With the global crackdown on foreign asset reporting and the growing use of virtual currencies for illegal activities, governments are expending significant resources to identify users and ensure compliance with reporting requirements. The US Internal Revenue Service (IRS) is battling against online digital currency platform Coinbase1 to obtain the identities of users of convertible virtual currencies (CVCs) such as Bitcoin.2,3 This battle is being closely watched around the world as it touches on a number of hot issues, such as the privacy of Bitcoin holder accounts, the worldwide income taxation of CVCs and the international reporting of CVCs.

The court case comes at a time when governments worldwide are focusing on identifying and taxing the foreign financial assets of their tax residents. More than 100 countries recently signed up to the Common Reporting Standard (CRS), agreeing to share information on the financial assets held in their country by residents of other countries.

Key challenges

When it comes to foreign asset reporting, CVCs such as Bitcoin pose two key challenges. First, CVC users are largely anonymous. They tend to value the privacy offered by CVCs , and governments are not currently able to uncover their identities. Second, countries disagree on how to define CVCs for income tax purposes – either as true currency or as personal property.

Governments are gradually making headway on anonymity. They are using court cases and actions to compel companies to reveal the identity of CVC owners. If these initial cases succeed, it will give governments access to information (such as evidence of improper reporting of taxable income from CVCs) that would allow them to make a stronger case for obtaining users’ identities.4 The categorization of CVCs as currency or property may seem inconsequential, but it could result in major tax headaches for CVC owners who are taxed in multiple jurisdictions.

Cross-border differences

Only recently have individual countries started to define CVCs and clarify their tax treatment in country. They have not yet reached a point where they can update their bilateral tax treaties. Without agreement on the nature of CVCs or guidance from treaties, countries may reach differing conclusions on:

  • which country has the primary right to tax the income
  • whether an income realization event has occurred and the timing of that event
  • the type of income generated from the CVCs
  • how the CVCs should be valued
  • the cost basis of property purchased with CVCs
  • how to determine the fair market value of the CVCs when a realization event occurs.

In all these cases, CVC users risk double taxation without the opportunity for relief.

Although CVC users may be tempted to hide behind the anonymity they offer, they do so at their own peril as governments intensify identification efforts. Users should be very conservative in their approach to informational reporting and taxation. They should also seek the advice of a competent tax adviser if they want to use CVCs as part of a complex planning structure.

For more information, contact:

Mishkin Santa
The Wolf Group, PC, US
T: +1 703 652 1720
E: msanta@thewolfgroup.com
W: www.thewolfgroup.com

1 https://www.coinbase.com/?locale=en-US
2 https://www.justice.gov/opa/pr/court-authorizes-service-john-doe-summons-seeking-identities-ustaxpayers-who-have-used
3 https://www.forbes.com/sites/kellyphillipserb/2017/09/05/irs-responds-to-privacy-other-challenges-inbitcoin-records-fight/#4738dfdb65aa