Context and decision
In recent years, it has become increasingly clear that Bitcoin has missed the intentional goal initially established by its creator: to become a common means of payment that would speed up the transfer of money globally. In effect, what has become evident in most cases is that the transactions underlying a transfer of cryptocurrency are a pure sale or purchase of the cryptocurrency itself (typically, exchanges between different cryptocurrencies or exchanges of cryptocurrency for and to legal tender currencies) and not the purchase of a specific good or service with the cryptocurrency being the remuneration. Moreover, there is a growing feeling that Bitcoin is increasingly used with a speculative purpose, thus as an investment. While Bitcoin is the most well-known cryptocurrency, the foregoing also applies to other cryptocurrencies created with the same purpose: being a means of payment.
The use of cryptocurrencies raises many questions regarding taxation, particularly challenging being the case of the Value Added Tax (VAT) given its harmonization with the VAT Directive of 2006[1] that codifies the VAT regime in EU Member States. This makes the treatment of VAT on cryptocurrencies more complex.
The VAT treatment of Bitcoin, specifically, has been discussed by the VAT Committee of the European Commission in three formal meetings that took place in 2014, 2015 and 2016, which has resulted in the issuing of working papers No 811, No 854 and N892. However, the VAT Committee has only an advisory role for the application of the VAT Directive and no legislative powers, so it could not solve the considerable degree of uncertainty around cryptocurrencies nor enhanced the VAT framework underlying it. In fact, it is the Court of Justice of the European Union (CJEU) who has the last word on the interpretation of EU VAT law, having jurisdiction to give preliminary rulings. In the absence of specific rules in the VAT Directive for this issue, the possibility of applying the existing rules to this reality lies on the sole effort of the CJEU. This is why the judgement in the case C-264/14 Hedqvist was such a landmark. For the first time, the CJEU addressed the VAT treatment of transactions concerning the exchange of Bitcoin for traditional currencies and vice-versa.
In the Headqvist’s case, the Swedish Supreme Administrative Court decided to stay the proceedings and refer the following questions to the Court of Justice for a preliminary ruling:
- Is the transaction subject to VAT pursuant to Article 2(1) of the VAT Directive?
- If so, does the transaction fall within the scope of one of the exemptions for financial services provided for under Article 135(1) of the VAT Directive?
The CJEU, in 2015, decided that exchange transactions, such as those at issue in the main proceedings, constitute the supply of services for consideration within the meaning of Article 2(1), but they are exempt from VAT within the meaning of Article 135(1)(e).
Long story short, regarding the first question, the CJEU justified its position by considering that currencies used as legal tender have no other practical use than as a means of payment, thus their function in a transaction is to facilitate trade in goods. As such, they are not consumed or used as goods. Therefore, their transfer as such does not constitute a chargeable event. On the other hand, the Court concluded that what applies for legal tender should also apply for the other means of payment with no other use than to serve as such, like Bitcoin in Court’s interpretation. However, and here lies the tipping point, as Mr Headqvist planned to buy and sell bitcoins for Swedish Crowns at a price that would include a mark-up on the exchange rate on a particular exchange platform, his activity included the supply of services for consideration in accordance with Article 2(1)(c) of the VAT Directive in the form of the exchange.
Regarding the second question, the CJEU held that Article 135(1)(e) of the VAT Directive also covers transactions involving Bitcoin by classifying Bitcoin as a means of payment, just like legal tender, and its trade as financial transactions within the meaning of this provision by relying on their supposed function and objective – alleviate the difficulties linked to the calculation of the taxable amount in the field of financial transactions. The Court has considered the former to be financial transactions (which may face those same difficulties) in so far as those currencies have been accepted by the parties to a transaction as an alternative to legal tender since they have no other purpose than to be used as a means of payment accepted as such by certain operators.
