​Taxing Stablecoins - Stablecoins and VAT

Author: Christophe J Waerzeggers, Irving Aw, & Jess Cheng

preface

Neutrality is widely regarded as a fundamental principle of good tax law design. In short, the tax system should remain neutral so that economic decisions are based on economic interests and other non-tax factors and not influenced by tax factors.

While tax regimes can be effective tools for achieving policy goals beyond taxation, most jurisdictions have so far based their taxation on transactions involving cryptoassets on a neutral basis.

Under this approach to taxing transactions involving crypto-assets, jurisdictions are required to rely on the first principles in their domestic tax legislation to maintain approximate neutrality with comparable routine transactions or activities. This approach requires a proper understanding of the facts on a case-by-case basis, which is not an easy task due to the nature and variety of cryptoassets and the unique workings of the crypto industry. This is further complicated by the rapid development of the underlying technology and its inherent global reach beyond any single jurisdiction. Similar challenges exist in other legal and regulatory areas, including those aimed at devising robust regulatory and supervisory approaches to cryptoassets and their statistical treatment.

A stablecoin is a cryptographic asset designed to maintain a stable value relative to a specific asset or asset pool, such as a sovereign currency (IMF, 2021, 41; FSA, 2020, 5). In this way, they aim to address the problem of price volatility of cryptoassets; price volatility often makes these assets unsuitable as a store of value and is one of the main obstacles preventing their wider use as a means of payment. Given the prospect of wider adoption of stablecoins, a more in-depth study of their tax treatment and associated challenges is warranted.

This paper argues that even if stablecoins prove to be more stable in value than other forms of cryptoassets, they cannot be used as a means of payment and be accepted without greater tax certainty and neutrality than is currently the case. broadly used. In addition, mismatches in tax treatment between jurisdictions also create opportunities for arbitrage and abuse, thus requiring greater and more comprehensive international cooperation and coordination to address these issues. Finally, whether the value of a particular stablecoin is appreciating or depreciating, tax treatment needs to be clarified, as taxpayers and tax administrations need to determine the appropriate tax treatment of gains and losses.

This article is divided into four parts. The first part mainly introduces the general situation of stablecoins, including the classification of the known types of stablecoins in circulation; the second part discusses the issues related to the value-added tax (VAT) specific to stablecoins; the third part deals with the main income tax of stablecoin transactions and capital gains tax issues. The discussion draws on representative national practices, but does not outline current national practices or approaches in detail, nor does it cover all VAT or income tax issues that may arise from trading in stablecoins, as that would be beyond the scope of this article .

1. Overview and classification of stablecoins

Cryptoassets have many advantages, including security encrypted through cryptography, which may make them useful for payment purposes. However, the volatility of encrypted asset prices severely reduces its potential application value as a medium of exchange and means of payment (IMF, 2020). Stablecoins have emerged as a subcategory of cryptoassets to address this, for example by aligning their value with another more stable asset (such as the U.S. dollar, precious metals, or even another cryptoasset) or other asset pools (such as a basket of Commodity) value link or “pegging” (pegging). Almost all stablecoins in circulation today attempt to mitigate price volatility through some sort of peg mechanism.

It is very important to distinguish between the two concepts of “pegging” and “backing”, and the difference between the two also depends on the nature of the holder’s claim on the stablecoin issuer (Nature of claim). The former only requires the value of the stablecoin to be pegged to the value of the underlying asset or asset pool (e.g., requiring the issuer to redeem it at face value in USD), but the latter also involves a reservation by the stablecoin issuer (or a third party acting on behalf of the issuer) Setting asides assets, and including the understanding that stablecoins have certain claims (e.g., pledged or otherwise use pools of short-term government securities) over these underlying assets, as they may be viewed as means to support such a peg . This distinction is important because some stablecoins may be explicitly tied to the value of an asset or pool of assets, but holders lack any clear, legal sense of use over any particular asset itself.

