In the last couple of years virtual currencies become more popular. Recently we can see that more and also well established businesses are accepting this as payment method every day, e.g. Dell, Overstock.com or Expedia – just to name a few completely different businesses. We already posted some updates on virtual currencies (here, here , here and here). In this update we focus on bitcoin, being one of the most widely known virtual currency and the VAT questions it has already triggered.
What is this and how it works?
Bitcoins and other virtual currencies are also referred to as crypto-currencies. It refers to the sophisticated cryptographic methods attached to its use and transfer and not to the cryptic circumstances how it was born. It seems to be a common understanding among commentators that Bitcoin with a capital “B” refers to the software and the peer-to-peer network that facilitates the proof and transfer of bitcoins (with a lower case “b” or “BTC”), which is the currency unit itself. Bitcoin is based on the protocol published in 2008 under the name of Satoshi Nakamoto. Nakamoto’s identity remains unclear and whether it refers to a person or a group of persons.
The protocol maximizes the number of bitcoins in 21 million units which is expected to be reached by around 2040. BTCs are created by ”miners” who / whose computers are required to solve and proof complex mathematical calculations. The formula to solve and the software are available for all to download and to start mining. In order to prevent double spending of bitcoins, the transactions during a certain period are collected by the network into “blocks”, which are then added to the block chain. This is the public general ledger of Bitcoin which allows tracking and identifying any transactions made. The miners’ task is to approve these blocks by creating a “hash” which is stored with the block. To generate the hash for any new blocks, the hash of the previous block must also be used. In addition the protocol requires “proof of work”, i.e. the hash must contain some further specific information and must look in a certain way, which makes the block chain a robust and transparent ledger. Every time when a miner creates a new hash, he gets rewarded with 25 bitcoins.
The 21 million cap on the number of bitcoins makes it more difficult to create new ones, therefore more powerful hardware capacity must be accumulated, which are also pooled by miners.
Storage and Payment
If you are not a miner, you can buy bitcoins on one of the specialized exchange sites on the Internet or in one of the bitcoin ATMs, even though the latter is not wide spread (yet). Your bitcoins are then stored in a virtual wallet, which have the same function as real wallets or bank accounts.
In the wallet there are “public keys”, that are anonymous addresses to which bitcoins can be sent. For a payment to make, bitcoins are sent from your wallet to the recipient’s bitcoin address and signed by the “private key” of the sender. If wished, bitcoins can be converted into real currencies by using on-line bitcoin exchanges.
Some main pros and cons
What are the main benefits? For example, lower transaction fees compared with e.g. credit cards. Also, it is a peer-to-peer network without the need of having a trusted third party for processing and verifying payments. In practice this is the payment system and currency of the Internet community, which is not backed by any (central) banks or physical assets.
This also leads to the extreme volatility of bitcoins’ value, while its anonymity often mentioned to be a good ground for money laundering. Anyhow, even critics who are doubtful of the longevity and sustainability of bitcoin as virtual currency, still tend to appreciate that Bitcoin as payment system can succeed and can fundamentally change electronic payment methods as we now know them.
What does it mean for VAT
Considering the above basics of how Bitcoin works and bitcoins can be used, the following VAT / indirect tax questions arise:
As mentioned above, when a new block is created by the requisite unique identification process and verification by the network, the miner gets rewarded by 25 bitcoins. In this regard there is no contractual relationship with the miner and there is not supply for consideration for VAT purposes when the reward is granted. Therefore, at least in an EU VAT context, there does not seem to be a supply for VAT purposes.
- Paying with / accepting bitcoins
In relation to paying with bitcoins it should be clarified if bitcoins are similar to money, and as such it would be outside the scope of VAT. Or it can be regarded as payment in kind, which would be subject to VAT as a barter transaction. Even within the EU there are countries which go for one or for the other interpretation.
Accepting bitcoins as payment triggers the question how should the exact value of the transaction be established on which VAT is due. The conversion of currencies for VAT purposes is generally linked to central banks’ official fx rates. However as bitcoin is not backed by any such institutions and are only traded on specialized on-line exchanges, an officially accepted valuation method should be determined.
- Exchange / conversion of bitcoins
The questions to be considered here are minimum twofold: 1) is VAT due on the bitcoin value being exchanged for fiat currencies and 2) is VAT due on any additional exchange fees or would it be an exempt transaction.
In a recent Swedish referral to the CJEU (C-264/14) the court is asked whether the “transactions in the form of what has been designated as the exchange of virtual currency for traditional currency and vice versa, which is effected for consideration added by the supplier when the exchange rates are determined, constitute the supply of a service effected for consideration” and if so, it is exempt from VAT (in accordance with the EU VAT Directive).
The CJEU’s decision will help to clarify certain questions, at least in an EU context where does not seem to be an agreement to the VAT treatment of bitcoins and related transactions.
Some countries outside the EU also try dealing with the (indirect) tax implications of bitcoins. This article does not allow us to summarize the latest & current positions in this regard, but we will keep you posted on the developments.