The rise to the contentious prominence of crypto assets has been frenetic, and the pace of innovation involved remains dizzying. From zero in 2008, the market value of crypto assets peaked at around USD 3 trillion in November 2021 and from Bitcoin, introduced in 2009, has now sprung several thousand other cryptocurrencies. On some estimates, perhaps 2 per cent of the adult population in the US and 1 per cent of that in the UK hold or have held some crypto assets.
These developments need to be kept in some perspective. USD 3 trillion, for instance, was only around per cent of the global value of equities. But the power of developments in crypto assets to disrupt traditional ways of doing financial business, including tax collection, and their potential to do more, has been made clear.
Regulators face a daunting task in identifying and striking a balance between enabling innovation while securing financial stability and investor protection. For tax authorities, the first-order task is ultimately more mundane, if no easier and no less important: to encompass developments in the use of crypto assets into a well-functioning tax system. Though its importance will differ, that task will remain whatever the future holds for crypto: whether crypto withers or blossoms, the tax system still needs to deal with it.
Governments and multilateral organizations such as International Monetary Fund (IMF), World Bank (WB) etc., are assessing and evaluating the scope of regulations and establishing a legislative sphere to promote the use of cryptos securing the financial sphere. Amid this, the IMF published a paper to provide an overview of the issues that the emergence of and likely developments in crypto assets raise for tax design and implementation, with an eye to the implications for the taxation of the rich.
The paper mentioned that the natural principle to apply in approaching these design issues, externalities aside, for the moment, is that of neutrality: taxing cryptocurrencies in the same way as comparable traditional instruments. For miners, for example, there seems no reason to treat income from fees and the generation of new coins differently from other business income, unless some specific (dis)incentive is intended. Application of neutrality principles to the treatment of cryptocurrencies is made difficult, however, by their dual nature, as investment assets and as a medium of exchange.
The paper tried to establish the relation of cryptos with both income taxes and VAT/sales tax. It highlighted that there are two main ways in which cryptocurrencies might be classified for income tax purposes: as property (like shares, or bonds) or as (foreign) currency. The implications of the difference will depend on domestic rules but can be highly material. The most common approach appears to be to treat cryptocurrencies for income tax purposes as property and subject to the corresponding capital gains tax rules. It also underlined the holding of cryptocurrencies and gambling, with the apparent implication that it should be taxed.
It emphasizes the VAT treatment of the fees and newly minted cryptocurrencies received by miners also requires a clear policy stance. In principle, there seems no reason why, again except by way of creating a deliberate disincentive, these should not be fully liable to VAT, with a corresponding right to the credit of VAT charged on inputs. While that is generally recognized as good practice, in practice many VATs exempt fees for financial services.
The research paper also discussed the concern with cryptocurrencies and crypto assets. It mentioned that there is no doubt that their criminal use is extensive, It is also suggestive of the shadiness that has long surrounded crypto that there is a strong negative cross-country correlation between usage of Bitcoin and various indicators of institutional quality/control of corruption.
Specific areas of concern include both ‘traditional’ crimes—money laundering, trade in drugs and other illegal goods and services, financing of terrorism—and newer ones that draw on similar digital skills, including online frauds and ransomware attacks. Tax evasion is commonly included in this long list, but, perhaps unsurprisingly, often rather low down. And, indeed, it is easier to get at least some direct handle on the use of crypto for criminal activity in general than for tax evasion in particular.
The future of cryptocurrencies is highly uncertain. For some, they are a bubble that will sooner or later fully implode. To others, they will prove the foundation for fundamental innovations in decentralized finance. In either case, however, tax systems need to accommodate them with coherence, clarity, and effectiveness that, not have been constructed without crypto assets in mind. They need to do so, moreover, in the context of continuing rapid and complex innovation, based on limited information, and while balancing the core objectives of securing efficiency, fairness and revenue in taxation against the risk of stifling innovation