Stablecoins can be further differentiated according to the type of reference asset they are linked to, either on-chain (i.e. another encrypted asset) or off-chain (such as traditional currency or commodity), and a stablecoin can be backed by more than one asset support. For example, Tether (issued by Tether Limited, which originally claimed each token was backed by one U.S. dollar), TrueUSD (TrustToken platform), USD Both Coin (the Center consortium, a partnership between Circle and Coinbase) and Gemini Dollar (the Gemini exchange) are pegged to the U.S. dollar, at least allegedly in value, one-to-one with various underlying assets. PAX Gold (issued by Paxos Trust Company) is another example of a stablecoin with an off-chain reference asset (precious metal). Each token is described as “convertible” and “backed” by one troy ounce of London Good Delivery gold stored in a specialist vault facility in London. Such off-chain support inevitably requires some degree of centralization, e.g., custody of the underlying assets by custodians, which arguably reduces the decentralization advantages of distributed ledger-based cryptoassets. In the technical field, there are also some stablecoins that claim their value is linked to or supported by various encrypted assets, some of which claim to be completely decentralized, that is, the underlying encrypted assets are managed by a smart contract system, Rather than being managed by a central entity. Dai, for example, runs on the decentralized Maker protocol and seeks to maintain a stable value using ethereum. However, the precise operating model (and also the legal nature of the backing mechanism) of different stablecoins can vary significantly.

In theory at least, stablecoins can be unbacked by underlying assets and still achieve some level of price stability. An example of such a stablecoin is Kowala’s kUSD, which claims to keep its supply up or down based on algorithms and information provided by market-based “oracles,” or data interfaces between the blockchain and relevant market data, thereby maintaining its Dollar peg. This stablecoin relies on a fully algorithmic “monetary” policy that regulates supply by reference to the value of the coin it is pegged to, that is, when the supply gets too low, the algorithmic protocol issues new stablecoins, but When demand gets too low, the algorithmic protocol reduces its supply (“burns”), ensuring that the stablecoin’s price remains within an acceptable range of its pegged value. Of course, there are more complex situations, such as stablecoins, generally known as “hybrid stablecoins” (Hybrid stablecoins), which combine support mechanisms and algorithmic protocols to reduce volatility.

As mentioned earlier, it is important to realize that holders of a stablecoin pegged to a certain asset do not necessarily have ownership of that particular asset. Conversely, stablecoins can be pegged to the value of one asset but backed by another. For example, the value of the SGA (Saga) stablecoin is pegged to the basket of currencies that underlie the value of the IMF’s Special drawing rights, but the stablecoin is backed by reserves of different currencies and assets, including cryptocurrencies. Therefore, those who choose to redeem the stablecoin can obtain the economic equivalent of the asset the currency is linked to, but not necessarily the asset itself. In a narrow sense, stablecoins can be further broken down into two types: with or without recourse to the underlying asset.

Figure 1: Classification of Stablecoins

If a stablecoin issuer can make its stablecoin price stable and broad user network characteristics, and be promoted by the reputation and market influence of the association supporting the stablecoin arrangement-like Facebook’s Diem (formerly Libra ) project—then this stablecoin would be well suited for economic purposes as a medium of exchange and store of value. They could serve as a more efficient means of settling retail payment transactions, especially in jurisdictions with highly volatile currencies, or could reduce the cost of cross-border payments, or enable cross-border payments between jurisdictions that currently lack the infrastructure for efficient interconnected payments (IMF, 2020, 14). But at the same time, these stablecoins may also be used as speculative financial instruments by investors who would be willing to take risks and try to profit from fluctuations in the value of stablecoins. The challenge now is therefore to determine where stablecoins fit within the existing legal structure, including from a tax perspective (Cheng, 2020). Regulators have responded to the rise of stablecoins in a variety of ways, and multiple existing regulatory frameworks may apply to specific currencies (for example, the Swiss Financial Market Supervisory Authority’s guidelines for stablecoins under Swiss regulatory law state that for Specific currencies, money laundering, securities trading, banking, fund management and financial infrastructure supervision may all be relevant). For these regulatory purposes, the regulatory scope of stablecoins may overlap. Specific stablecoin arrangements may be placed under different regulatory regimes and apply simultaneously, but the tax law requires a single or primary classification to determine the treatment of a particular coin - in other words, the treatment of stablecoins can only be placed under one tax law under classification and system.

2. Value-added tax treatment of stable currency

VAT & Currency

The vast majority of VAT regimes do not separately tax money paid for in the supply of goods or services, they generally do so by (often implicitly) treating such money supplies as “out of scope” or by explicitly excluding them from “supply”. implemented outside the definition. This is so because, conceptually, currency is not consumption per se, but rather a measure of consumption expenditure, against which VAT taxation related to the supply of goods or services (other than currency) is determined. Therefore, the provision of money as a medium of exchange and means of payment for goods and services does not constitute a separate taxable transaction for VAT purposes. From a practical point of view, this type of approach also has the advantage of reducing tax complexity and avoiding double taxation on a single transaction.

