Trading in Bitcoin – Keep the Tax Man in mind
Virtual currencies or cryptocurrencies, such as Bitcoin, are a recent global phenomenon. South Africa as yet does not have any specific laws or regulations governing the use of cryptocurrencies, including the tax treatment of Bitcoin related transactions. However, the South African Revenue Service (SARS) has expressed its plans to release guidance on the tax implications relating to the trading in Bitcoin, or any other currency, and in particular, whether it should be considered as an asset, a currency or a barter transaction.
What is Bitcoin?
Bitcoin is an open source math based peer-to-peer payment system invented in 2008, which can be described as a decentralized convertible virtual currency. Bitcoin is protected by cryptography which relies on a public and private key to transfer value from an individual to another and each transaction must be cryptographically signed. Public key cryptography requires that each user be assigned a private key and a public key. The private key is kept secret like a password and the public key can be shared and is required to receive payment. The private key is required to sign a transaction to send payment. Bitcoin users may use a Bitcoin wallet to store a collection of Bitcoin private keys. Typically a wallet is encrypted with a password or otherwise protected from unauthorized access. Signing an unconfirmed transaction acts as proof that the transaction originates from the senders address. Confirmation occurs when the transaction is written into a shared public database of all confirmed Bitcoin transactions. The public database is known as the ‘blockchain’. Bitcoin, however, is unregulated and has no central authority, no central monitoring, nor oversight.
The blockchain is a decentralized ledger of all transactions that serves as an irreversible and incorruptible public repository of information. Blockchain technology allows unrelated individuals to reach agreement on the occurrence of a particular transaction without the need for a centralized controlling authority.
The acquisition of Bitcoin can be achieved in three ways. First, individuals can convert local currency to Bitcoin using many marketplaces commonly known as a ‘Bitcoin exchange’. An example of a Bitcoin exchange is Luno, South Africa’s first Bitcoin exchange platform, which was founded in 2013. Secondly, individuals can exchange goods or services in order to acquire Bitcoin. Thirdly, Bitcoin may be acquired through what is known as ‘mining’. Bitcoin mining is achieved by successfully verifying Bitcoin transactions in the public ledger. This verification is achieved by the miner through the solving of complex algorithms. The miner verifies a Bitcoin transaction and simultaneously releases new Bitcoin into the network. The miner is then rewarded with a specific amount of Bitcoin for solving these algorithms to verify transactions.
Once Bitcoin is acquired, it may be used predominantly for three purposes. First, Bitcoin may be held purely as an investment. Secondly, it may be exchanged for goods and services using online commerce internet sites and online payment platforms. There are more and more vendors today who accept and treat Bitcoin as a currency that can be exchanged for their goods and services. Thirdly, Bitcoin may be traded using an online Bitcoin exchange.
In predicting how SARS will tax Bitcoin transfers, one should consider current international practice on the taxation of Bitcoin as a starting point.
The United States of America
The Internal Revenue Service (IRS), the American tax authority, defines virtual currency as a “digital representation of value that functions as a medium of exchange, a unit of account or a store of value”. For federal tax purposes virtual currency, such as Bitcoin, is treated as property, thus existing tax principles will apply to virtual currency transactions.
The IRS treats any disposal of property as a capital gain or a capital loss. Therefore, if a taxpayer holds virtual currency as a capital asset, then that taxpayer may realise a capital gain or loss on the sale or exchange of that virtual currency. American tax reporting requirements will apply to Bitcoin transactions as are applicable to any other transaction involving property.
Notably, the IRS requires a taxpayer who ‘mines’ Bitcoin to include the fair market value of the Bitcoin as gross income in their taxable income.
The Australian Taxation Office (ATO) considers Bitcoin transactions as being akin to barter transactions and is of the view that Bitcoin is neither money nor a foreign currency. Further, the supply of Bitcoin is not a financial supply for the purposes of goods and services tax (GST). The ATO, however, considers Bitcoin as an asset for capital gains tax purposes.
A taxpayer who predominantly uses Bitcoin for the purchase goods or services for personal use may disregard any capital gain or loss from the disposal of the Bitcoin if the cost of the Bitcoin is AUD10,000 or less. Doing business with Bitcoin, however, is treated differently by the ATO. If a business receives Bitcoin for goods or services, the business will need to record the value in Australian dollars as ordinary income. The value in Australian dollars will be the fair market value which can be obtained from a reputable Bitcoin exchange at the time of receipt.
