The Income Tax Ordinance stipulates the taxpayers obligations to report in their tax return whether they have taken a “reportable tax position”. The Tax Authority has added a position entitled “taxation of virtual currencies” to that list.
The Tax Authority indicates there that Bitcoin, Ethereum and others “virtual currencies” are defined as “assets” and therefore their sale is subject to capital gains taxes. In the same breath, however, the Tax Authority has indicated that if those sales reach “business” proportions they are subject to taxes imposed on all business income, that is – regular tax rates which at higher brackets may pass the 50% mark (including the surtax).
The Authority has further stated in the position that “virtual currency” “is not foreign currency and therefore an increase in its value is not to be considered ‘linkage differentials’ or ‘exchange rate differentials’ ” (the provisions of the Tax Ordinance stipulate that differentials of linkage or exchange rate are tax exempt by individuals).
Our office has been advising many clients in recent months on issues related to digital currencies;
questions that have come up regarding their taxation include the following:
selling of cryptocoins by someone who had purchased them previously.
selling of cryptocoins obtained by ‘mining’ (a computational operation for creating new cryptocoins).
selling by someone who obtained cryptocoins by exchange or by initial coin offering (ICO).
selling by someone who obtained cryptocoins in exchange for services or product sales.
selling of cryptocoins created by a split from an existing cryptocoin (such as Bitcoin Gold or Bitcoin Cash).
We will not analyze all the tax events presented above nor expand upon them; however, we will present the central points on the subject:
Classification of the sales as a “business” – The definition of income from a business (or from a “commercial nature” casual transaction) has been addressed in rulings many times over; in short – it suffices for a person to carry out a number of acquisitions and sales, and to participate in initial coin offerings (ICO), for example, in order for the Tax Authority to claim that the corresponding income derives from “a business”. The nebulous term “casual transaction” which is of a commercial nature will also drag along with it similar taxation – income classified as such is subject to full taxation! Our position is that the criteria that have been determined in previous rulings are not necessarily appropriate for the considering the definition of “business” with respect to virtual currencies.
“Virtual currency” may be claimed to be foreign currency! We would like to state here at the outset – the Tax Authority’s stubborn insistence on this matter stems from one main reason, and that is the exemption for individuals on exchange rate differential.
If not for that exemption, the Authority would not be so eager to claim that virtual currency is not considered foreign currency. We present several arguments supporting our claim that the issue at hand is actually foreign currency and exchange rate differentials:
The definition of foreign currency as indicated in the Bank of Israel Law referred to by the Authority as reinforcement for its position is not the only interpretation that may be applied, as there is no explicit reference to that law in the Income Tax Ordinance. Even if we use the definition as specified in the Bank of Israel Law, it is still clear that the term “banknotes or coins” does not only refer to “currency” in its physical form. “Physical” currency – banknotes or coins – are only a small percentage of the total aggregate of cash that exists; it also includes current accounts, bank deposits, etc. Although the dollar, the euro, and other known currencies do not fit the precise definition of “foreign currency” (banknotes or coins), there is no question that exchange rate differentials do accrue in a foreign currency deposit held at a bank.
If it’s used as currency and is accepted as currency – it’s currency – bitcoins along with the other digital currencies serve for all intents and purposes as currency. Hundreds of thousands of businesses worldwide provide products and services today in exchange for bitcoin. Digital currencies trading is extremely active – on the order of a billion dollars a day – both within the digital currencies and in exchange for regular currencies (“fiat currency”). Exchange rates for all of these currencies can easily be found in the financial media. These reasons and many more lead to the conclusion that digital currencies are in fact “currencies”. Many countries have recognized digital currency – bitcoin is recognized in Japan as a method of payment and nearly 300,000 business accept payment of this form; the German Federal Ministry of Finance has recognized bitcoin as a “unit of account” (“Der Spiegel, August 20, 2013); in Italy sale of bitcoin is classified as any other foreign currency business transaction with regard to VAT; virtual currency in Belarus has been granted legal status. Adoption of virtual currency as money by many countries, with currency based on blockchain technology (the technology at the basis of the bitcoin) to be issued by the central banks (including the Bank of Israel), seems to be just around the corner.
Tax settlements with the Tax Authority for clients engaging in virtual currency: A voluntary disclosure procedure (VDP) was published in December 2017 as a temporary order.
The procedure allows for anonymous submissions to the Tax Authority for one year only, during which time negotiations on tax liability take place.
The combination of VDP with the burgeoning market of digital currencies – which includes cash-outs, participation in trade and ICOs – is an excellent opportunity to settle cases that have thus far been “under the radar”.
In our experience, many clients are now finding themselves in a situation in which a small investment in Bitcoin several years ago has multiplied over the years – and must now be settled with the Authority.
In addition, we believe that the Authority will begin to actively hunt down those investors, similar to their aggressive efforts against unreported offshore bank account holders, by and large due to the completely transparent nature of blockchain technology which allows tracking of every past transaction.