On the other hand, the exchange of currency for another currency, i.e. currency exchange, will usually be considered a supply for VAT purposes, but even then will generally be exempt from VAT. The exclusion of such transactions from the excise tax base is justified, since in currency exchange transactions there is no consumption, only the exchange of one medium of exchange for another, or a pure investment. Such exemptions are also important to facilitate hassle-free payments, as they avoid the practical difficulty of determining tax liability and deductible VAT on a transaction-by-transaction basis.

Viewing money supply as tax-free supply rather than non-supply (or out-of-scope supply) is not without consequences. While no tax is payable in either case, in the case of exempt supplies, the taxpayer’s right to input tax credits depends on the amount of money it supplies, and when the money supply is considered to be in scope They are usually not affected in this way when supplied externally. From a compliance perspective, jurisdictions generally require exempt supplies to be reported separately in the VAT return, while out-of-scope supplies are not required to be reported at all.

Finally, it should also be noted that VAT is not levied only when the currency is used as a medium of exchange or acquired as an investment. For example, if the currency supplied is a coin or collectible, it is taxable because the coin itself has intrinsic value and is therefore subject to VAT as a supply of goods.

Trends in the VAT treatment of non-traditional digital payment methods

Jurisdictions imposing VAT appear to be increasingly willing to treat certain non-traditional digital means of payment as currency for VAT purposes, even though they are not currency and do not enjoy legal tender status (IMF 2020, 11-12).

In Skatterverket v. David Hedqvist case C-264/14 (Hedqvist), the Court of Justice of the European Union adopted a purposive interpretation of Article 135(1)(e) of the EU VAT Directive, holding that the EU VAT For tax purposes, the exchange of traditional currencies for non-traditional “currency” units (i.e. currencies other than those that enjoy legal tender status in one or more countries) for the difference in value (or vice versa) is a financial transaction exempt from VAT. However, the Court made clear that such VAT-free treatment should only apply to non-traditional “currency” that (1) has been accepted by both parties as a substitute for currency with legal tender status; (2) There is no other purpose.

The Court of Justice of the European Union found that imposing VAT on such exchange transactions (in this case involving an exchange transaction between traditional currency and bitcoin) faced the same difficulties as those faced by (traditional) currency exchanges, namely how to determine on a per-transaction basis Taxable amount and deductible VAT amount. Therefore, not exempting exchange transactions involving non-traditional currencies such as Bitcoin would render the VAT exemption partially ineffective. As far as VAT is concerned, EU member states believe that such non-traditional currencies should be considered as money, as long as it is subjectively accepted by all parties as a substitute for money and objectively serves no other purpose than as a means of payment. While Hedqvist deals with exchanges between Bitcoin and traditional currencies, the EU Court of Justice judgment also means that when non-traditional currencies such as Bitcoin are used in the EU to obtain goods and services, the supply itself does not need to be used in the same way as traditional currencies. That would be subject to VAT.

In 2017, Australia amended the Goods and Services Tax (GST) Act to stipulate that when digital currency is used to pay for other goods and services, its supply enjoys the same GST treatment as money supply, that is, it is not used for GST purposes. supply. The purpose of changing the law is to ensure that the definition of “digital currency” “approximately has the same characteristics as national legal tender.” Among other things, a digital currency must not (1) be denominated in the currency of any country; (2) have a value dependent on or derived from the value of anything else; or (3) confer acceptance or instruction to supply A right in a particular item or items, unless such a right is purely incidental to its holding or use as consideration. This approach stands in stark contrast to the CJEU ruling in Hedqvist, which did not explicitly prohibit digital means of payment being denominated in national currency, or whose value was derived from or depended on the value of something else, but did require digital means of payment to be denominated in It has no objective function other than being a means of payment. Therefore, under Australian tax law, if a digital means of payment does not meet the definition of “digital currency” because its value depends on or is derived from something else, it will be treated as an “input tax” financial services supply (i.e. exempt from output GST, Input tax credits are generally not allowed).

