL. Accordingly, the gain derived from the disposal (exchange, transfer or sale) of a cryptocurrency is not taxable when the latter has been held for more than six months. If it is not the case, the gain is taxable at progressive income tax rates (up to 45.78%, plus 1.4% dependency contribution) for the gain exceeding EUR 500. The circular also states that the exchange of a cryptocurrency against another one or the purchase of goods or services with cryptocurrencies should be regarded as a transfer for consideration of the asset given in exchange, followed by the acquisition of the asset received in exchange at fair market value. In order to be able to demonstrate the length of the holding period during which the cryptocurrency was held, the taxpayer should have adequate supporting documentation to provide proof of the acquisition date and the related expenses incurred. For short-term taxable gains, since it may be difficult to determine the acquisition price of the asset in the event of multiple acquisitions, the weighted average cost method shall be used to determine the acquisition price (excluding the "first-in, first-out" or "last-in, first-out" methods).
In both cases (commercial profit or other income), the income derived should be determined based on the exchange rates of the day during which the gain/expense occurs.
VAT: In June 2018, the Luxembourg VAT authorities published Circular No 787, stating that the VAT exemption applicable to transactions (including negotiation) concerning currency used as legal tender was extended to virtual currencies (e.g. Bitcoin), to the extent that they are regarded as a method of payment and are accepted for this purpose by some operators. That position was taken following the judgment regarding Skatteverket v David Hedqvist (Case C-264/14) of 22 October 2015.
In conclusion, Luxembourg’s direct tax authority (Administration des contributions directes) and indirect tax authority (Administration de l'enregistrement et des domaines) have taken a step in the right direction to provide more clarity regarding the tax treatment of cryptocurrencies. In doing so, they have referred to existing concepts and tax frameworks, e.g. qualifying cryptocurrencies as any intangible asset, not as a true currency, for direct tax purposes. In that sense, Luxembourg has not yet defined cryptocurrencies as a new type of asset that is considerably different from other assets, thus adopting a careful and conservative approach.
Tax Partner, PwC Luxembourg
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Partner, PwC Luxembourg
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Director, PwC Luxembourg
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