Personal Finance

Trading in bitcoins attracts income tax


Since cryptocurrencies are not recognized as legal currencies by the CBK, dealings with them may not be regarded as financial services. FILE PHOTO | NMG

Digital technology has emerged as one of the major disruptors in the 21st Century. This has been occasioned by the ubiquitous developments in information technology.

One of the major innovations that has hit the world by storm is cryptocurrencies. It is generally defined as a digital asset/currency that is used as a medium of exchange.

Bitcoin is the most popular virtual currency. In Kenya, these currencies are not recognised by Central Bank of Kenya (CBK) as a legal tender. This however, does not necessarily exclude them from taxation.

Currently, Kenyan tax law does not have a specific framework dealing with the taxation of cryptocurrencies.

That notwithstanding, income derived from dealing with these currencies fall within the scope of taxable income under the Income Tax Act.

The CBK has repeatedly warned the public against dealing with cryptocurrencies citing the lack of a regulatory framework. Could we thus deem this as income from illegal sources?

The lack of a regulatory framework or support from the CBK should not be construed to imply that dealing with cryptocurrencies is illegal. Granted, income derived from unregulated activities is still subject to tax in Kenya.

Mining cryptocurrencies has also become a familiar phenomenon. This is the process of generating new cryptocurrencies. The debate as to whether mining is an economic activity for VAT purposes has been rife world over.

This is because of the weak linkage between any services provided and any consideration received for it to qualify as an economic activity for VAT purposes.

Cryptocurrencies such as bitcoins can be obtained through mining or purchase. Mining is a system that allows computer users to calculate complex algorithms required to verify each transaction in the block chain and be rewarded with a cryptocurrency.

READ: Mucheru finally sells stake in Bitcoin dealing firm Bitpesa

Alternatively, the cryptocurrencies can be purchased in exchange for real world currencies such a dollars or euros. Bitcoin may be held as an investment or used to pay for goods or services at merchants where it is accepted.

Thus, mining and trading of a cryptocurrency is a business whose profits are subject to income tax. The miner would need to report the profits.

Expenses which are wholly and exclusively incurred in generating the income would be deductible for tax purposes.

Since cryptocurrencies are not recognized as legal currencies by the CBK, dealings with them may not be regarded as financial services.

If they are deemed as intangible assets would gains derived from the buying and selling of the cryptocurrencies be deemed to be of a capital or revenue in nature?

The virtual nature of cryptocurrencies operations has created loopholes which may lead to losses of tax revenue. The government should clearly address taxation of the digital economy in the new Income Tax Act.

Further, complementary tax legislation should be amended to incorporate taxation of the emerging digital technologies. With ambitious revenue collection targets, the tax authorities will eventually catch up with players in the digital economy.

Beth Muraya and Tonny Watuka, Tax specialists at EY