Likewise, Singapore has de facto considered digital payment tokens to be currency for GST since January 1, 2020; that is, payments in digital payment tokens do not Exchanges into traditional currencies or other virtual currencies are exempt from GST. The proposed definition of “digital payment tokens” in new section 2A of the Goods and Services Tax Act (The GST Act) is broadly similar to Australia’s definition of “digital currency”, with two notable differences. First, the definition excludes tokens that: (1) confer the right to receive or direct the provision of goods or services; and (2) no longer function as a medium of exchange after the right has been used. This is less stringent than the Australian GST approach, which prohibits digital currencies from providing any non-contingent right to receive or direct the supply of any item. Second, tokens cannot be denominated in any currency, nor can they be pegged to any currency by their issuer, whereas the Australian approach does not allow tokens to be denominated in any currency, or to derive or depend on anything for their value. However, despite the clear legislative wording, the Inland Revenue Authority of Singapore (IRAS) stated in its recent e-tax guidance that “tokens pegged to or backed by any fiat currency, basket of currencies, commodities or other assets” should be considered derivatives, the supply of which constitutes a GST-free supply of financial services even if used for payment (IRAS 2022, para 5.7).

VAT and Stablecoins

As mentioned earlier, the volatility of cryptoasset prices generally makes them unsuitable as a store of value and hinders their widespread adoption as a means of payment and medium of exchange. Stablecoins were created to solve this problem by pegging their value to other relatively stable currencies or assets. However, the peg mechanism means that stablecoins will always be treated as derivatives rather than currencies under the Australian and Singaporean approaches, so their supply will be exempted rather than ignored entirely, with substantive and administrative or compliance implications for both parties to the transaction Sexual VAT impact. While Australia’s approach is more lenient than the EU Court’s approach to tokens that have ancillary purposes other than being used as a means of payment, this does not change the fact that stablecoins are only a category and cannot be considered currencies , because they are inevitably pegged to other assets or currencies for stability.

On the contrary, according to the approach of the European Court of Justice, the peg mechanism - whether it is linked to the currency or other assets - does not in itself rule out the possibility of imposing VAT on the stablecoin as a currency, provided that the parties subjectively regard the stablecoin as a substitute for the currency. Goods, objectively, have no other purpose except as a means of payment. As far as the former requirement is concerned, the stability of a coin or token goes to some extent to support the presumption that parties are more likely to use it as a substitute for money. On the other hand, given that lack of stability does not in itself prevent traditional currencies from being treated as money for VAT purposes, their relative stability should not in itself be decisive. The stringency of the latter requirement — that tokens objectively have no other purpose than as a means of payment — may preclude hybrid tokens, including hybrid stablecoins, which may have objective purposes other than as a means of payment.

**hook and/or recourse? **

In the explanatory memorandum of the Australian Amendment Act, it is believed that the value of digital currency, like traditional currency, “must come from the market’s assessment of the value of currency to achieve the purpose of exchange, although it has no intrinsic value”. Therefore, pegging the value of a digital means of payment to the value of another asset or currency would, for GST purposes, preclude such a unit from qualifying as a digital currency and be considered a derivative instrument, the price of which depends directly on The value of its underlying asset or currency.

However, given that many traditional currencies also de facto or de jure use one or more major currencies as exchange rate anchors, it is not clear why pegging to a traditional currency or basket of traditional currencies would in itself automatically deprive non-traditional digital means of payment Eligibility to be treated as currency for GST purposes. Furthermore, the analogy between stablecoins and derivatives is not entirely correct. Most derivatives are financial contracts that create rights and obligations between two parties based on the value of an underlying asset or currency at a predetermined date in the future or when a predetermined event occurs. In contrast, any rights or claims that stablecoin holders have against their issuer or others are open-ended, on demand, and do not involve a fixed date or event in the future, whereas for algorithmic stablecoins or seigniorage stablecoins , since there is no asset backing and cannot be exchanged for any other assets, its holders can only make unsecured claims on the issuer. Likewise, asset-backed but unclear or non-existent recourse to the underlying assets—including due to a lack of consumer protection regulations—stablecoins do not provide their holders with any claim to the assets, even if those assets are Some way is used to maintain the value of the stablecoin, regardless of its mechanism.

