Over the past years, there has been a growing interest in cryptocurrencies, mainly driven by Bitcoin’s, the first and most important cryptocurrency, impressive performance. However, very little is known today about who really owns cryptocurrencies, their capital gains and how they are distributed.
Cryptocurrency has, thus, put pressure on the existing tax rules, feeding concerns that, due to the increasing use of digital technology, its profits may, most likely, be falling outside the compass of the established tax framework. This is undoubtedly a complex issue, in constant evolution along with the technology that supports it, that raises many doubts about its treatment in Portugal. In fact, the lack of centralised control over cryptocurrency, its anonymity, valuation difficulties, volatility, difficulties in identifying the taxable event and in locating transactions, pose a challenge to tax authorities and raise important policy questions – namely in what regards the Personal Income Tax (“PIT”)[I].
First things first
One of the fundamental questions that must be answered before considering tax aspects of cryptocurrency concerns its nature and classification. The answer to this question will obviously have implications on how it will be treated in fiscal terms, namely whether it will fall within an existing category of income, and therefore be taxed in the usually way for that form of income, or not.
Generically, cryptocurrencies are not considered fiat currency, as they do not simultaneously fulfil the three functions that characterise a legal tender: (i) store of value, (ii) unit of account and (iii) means of payment/ exchange. On top of it, they are neither issued nor guaranteed by a central bank or public authority. There are also doubts as to whether cryptocurrencies can be classified as financial assets as they are neither equity nor do they give rise to contractual rights for its holder to receive cash or to exchange financial assets of financial liabilities with another entity. Moreover, at least in Portugal, given the definition and exemplification that is made of securities in the PIT Code and the Portuguese Securities Code, it does not seem possible for the current definition of securities to cover cryptocurrencies.
In light of the above, it seems cryptocurrency could only be regarded as an asset (property) in kind – they can have an equity correspondence convertible into a pecuniary amount – as the owner can use it in any way he sees fit. This is similar to ownership of assets where the owner can sell or use his asset at his own discretion. However, even this qualification raises doubts since, sometimes, crypto-assets can have characteristics that enable their use for more than one purpose at any single point of their lifetime and some have characteristics that change during the course of their lifetime as well.
Another fundamental question that should be looked into is how can taxable events be identified and transactions located. Obviously, in a globalized world, the absence of a coordinated exchange of information on cryptocurrency related income among countries makes it rather difficult for a single tax authority to assess if the taxable income derived from owning cryptocurrencies is correctly reported by a taxpayer. However, the envisaged update of the Directive on Administrative Cooperation (DAC) with the expansion of its scope, laying down new rules on reporting and exchange of information for tax purposes on crypto assets, may help on this in the near future.
Where we stand
In Portugal, there is still no specific legal provision addressing the tax treatment of cryptocurrency. Despite the doubts that still exist surrounding the nature of cryptocurrencies and the tax treatment that should be given to them, the Portuguese Tax Authority has already been called to address specifically the possible framework of the income obtained with the exchange of cryptocurrency for fiat currency, namely whether it could fall within an existing PIT category of income and taxed accordingly.
Shortly, according to the first binding information issued by the Portuguese Tax Authority on this subject[ii], unless the taxpayer develops a professional or business activity of investment in cryptocurrency (“Category B” of PIT Code, self-employment income), no taxation shall be due on income relating to the exchange of cryptocurrencies, meaning its purchase or sale.
In fact, together with other features that should be met in order for a certain income to be considered earned through the exercise of a professional or business activity, like the “habituality” of the activity as a way of life and the achievement of a profitable purpose, it should be highlighted that “Category B” taxes income based on the exercise of an activity and not according to the source or nature of the income, unlike the other categories.
Considering the Portuguese tax framework, the Portuguese Tax Authority could hardly have reached a different conclusion, namely its framing under Category E (investment income) or Category G (capital gains) of the PIT Code.
Where to go next
The decision to tax or not cryptocurrencies is a tax policy decision with technical implications that would have to be addressed.
Firstly, the identification of the relevant taxable events. The following activities[i] can be key taxable events related to cryptocurrency, hence relevant under the Portuguese PIT[ii]: (i) the mining of cryptocurrency; (ii) exchanges of any goods or services for cryptocurrency; and (iii) exchanges of cryptocurrency for fiat currency.
i) Mining cryptocurrencies
Cryptocurrency miners seem to provide a service (solving cryptographic algorithms to verify cryptocurrency transactions) in exchange for newly-created cryptocurrency. However, not every mining effort is rewarded with the creation of cryptocurrency. As there are more and more users and cryptocurrency in circulation, it becomes more difficult to mine. For this reason, some literature has seen mining activity as similar to a game of chance or a lottery, especially if performed as a hobby, which has no place under PIT. Following this understanding, it could be considered, for example, to treat the income derived from mining under the Stamp Duty Tax, since it is a tax levied on similar realities linked to the game of chance or a lottery (e.g. bingo prizes, raffles, lottery, and other contests).
