Naysayers have been waiting for the bitcoin bubble to burst. Instead, bitcoin, a decentralised cryptocurrency, has over the years grown value and gained fame. Policy makers and central banks are grappling to offer clarity on the place of bitcoins in the financial system.
However, little attention has been paid to tax consequences in mining and trading in bitcoins.
Lack of taxation guidance and enforcement will lead to non-taxation of cryptocurrencies, eventually distorting competition, and causing noncompliance by the taxpayers and revenue loss by the country.
The Kenya Revenue Authority (KRA) is yet to issue any guidance. The assumption is that taxpayers who mine and trade in bitcoins in the country are subject to the general taxation rules.
Trading in bitcoins involves transferring them from computer to computer through a system of cryptographic hashes and keeping them secure through public-private key cryptography.
Users store their coins in a “wallet,” this being software installed on their computer or a web-based account. Mining bitcoins involves generating new coins by computers called “bitcoin miners” through solving complicated algorithms.
Before investigating the tax implications, there is need to clarify whether, in the Kenyan setting, bitcoin may be regarded as money or commodity. In economic sense, money must serve as a medium of exchange, unit of account and measurement, and store of value.
Even though bitcoin may act as a medium of exchange, it can barely serve as store of value due to its volatility. It can barely be a unit of account as the value must first be translated into a traditional currency. In the legal sense, money must have legal tender status, issued and managed by a central bank, and physical characteristics as either coins or banknotes.
Bitcoin does not fulfil the criteria of money in both economic and legal sense. It can therefore be viewed as an asset or commodity, even for purposes of taxation. In view of the bitcoin business model, the main tax consequences would be the income taxes and the value added tax (VAT).
Income tax is imposed on persons who have earned taxable income for a relevant tax period. It is charged from, among others, gains or profits from business and from gains resulting from transfer of property.
In regard to transacting in bitcoins, the question is whether such is a business activity giving rise to business income, hence income tax, or it is a transfer of property that would merely give rise to gains subject to capital gains tax (CGT).
Whether dealing in bitcoins results in a business income or capital gain will be determined by the ‘badges of trade” tests. When a person stores Bitcoins for a long period waiting for their appreciation before disposing of them may only be subject to CGT on accrued gain.
On other hand, traders whose business involves speculating in bitcoins through buying and selling may be deemed to be engaging in a business activity, subjecting them to normal income tax.
The Kenyan Income Tax Act does not recognise virtual assets such as bitcoins. In such a case, an aggrieved taxpayer not intending to pay tax on gains emanating from bitcoins could move to the tax tribunal to challenge such taxation, on the established ground that tax should be levied on established statutory rules rather than on intendment.
This therefore originates a case for law reform. There is need to clearly define virtual assets in the Income Tax Act. Further, due to volatility of bitcoins, it is important to designate income resulting from trading in them as a specific source of income.
This will ensure risk-taking currency speculators do not incur huge losses and offset such losses from their general incomes, depriving the country of revenues.
Other issues that would benefit from statutory clarity are virtue income characterisation, allowable deductions resulting from mining activities, valuation and income computation, and records to be kept.
The other taxation issue results from the sale of goods and services for bitcoins. Having established Bitcoin as a commodity rather than money, such sale will therefore constitute a barter trade.
For purposes of taxation, in transactions where consideration does not involve monetary amounts, the determination of value of the exchanged objects is the market value, this being the amount an asset could be exchanged between knowledgeable individuals at arm’s length.
Trading in bitcoins may also have VAT consequences. In this case, supplies of bitcoins may constitute taxable supplies. However, since bitcoin does not have the status of a legal tender, the exemption available for financial services could be dis-applied. It may therefore be treated as supply of electronic services, which attracts VAT at a normal rate.
Elsewhere, in the United Kingdom, Her Majesty’s Revenue and Customs (HMRC) issued a brief in 2014 on taxation of Bitcoins, clarifying that such income is subject to the general rules of income tax and capital gains tax. For VAT purposes, the HMRC brief outlined that mining is outside the VAT scope.
Further, exchanges of Bitcoins into traditional currencies are VAT-exempt. Supplies of goods and services for bitcoins are subject to general VAT rules. If the KRA were to issue such a brief, there is a likelihood it would adopt the position taken by HMRC.
Still, it will be challenging to enforce tax on trading in Bitcoins. The reality is transactions take place anonymously and usually in a multijurisdictional setting. There is no paper trail from which to conduct a tax audit.
Although the entire history of Bitcoin transactions is publicly available, it is extremely difficult to trace the earnings accumulated in a particular wallet back to a particular taxpayer.
It is unlikely that tax authorities would know about the income, unless the taxpayer volunteers it.
Gatuyu is an Advocate of the High Court of Kenya. @gatuyu