On the contrary, a stable currency linked to a sovereign currency is more similar to a negotiable promissory note, a banknote or a traveler’s check. Enjoy legal tender status (that is, creditors are not required by law to accept redeemable stablecoins offered by debtors to pay monetary obligations, unless the contract specifies otherwise). The fact that stablecoins are not issued by sovereign states (through their central banks) should not determine whether they should be treated as money for VAT purposes, e.g. a bank deposit representing a claim on a commercial bank is privately issued but is still treated as currency. Regardless, to consider certain types of privately issued non-traditional digital currencies as money for VAT or GST purposes is to tacitly assume that issuance by a sovereign state is not a prerequisite. Likewise, the fact that jurisdictions consider certain types of digital means of payment without legal tender status as money for VAT purposes means that legal tender status is not a requirement for their primary use as a medium of exchange and means of payment. In fact, VAT laws generally do not impose legal tender requirements on items that are considered money.

However, stablecoins pegged to assets other than sovereign currencies raise concerns of VAT evasion or avoidance, as the supply of the underlying commodity may be a taxable supply. If the parties do not intend to use the stablecoin as a medium of exchange, but as a supply or substitute for the underlying asset, then there is a risk of tax evasion as long as the supply of the underlying asset is not out of bounds or tax-free. This problem is compounded by low barriers to entry for token creation and issuance, which may allow individuals to circumvent VAT on otherwise taxable supplies of goods by repackaging transactions as token issuance and transfers. The fintech regulatory framework is still in its early stages of development, with many jurisdictions expressing the need to design regulatory regimes so as not to impede innovation and entrepreneurship. However, absence or inconsistency in regulation may also make it more difficult for tax authorities to monitor any transactions in, or even the existence of, underlying assets.

Therefore, the requirement that the value of a digital payment unit must not be linked to the value of any other commodity under the Australian and Singaporean approaches can reasonably be interpreted as a means of dealing with this potential leakage and circumvention. The CJEU approach does not impose this requirement, but instead focuses on the subjective intent of the parties to the transaction and whether the token is being used as a substitute for money. While the subjective intent test allows different relevant factors to be considered as a whole without excluding tokens whose value is tied to other assets, it may be more difficult to ascertain in practice, potentially reducing tax determination for taxpayers and tax administrations sex.

Mixed

Tokens may have more than one functional characteristic, which creates additional challenges for classification for tax and other purposes. The objective test of the Court of Justice of the European Union in Hedqvist addressed the issue of tax evasion and avoidance, namely the refusal to grant currency-like benefits in VAT terms to tokens that serve any purpose other than as a medium of exchange (i.e. pure payment tokens). treatment. Under this approach, tokens of any other type would not be considered money for VAT purposes, and their supplies would generally be taxed unless they were sufficiently similar to financial transactions to qualify for the existing exemption.

However, many tokens with other built-in functions have the potential to become widely accepted as mediums of exchange and means of payment. In this regard, Australia’s spin-off test appears to be less stringent than the EU’s approach, allowing tokens designed primarily as payment tokens to be considered digital currencies as long as the currency’s non-payment function is the primary purpose of its use as a medium of exchange Comes with features. As explained in the explanatory memorandum of the Australian amendment bill, its purpose is to ensure that “side functions common to the operation of many digital currencies, such as updating distributed ledgers to confirm transactions, do not affect the status of these currencies as digital currencies”.

The means of payment test in Singapore’s GST legislation is the most lenient of the three approaches, with no restrictions on the extent to which a hybrid token’s non-payment function is primary or incidental. Instead, the ability of tokens to be used as a medium of exchange and means of payment after non-payment benefits or rights have been exhausted. However, this approach presents challenges in drawing the line between the money supply and the supply of tokens, since tokens continue to exist as a means of payment even after benefits or entitlements have been exhausted. This can be illustrated by the facts in Example 2 of the IRAS e-Tax Guide:

Example - digital payment tokens, used to receive specified services and can be used as a medium of exchange

StoreX is a digital token designed to be an exclusive payment method for Company X’s distributed file storage network. Under the terms of its ICO, StoreX grants holders a perpetual right to a specified amount of file storage space. The token can also be used to pay for goods and services of other merchants on Company X’s platform, even after exercising a certain amount of file storage rights. StoreX will qualify as a digital payment token if all other conditions for a digital payment token are met.

In this example, even though StoreX also has file storage rights, the initial issue of StoreX by Company X is considered a money supply because it is not subject to excise tax collection. Assuming that the token only has the right to store files, then the token will be regarded as a product certificate, and GST will be payable when the certificate is issued. Since StoreX has a payment function, it is treated as a currency rather than a voucher, and there is no taxation on the file storage service provided.