In the context of drawing level with the constantly-evolving digital Assets space, federal governments worldwide have been keen to ensure all aspects are properly outlined in their guidance as far as taxation goes. The pursuit of clear tax guidance in the US has, however, been an elusive affair birthing obscure and inchoate guidelines. Speaking at Consensus 2023 event on Friday, IRS Project Director for Digital Assets Julie Foerster hinted at new tax guidelines arriving in the next 12 or so months. Foerster, the revenue authority’s lead on Crypto taxation, said the agency plans to change the current tax treatment.

Existing crypto tax guidance in the US

Taxation in the US is broadly overseen by the federal government revenue service (IRS), which recognizes digital assets as property – just like jewelry. This classification makes the assets subject to the general tax principles applied to property transactions, and as such, taxpayers are obligated to report capital gains/losses in their tax filing. Per the existing rules, cryptocurrencies be taxed as either assets or income. In the case of convertible virtual assets, the Internal Revenue Service borrows from the tax scheme on stock, i.e., it views crypto income and Capital Gains as taxable. These capital gains depend on how long an individual holds onto an asset before selling, while crypto losses are treated as tax-deductible.

Research espouses the preclusion of crypto from other tax deductions

A study on crypto taxation in the US published in February proposed a new framework for deducting crypto losses. Faulting the current guidance, which offers a deductible against capital gains, the researchers advocated for an approach where crypto losses are only deducted from crypto gains. Crypto losses are subject to the same taxation rules as other capital assets, i.e., typically deductible against capital gains with provisions for how much and when deductions are factored.

“Such a rule would not be based on moral disapproval of crypto trading as opposed to other investment activity, but instead would be supported by the unified justification underlying many loss limitation rules in our tax system,” the authors of the paper wrote.

Per the study’s recommendations, deduction limitations will apply to losses arising from scenarios like sales. In cases where assets are forfeited to burn events, crypto holders could deduct the losses wholly. Foerster, conveying in her capacity at the office of the Deputy Commissioner for Services and Enforcement, insinuated that the agency could be compelled to resort to other means to help “get its message across” in addition to voluntary compliance. Her remarks further gave away that the US is discussing the best taxation approaches with other countries whose names she withheld.

Taxman calls for community participation in drafting the guidance

Foerster, whose views neither indicate nor reflect the position of the IRS, also ingeminated the need for better interaction between the agency and players in the space. She called for community involvement while accentuating the need for the wholesome inclusion of industry participants.

” [The IRS] needs to look at the skills of the people we have today and those we will bring on in the future. […] We need to have the right tools and the right people.”

This, she said, in reference to the proposal on taxing non-fungible tokens (NFT) published by the IRS in March. Marking the first move by US tax authorities to establish a solid approach to digital collectibles taxation, the IRS published a notice attempting to address the grey last month.

IRS seeks public feedback on NFTs taxation approach

The revenue body proposed to tax NFTs, especially those certifying ownership of physical property, like the underlying assets awaiting a final framework governing the same. This proposition would see NFTs become taxable collectibles like stamps, sculptures and physical art items. The IRS defines an NFT as any “unique digital identifier that is recorded using distributed ledger technology and may be used to certify authenticity and ownership of an associated right or asset.” The joint statement with the Treasury Department requested persons to give feedback by June 19 on contentious issues around the upcoming guidance to be released under the US tax code.

Tax guidance in other jurisdictions

The US isn’t the only country looking to bring NFTs or digital assets, for that matter, under a legal tax regime. In Canada, individual marginal tax rates of between 20.5% to 33% federally are used to calculate tax on income from crypto-rewarding activities like mining or staking. Provincial taxes are capped at 21%. Last month, local reports from Singapore detailed that authorities were looking to subject income from NFTs to existing income tax rules.

Meanwhile, in Europe, the European Securities and Markets Authority (ESMA) has stipulated guidelines for initial coin offerings in addition to the forthcoming Markets in Crypto Assets (MICA) package.  Specific countries have adopted additional laws, such as Germany, where crypto tokens are considered assets, hence subject to capital gains tax on profits from the sale or exchanges. In the UK, the Chancellor of the Exchequer, Jeremy Hunt, announced mid-March new guidelines to take effect starting, which include separately reporting profits.

Singapore regulators treat income from mining or staking as capital gain. While this means income is generally not taxed, miners and stakers can incur taxes in other avenues. A similar tax exemption has been adopted in Switzerland, where holders aren’t taxed for their held assets or when transacting between wallets. This contrasts the situation in some Asian countries like South Korea, where the government revealed intentions to tax cryptocurrency exchanges and enforce a 20% crypto earnings tax.

UK proposes legislative changes to tax guidance

The UK government separately plans to change the current Capital Gains Tax (CGT) scope to better represent the capture decentralized finance (DeFi) niche. HM Revenue & Customs this week opened a consultation period asking for views on the tweak to the tax treatment of crypto activities. Per the changes, participants would only pay for capital gains or income tax when digital assets are “disposed of” in the economic sense – if sold or exchanged in a non-DeFi transaction. DeFi transactions entail those executed using smart contracts or when returning borrowed assets.

“The need to determine and record the market value of assets at each step in the transaction may also give rise to a disproportionate administrative burden,” a section of the consultation document read.

Earnings from DeFi-rewarding schemes like borrowing and lending are currently not exempt from income tax in the UK but would be in the proposed revision. Capital gains tax only comes into the picture if assets from the activity are later sold. The government will accept views and insights on tax modification until June 22, when the consultation period expires.

Hong Kong court classifies crypto as property in a case involving defunct Gatecoin exchange

Last week, a court in Hong Kong classified crypto as property in a case involving the defunct exchange platform Gatecoin. In the ruling, Justice Linda Chan explained that the definition of property in the city-state is comprehensive and of wide-reaching significance.  Hong Kong has joined other common law jurisdictions by branding crypto as property at par with other intangible assets like stocks and shares.

The incident marked the first time a decision of this nature has been issued in Hong Kong, though rulings of this kind have previously been seen in Mainland China, and the US, the IRS considers crypto to be property for tax reasons. Gatecoin liquidators had sought guidance from the court on whether crypto assets held by the exchange should be treated as customer trust property or be made available to all creditors. In response to their query, the court determined that although crypto can generally be the subject matter of trust, no trust had been established in this instance. Chan’s ruling effectively confirmed that crypto could be held in trust under the law.

Adopting standardized approaches to taxation

Tax guidance, specifically on digital assets, remains a tendentious subject, but future discourses around the same are expected to introduce much-needed transparency. The divergent consideration of cryptocurrencies as property, asset, or even currency in different jurisdictions for taxation purposes has made tax treatment slightly complicated. Nonetheless, it is through this classification that appropriate approaches can be defined.

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