Although the global cryptocurrency boom has been going on for several years, it’s a comparatively recent fad in Latvia. The press and other media are publishing articles about changes in the cryptocurrency market, about goods and services that we can at last pay for using Bitcoin, and about various risks associated with these investments. This article aims to offer a brief “introduction into cryptocurrencies” and to answer the question of how individuals are taxed on their cryptocurrency dealings in Latvia.
What is cryptocurrency
Cryptocurrency is a virtual currency that can be used as a means of exchange (payment) just like any national currency. However, unlike traditional currencies, a cryptocurrency is not issued or guaranteed by the central bank of any country. Cryptocurrency transactions are protected and controlled using cryptography. Bitcoin is considered the world’s first cryptocurrency, but it’s not the only one – there are some other more or less well-known cryptocurrencies available on the market.
The main advantages of cryptocurrency include its technological protection and the opportunity to trade in cryptocurrencies on the global market in a simple way and with low commissions. And the value of cryptocurrencies is not affected by inflation. As a result, the demand for various cryptocurrencies has increased considerably in recent years, and cryptocurrencies such as Bitcoin, Etherium and Litecoin have grown in value at an extraordinary pace. And the idea of cryptocurrency allows us to buy a percentage of its unit (e.g. 0.3% of 1 Bitcoin). So, since the value of various cryptocurrencies directly depends on the demand and supply dynamics, increasingly more users are investing in cryptocurrencies, thereby contributing to their value growth.
At the same time, if we step back from the overall excitement about this phenomenon, the cryptocurrency boom has created difficulties not only for the financial regulators around the world, who have even likened cryptocurrencies to the Wild West of the financial market, but also for the tax authorities, who need to find the answer to the question of how the global cryptocurrency boom could generate more tax revenues.
Although Latvian legislation is silent about cryptocurrency, several government agencies have stated their views on the proper treatment, or rather the lack of it.
The State Revenue Service’s current position is that from a financial accounting perspective, cryptocurrency should essentially be recognised as a product that can be used as a means of exchange if the parties agree on that. Similar views have been expressed by the Bank of Latvia, stating that cryptocurrency is a contractual, not statutory, means of payment that can be used in transactions of exchange. The Financial and Capital Market Commission also recognises that “Bitcoin and similar instruments cannot be considered an official currency or legal tender because the way these types of instruments can be issued and used remains unregulated and they are not linked to any national currency.”
So we can conclude that Latvia treats cryptocurrency as any product or service whose value needs to be measured in an officially recognised currency. Since there are various cryptocurrency markets based on supply and demand, this position offers advantages and restricts the users, for example, by not explaining the tax treatment of cryptocurrency dealings.
More difficulties stem from the unpredictable cryptocurrency fluctuations, which are dependent only on the demand for a particular cryptocurrency rather than on economic conditions in any country. We recently witnessed a rapid fall in Bitcoin value due to a large percentage of Bitcoin investors using a sell limit order, which provides for selling Bitcoin once its value reaches EUR 10,000. However, that fall was followed by a steep rise in Bitcoin value: over the last four months the value of 1 Bitcoin has quadrupled from USD 3,686 on 15 September 2017 to USD 15,952 on 5 January 2018.
Early steps in the European Union
While there is still no consensus on the regulation of cryptocurrencies at EU level, the Court of Justice of the European Union (CJEU) stated in its ruling of 22 October 2015 on the case Skatteverket vs David Hedqvist that Bitcoin is neither a security that grants ownership to legal entities nor any similar security. The purpose of Bitcoin is to be a means of payment. In the court case the CJEU emphasised that transactions which involve exchanging traditional currencies for Bitcoin units and vice versa should be exempt from VAT. So the CJEU recognised that Bitcoin with its goal to be a means of payment can be treated as a currency being used as a means of payment.
Since Latvia is bound by CJEU rulings, it’s important to note that the VAT Act should be interpreted in a way that recognises cryptocurrency units as a means of payment, and dealings in cryptocurrency units should be exempt from VAT.