The Canadian Revenue Agency (CRA) provides that where digital currency is used to pay for goods or services, the rules for barter transactions apply. A barter transaction occurs when any two persons agree to exchange goods or services and carry out that exchange without using legal currency. Therefore when a taxpayer receives Bitcoin as payment, the revenue earned will be deemed to be what the taxpayer would have ordinarily charged for the good or the service, and ordinary income tax principles will apply.
The CRA also provides that digital currency can be traded like a commodity. The tax consequences of the realisation of gains or losses from trading of Bitcoin will depend on whether the transaction is considered to be capital or income. If Bitcoin is acquired for investment purposes, the disposal of Bitcoin will result in a capital gains tax liability. Conversely, if the invention of the Bitcoin holder is to realise a profit, then the disposal of Bitcoin will result in an income tax liability..
South African tax legislation and its impact on Bitcoin
South African industries were initially slow to react to the use of Bitcoin; however, this is changing rapidly as an increased number of companies are deciding to use Bitcoin. Takealot.com, one of South Africa’s prominent online retailers, for example now accepts Bitcoin as a method of payment. In September 2017, South Africa’s second largest supermarket chain Pick n Pay piloted a project at a store in Cape Town where Bitcoin would be accepted as a method of payment. South Africa currently has two Bitcoin exchange platforms, namely Luno and Icecube. These platforms accept bank deposits in exchange for Bitcoin which, thereafter, may be used to trade or to purchase goods and services from vendors who accept the cryptocurrency as a method of payment.
In 2013, Pravin Gordhan, the then Minister of Finance tasked the Davis Tax Committee (DTC) to assess South Africa’s tax policy framework in supporting inclusive growth, employment, development and fiscal sustainability. In its report, released in December 2014, the DTC recommended that notwithstanding the limited use of virtual currencies in South Africa (at that time at that least), legislators should consider the potential impact of virtual currencies on tax compliance and monitor international developments in order to determine a suitable approach for South Africa.
Considerations of whether Bitcoin is currency or an asset and the implications thereof
The Income Tax Act, 1962 (the Act) does not define the word “currency”. However, the definition of “local currency” under section 24I(1) includes “currency of the republic”. Therefore Bitcoin cannot be deemed “local currency”. The definition of “foreign currency” is defined in section 24I(1) as “any currency which is not local currency”. Bitcoin may potentially be considered to be foreign currency.
Section 24I(3) requires a taxpayer to include in his taxable income any gain from a foreign exchange differential. Conversely any loss must be deducted from his taxable income. This inclusion in or deduction from a taxpayer’s income is in lieu of any inclusion or deduction ordinarily allowed in terms of the Act.
In short, section 24I taxes all profits and loss whether realised or unrealised and whether of a capital or revenue nature, relating to any foreign exchange transactions entered into by a taxpayer as income. The marginal tax rate on taxable income for the 2017 tax year of assessment is calculated in terms of a sliding scale, with the highest rate for an individual is 41%, for a company is 28%, and for a trust is 41%.
In terms of the Eighth Schedule to the Act, an “asset” includes “property of whatever nature whether movable or immovable, corporeal or incorporeal, excluding any currency but including any coin made from gold or platinum and a right or interest of whatever nature to or in such property”. It follows that an asset, for taxation purposes, currently specifically excludes currency.
Bitcoin may be considered as a commodity that one trades, similar to gold or silver, in the hope that its value will rise and yield a profit. Due to this similarity to gold and other comparable commodities, SARS may regard Bitcoin as an asset. It must then be established whether Bitcoin will be treated as income or revenue.
The taxpayer will be deemed to have held the Bitcoin as a capital asset if the intention of the taxpayer in acquiring, storing, disposing or exchanging of the Bitcoin was a capital intention and remained as such throughout the period that the Bitcoin was held, and there was no profit making scheme present and no factors indicating a scheme of profit-making were present. In these circumstances, the taxpayer will include in his taxable income any capital gain calculated under the Eighth Schedule to the Act. The effective capital gains tax rates for the 2017 tax year of assessment is 16.4% for individuals, 22.4% for companies, and 32.8% for trusts.