Being the first of its kind, this decision has been followed by several Member States’ Tax Authorities on how to determine the correct VAT treatment of trading Bitcoin and other cryptocurrencies. The Portuguese Tax Authority is no exception, having issued several binding informations on the VAT treatment of crypto-assets. In 2018, it took the view that as long as a “utility token” serves as a means of payment, its sale must be exempt in line with the national provision[2] corresponding to Article 135(1)(e) of the VAT Directive[3]. In 2019, the Tax Authority confirmed that the same exemption would be applicable to exchanging cryptocurrencies for legal tender and vice-versa[4]. Afterwards, it ruled that the very same exemption corresponding to Article 135(1)(e) of the VAT Directive could also be applied to crypto-mining activities[5].
Houston, we might have a problem
If the application of Article 2 of the VAT Directive to the present case does not merit discussion, the same cannot be said with regard to Article 135(1)(e), especially given the use that has been made of Bitcoin.
At the core of the reasoning developed by the CJEU are three premises which, however, are open to debate. Firstly, Bitcoin was comparable to legal tender because it was accepted as a means of payment by those who used it and did not serve any other purpose than that, hence should be treated as a financial transaction. Secondly, the wording of the exemption envisaged in Article 135(1)(e) in the different language versions of the Directive is not sufficiently precise to determine whether the provision applies only to legal tenders. Thirdly, due to the lack of clarity deriving from the different versions, the context in which the exemption is used and the aims and scheme of the VAT Directive had to be considered.
The first criticism that can be pointed out to the CJEU decision is that Bitcoin, like other cryptocurrencies, was not and has not been used exclusively as a means of payment, but instead as a speculative asset, being acquired by users as a possible store of value to be sold at a later stage. Obviously, this raises questions about whether the exemption contained in Article 135(1)(e) could be extended to Bitcoin or other similar cryptocurrencies as they are not only used as a means of payment. This, of course, could require a case-by-case evaluation. It can be argued that also foreign currencies transactions, for example, can have a speculative purpose. However, the main purpose of foreign legal tender is still to be used as a means of payment. The same cannot be said for Bitcoin, whose purpose, especially in recent years, appears, at least, distorted. Contrarily to Bitcoin, legal tender currency has three fundamental characteristics: (i) store of value, (ii) unit of account and (iii) means of payment/ exchange. On top of it, domestic or foreign, their fiat nature is guaranteed by a central bank or public authority and have an exchange reference rate, which are the ones referred to in Article 91(2). The main point here, showing how the decision of CJEU may be outdated is that, in the case of Bitcoin, the speculative purpose seemed to have taken over the means of payment function. This reality makes it hard to justify the application of the exemption envisaged in Article 135(1)(e). That doesn’t mean that a transaction like this would not be exempt at all, though. Following the steps of the VAT Committee working paper No 892, bitcoins and cryptocurrencies could be classified as negotiable instruments, probably falling in the scope of Article 135(1)(d). It is noteworthy that the reasoning contained in the Court’s decision keeps being relevant in the case of cryptocurrencies which are pure means of payment.
The second criticism is linked to the assumption made by the CJEU that the various language versions of the provisions do not allow to determine without ambiguity whether the exemption covers only traditional currencies (i.e. currencies used as legal tender) or also other currencies, which has been referred to by the CJEU as justification to sustain that no strict interpretation shall be applied in the case of the exemption of Article 135(1)(e). It is true that by the time the VAT Directive was approved, the cryptocurrencies were not a reality. However, we cannot ignore the clear use of “legal tender” in the Article. It is also true that depending on the version of the VAT Directive (CJEU compares the English, German, Finish and Italian versions), the word “currency” could mean “currency”, in the “singular”, or “currencies, in the “plural” form. For example, and in accordance with the opinion of the Advocate General, the word “currency” used in its singular version is to be understood that only one legal tender is needed in the transaction for it to be exempt. This would mean that a transaction involving two cryptocurrencies would not be exempt, which would entail a different treatment of similar situations, with an impact on the neutrality of the system.