The European Commission has also issued an opinion indicating, among other things, that there are plans to regulate cryptocurrency transactions. However, these initiatives are mainly associated with anti-money laundering and counter-terrorism financing. At the same time, it’s clear that introducing the regulation of cryptocurrency would involve making major amendments to several pieces of EU legislation governing the financial sector.
Cryptocurrency as a taxable item for individuals in Latvia
Latvian tax legislation neither defines cryptocurrency nor explains the tax treatment of income from cryptocurrency, and so taxpayers can raise many questions when it comes to reporting their income and paying taxes. In the absence of an explanation for a particular type of income or transaction, the principles of statutory interpretation dictate that we should follow the general rules.
First of all, cryptocurrency might be mistakenly thought of as electronic money because of its name. Unfortunately such a simple approach is contrary to section 2(2.1) of the Payment Services and Electronic Money Act, because electronic money payment services can only be provided by properly authorised institutions (credit institutions, payment institutions etc) but cryptocurrency is not issued by those institutions.
Likewise, cryptocurrencies might prima facie be perceived as financial instruments because income from the purchase of a cryptocurrency unit does not arise until it is sold. However, this perception is out of line with Latvian legislation, under which cryptocurrency is neither legal tender nor economically linked to any national currency. Thus, cryptocurrency transactions are currently not governed by the Financial Instruments Market Act either.
According to the State Revenue Service, income from cryptocurrency is considered an individual’s other income under section 8(3)(21) of the Personal Income Tax (PIT) Act, attracting the standard rate of PIT – currently the progressive rate. Without a uniform position adopted by the tax authorities, income from cryptocurrency could be treated under the general rules as various types of other income depending on the purpose of a particular Bitcoin deal. This is especially important since Bitcoin and other cryptocurrencies are mainly used for investment purposes, as payment for goods and services, or as remuneration taxable according to rules specified by the PIT Act.
Experience in neighbouring countries
According to a survey conducted by PwC’s global network, most of the foreign tax authorities have yet to adopt rules for cryptocurrency transactions. As part of the study we asked our colleagues to state what kind of income individuals would earn from an increase in cryptocurrency value according to their applicable general tax rules. As a result of the survey, the majority believed that cryptocurrency is a capital asset that creates a capital gain at the time of sale.
We also believe that for tax purposes, cryptocurrency is more consistent with a capital asset that creates a capital gain at the time of sale. Accordingly, the capital gain should be measured by comparing the acquisition cost with the selling price. Since cryptocurrency transactions are cashless, their acquisition cost and selling price can be established according to their market price at the time of each transaction. The rate of tax on capital gains was 15% in 2017 and is 20% from 1 January 2018.
At the same time, cryptocurrency is increasingly used in paying for goods and services (i.e. this is the supplier’s employment or business income). So this income needs to be assessed on its merits and taxed according to the type of income. For example, when cryptocurrency is received in payment for services, this income should attract the relevant tax rate as business income.
A practical suggestion
The simplest transaction we can do with a cryptocurrency is to buy or sell it in exchange for a regular currency (EUR, USD etc) because the exchange rates for internationally recognised currencies are regulated in a centralised manner and the value of a capital asset can be accurately measured at the time of its purchase and sale. Since it is quite common in foreign countries, especially the US, to use cryptocurrency in paying for various goods and services, a number of tools and mobile apps have been developed for conducting and recording transactions, which allow the value of cryptocurrency to be measured at the time of the transaction, giving sufficient information for the proper application of taxes.
Publicly available sources of information recommend that taxpayers monitor their cryptocurrency dealings and record the time of each transaction and the resulting income. This information will be useful at the time of reporting the transaction, when the taxpayer will have to determine the time of sale of the capital asset and its value for tax purposes. These apps enable fast domestic and international payments, as well as storing information about the amount and time of transactions.