If the intention of the taxpayer is to obtain Bitcoin for the purpose of profit making, then the Bitcoin will be considered to be “trading stock” and of a revenue nature. Here, the taxpayer will include such receipt in its taxable income.
Value Added tax implications on Bitcoin transactions
For a transaction to attract valued-added tax (VAT) in terms of the Value Added Tax Act, 1991 (the VAT Act) there should be a supply of goods or services by a vendor in the course of furtherance of an enterprise, on the importation of any goods in the republic, on supply of any imported service.
The VAT Act requires any person to register as a vendor for VAT purposes in South Africa if the person carries on an “enterprise” in South Africa, and the total value of taxable supplies made by that person exceeds or is likely to exceed the registration threshold of R1 million for a 12 month period.
The supply of goods and services are generally subject to VAT at the standard rate, unless such supply is specifically zero-rated or exempt in terms of the VAT Act. Standard rated supplies are subject to VAT at the prescribed rate of 14%.
Where a taxpayer involved in the mining and distribution of the newly mined Bitcoin (supply), and the supply exceeds R1 million, that taxpayer in our view is obliged to register as a VAT vendor as that supply will be subject to VAT in terms of section 7 of the VAT Act.
“Financial services” as defined in section 2 of the VAT Act are exempted from VAT. In terms of section 2(1)(a), the “exchange of currency” is considered to be a financial service. Therefore, if SARS considers Bitcoin to be foreign currency, transactions involving the exchange of Bitcoin will be exempted from VAT.
Section 11 and 12 of the VAT Act deal with supplies which are zero-rated and exempted supplies respectively. It is highly unlikely that Bitcoin will be considered a zero-rated supply, in terms of section 11 of the VAT Act, or be considered as an exempted supply, in terms of section 12 of the VAT Act.
Bitcoin, and its taxation, is not currently regulated by specific legislation in South Africa. Without tighter regulations relating to the trade and usage of Bitcon it will be difficult for SARS to hold individuals to account for their taxes and will need to rely on the individual to accurately and honestly identify the tax consequences in their annual tax returns.
In our view, SARS should amend the definition of the term ‘asset’ in the Act to explicitly include virtual currencies. As Bitcoin is not yet widely accepted as a medium of exchange it seems unlikely to be classified as currency. It would be prudent to follow international practice on this matter and classify Bitcoin as an asset, such that taxpayers will be taxed using the existing tax legislation.
Whilst Bitcoin trading may still go unregulated, the proposed interpretation or practice note will provide South African taxpayers certainty in the tax treatment of Bitcoin and other cryptocurrencies and should have a positive effect on the number of taxpayers reporting Bitcoin profits or gains in their annual tax returns.
Notes to editors
- Allen & Overy is an international legal practice with approximately 5400 people, including some 550 partners, working in 44 offices worldwide.
- In this press release ‘Allen & Overy’ means Allen & Overy LLP and/or its affiliated undertakings.
- The term ‘partner’ is used to refer to a member of Allen & Overy LLP or an employee or consultant with equivalent standing and qualifications or an individual with equivalent status in one of Allen & Overy LLP’s affiliated undertakings.
 Financial Action Task Force. 2015. Guidance for a risk-based approach: Virtual currencies. France: FATF. (no. June 2015).
 J Brito and A Castillo ‘Bitcoin: A Primer for Policymakers’ (2016) at 6-7
 B Tan and K Low ‘ Bitcoin – Its Economics for Financial Reporting’ (2017) at 220
 Supra note 2
 K Craig et all ‘ Bitcoin: Questions Answers and Analysis of Legal Issues’ (2015) at 2
 Bitcoinzar. 2015(b). Buy bitcoin in South Africa from a bitcoin exchange
 Internal Revenue Service (IRS) Notice 2014-21
 Internal Revenue Service Publication 550
 E Lambert ‘The internal revenue service and bitcoin: A taxing relationship.’ (2015)
 Supra note 7
 ATO Tax Determination 2014/25
 Section 24I(6) of the Income Tax Act, 1962
 CIR v Pick ‘n Pay Employee Share Purchase Trust 1992 (4) SA 39 (A), 54 SATC 271;
Natal Estates Ltd v SIR 1975 (4) SA 177 (A), 37 SATC 193 at 220
 Section 26A of the Income Tax Act, 1962
 Supra note 15
 Section 22 of the Income Tax Act, 1962