However, in this exercise of comparing language versions, the Court did not take into consideration many other versions, namely those from countries which were the Member States at the time of the adoption of the sixth Directive (1977): France, Spain, the Netherlands and Denmark[1]. On the Directive dating from 1977, all the official languages were clearly referring solely to legal tender. Moreover, the exact same wording was used also in the updated version of the sixth VAT Directive adopted in 2006 (cryptocurrency was first described in 1998), and has remained the same from that moment on. Taking into consideration the evolution of the Directive, it seems clear that the intention from the EU legislator was that the scope of the exemption on currencies’ exchange should be limited to legal tenders. The CJEU seems to have seen ambiguity where there was none. Based on a fragile argument and assumption, the Court disregarded the wording and reasoning of Article 135(1)(e) and sought to make an extensive interpretation of it by encompassing a reality that, in its opinion, was comparable to the idea of legal tender currency. However, it seems difficult to understand why the CJEU did not explore the reasoning behind the legislator’s decision to use specifically the concept of “legal tender” and did not include currencies different from the ones that had legal tender status.
All things considered, and despite the Court’s best intentions, its decision apparently expands the effects of Article 135 (1)(e) beyond the purpose considered by the EU Legislator.
Given the supposed ambiguity caused by the different language versions, and in order to overcome it, the third criticism is linked to the Court’s interpretation that the application of Article 135 must be consistent with the objectives pursued by the exemption and comply with the requirements of the principle of fiscal neutrality inherent to the common system of VAT, not depriving the exemption of its effects. By moving away from the wording of the Article, focusing on the purpose of the exemption and Bitcoin, the Court applied a “substance-over-form” analysis preserving the neutrality of the system. By doing so, it is fair to say that the Court tried to demonstrate that VAT law could be flexible enough to adapt to new business models and ever-evolving technologies that could not be foreseen by the legislator at the time of the adoption of the law. However, this approach is not watertight. As highlighted by the CJEU, the purpose behind this exemption is to alleviate the difficulties connected with determining the taxable amount and the amount of VAT deductible which arise in the context of the taxation of financial transactions. The Court’s decision stemmed from the assumption that Bitcoin can be compared to legal tender, and the trades involving it are treated as financial transactions. Questioning the comparison between Bitcoin and legal tender, since the former, as highlighted before, has other purposes than to be only a means of payment, means that this reasoning falls apart. On top of that, it would be interesting to understand whether these so called “difficulties connected with determining the taxable amount” still persist or if it is just a remnant from old days that must be confronted
Conclusion
Based on the Hedqvist decision, it seems that trading bitcoins constitutes a supply of a service exempt under VAT. Even if it is considered counterintuitive, cryptocurrencies cannot be equated to legal tender, which would entail that crypto exchange platforms should be treated differently than legal tender exchange businesses. There appears to be no clear evidence that they are commonly used as a means of payment, hence comparable to legal tender. On the contrary, it seems evident that bitcoins, and similar cryptocurrencies, are being mined and traded primarily for speculative purposes. Having said this, since the Hedqvist case, the landscape on cryptocurrencies, and crypto-assets in general, have profoundly evolved. So, at that time it was taken, perhaps the decision of the CJEU could not be different. However, today, the decision seems outdated and based on premises that are hardly verifiable.
For these reasons, and following the Court’s line of thought, the effects of the Hedqvist case seem to be limited nowadays to transactions involving just cryptocurrencies with the sole purpose of being means of payment. Therefore, no other transaction involving any other type of cryptocurrencies should be exempt from VAT. One thing seems to be clear, despite the amendments already made since its restructuring in 2006, the VAT Directive will have to evolve to face new challenges, namely the ones related to this kind of ever-evolving technology.
In this sense, it will be convenient to modernize the concepts included in the VAT Directive regarding the treatment of these new realities. The forthcoming Commission proposal to simplify and update the VAT rules for financial services might be a good opportunity to do so.
Gonçalo Grade
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[1] Council Directive 2006/112/EC of 28 November 2006 on the Common system of value added tax
[2] Article 9 (27) (d) of the Portuguese VAT Code
[3] Processo n.º 12904, Despacho de 2018-02-15, da Diretora de Serviços do IVA (por subdelegação)
[4] Processo n.º 14763, Despacho de 2019-01-28, da Diretora de Serviços do IVA (por subdelegação)
[5] Processo n.º 14436, Despacho de 2019-07-03, da Diretora de Serviços do IVA (por subdelegação)
[1] Avaiable at EUR-Lex – 31977L0388 – EN – EUR-Lex (europa.eu)