However, currently, we can observe a soaring mining market concentration. Nowadays, it has become very challenging to mine cryptocurrency on home computers and casual miners have to give way to professional ones. Miners with more powerful equipment (e.g., server farms) can almost be certain to solve cryptographic algorithms and generate new cryptocurrency. For professional miners, the outcome of mining can be influenced and is not as unpredictable as that of lotteries. In this case, the income derived from mining can fall within the definition of Category B. Therefore, the costs incurred with the mining process (e.g. energy) could also be deducted.
It would also be important to define which event could give rise to a taxable event when mining cryptocurrencies, whether it is the receipt of newly mined tokens or when the miner first exchanges, or otherwise disposes, of the cryptocurrency.
ii) Exchanges of any goods or services for cryptocurrency
Exchanges of any goods or services for cryptocurrency may result in a taxable income and represent barter transactions where income is received in the form of a benefit in kind. The receipt of cryptocurrency as payment for goods or services would not change the underlying tax treatment that would have been applied had the purchase been made in fiat currency, most likely, Category B. In transactions where the consideration does not involve fiat currency but benefits in kind, the determination of value becomes essential. Market value is the basic valuation standard for it. However, given the cryptocurrency characteristics addressed, defining its market value can be a challenge of its own.
iii) Exchanges of cryptocurrency for fiat currency
The only activity likely to be a taxable event related to cryptocurrency already addressed by the Portuguese Tax Authority is cryptocurrency exchange for fiat currency. As referred, the income obtained from the sale of cryptocurrencies is not taxed in Portugal, as long as it is not obtained in the context of a professional or business activity developed by the taxpayer (Category B). However, this activity can also be carried out in a non-professional manner, by hobbyists or small investors, which is currently not subject to taxation.
Since it has been used as an option for investors seeking high return, and given the soaring value of cryptocurrencies, despite its high volatility, it is understandable the temptation to fit it in the definition of securities. We already know how unsuccessful this road might be. Not only because cryptocurrencies do not fall within the different types of securities described under the PIT Code (Category G) or in the Portuguese Securities Code, but also because, even if we wanted to stretch the compass of securities resorting to “Other titles representing similar legal situations provided they are market tradeable” (Portuguese Securities Code, article 1), we would hardly find a parallel with the characteristics commonly accepted as characterizing securities.
Therefore, the only way to consider a cryptocurrency as securities would be to change the law accordingly. But not only would that be artificial – as, as we have just mentioned, cryptocurrencies do not seem to share the generality of the characteristics associated with the typified securities –, it could also raise problems in terms of compatibility with EU law, which is also evolving on this subject.
So, to conclude, if a decision is made to tax cryptocurrencies, rather than trying to encompass it in the current PIT categories perhaps the best would be to create an “ad hoc” regime that encompasses not only cryptocurrencies but also other instruments (e.g. NFTs) from this new and challenging Distributed Ledger Technology without considering, for example, their fungible or non-fungible nature, flexible enough to cover possible evolution or new instruments.
As seen, the tax handling of cryptocurrency from a Personal Income Tax perspective is highly challenging and interesting. This debate is in its early stages but already facing practical implications and grappling with an ever evolving reality, with several issues from a domestic perspective being identified. In any case, the globalized nature of cryptocurrencies, and crypto assets in general, also calls for a wider debate on tax approaches to this reality.
—————
[i] Taxable events related to cryptocurrency can also be tied to other taxes like Corporate Income Tax, VAT or Stump Duty.
[ii] Processo n.º 5717/2015, Despacho de 27-12-2016, da Subdiretora Geral do IR, available at https://info.portaldasfinancas.gov.pt/pt/informacao_fiscal/informacoes_vinculativas/rendimento/cirs/Documents/PIV_09541.pdf
[i] Distinct from the situation where a taxpayer receives salaries, fees, dividends, interest, rents, the payment of the sale of shares or houses, or pensions in cryptocurency, which should be considered as payments in kind and taxed in relation to each 6 categories of the Portuguese Personal Income Tax.
[ii] These activities can have a VAT dimension, which it will be touched upon in another occasion.