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Tax law: Federal Fiscal Court negotiates the taxation of cryptocurrencies: Are Bitcoin and Co. economic assets?

Taxpayers and crypto investors are eagerly awaiting a decision by the Federal Fiscal Court (BFH - IX R 3/22) on the taxation of cryptocurrencies Bitcoin, Ethereum and Monero. The proceedings before the Federal Fiscal Court (Bundesfinanzhof – „BFH“) are intended to clarify the question of whether gains from the sale of cryptocurrencies are subject to taxation as "private sales transactions". In this case, a sale within one year of acquisition would be subject to income tax. On February 14, 2023, the oral hearing took place before the IX Senate.

1. Previous discussion on the taxation of cryptocurrencies

For the first time in its history, the BFH is now dealing with the taxation of cryptocurrencies. Basically, the question is whether Bitcoin and Co. are considered economic goods at all and thus relevant for tax purposes.

For taxpayers, the sale of Bitcoin and Co. is likely to be in the foreground as part of their investment strategy. In the event of an increase or decrease in value from cryptocurrencies, in principle only income from so-called "private sales transactions" in connection with "other economic assets" can be considered. These are only income taxable if there is less than one year between acquisition and disposal. In particular, there is no income from capital assets, so that the personal tax rate of up to 47.5% applies and not the final withholding tax of 26.4%. Accordingly, no tax is withheld at source, as is the case, for example, with banks for capital gains tax.

The tax courts are predominantly of the opinion that cryptocurrencies qualify as (intangible) assets that lead to income from private sales transactions when sold at a profit (Finanzgericht (FG) Berlin-Brandenburg dated June 20, 2019 - 13 V 13100/19; FG Baden-Wuerttemberg dated June 11, 2021 - 5 K 1996/19; FG Cologne dated November 25, 2021 - 14 K 1178/20). So far, only the FG Nuremberg expresses doubts that cryptocurrencies should be economic assets (FG Nuremberg of April 08, 2020 - 3 V 1239/19).

According to the definition by the BFH, the term economic asset includes, in addition to things and rights, other benefits, i.e. actual conditions and concrete possibilities and advantages for the business, the obtaining of which a merchant incurs a cost and which are accessible to a special valuation according to the market perception.

In the view of the tax authorities, units of virtual currencies (Bitcoin and Co.) represent intangible assets (BMF letter dated May 10, 2022). Accordingly, virtual currencies convey the possibility of assigning the pecuniary advantages assigned to one's own public key to another public key.

The tax literature has also affirmed the economic asset quality of cryptocurrencies so far (Ratschow in Brandis/Heuermann, EStG, as of November 2022, § 23 marginal no. 66; Levedag in Schmidt, EStG, 41st ed. 2022, § 23 marginal no. 26; Trossen in BeckOK EStG, as of 01.10.2022, § 23 marginal no. 199.6).

2. Current proceedings before the BFH

The plaintiff and appellant invested approximately EUR 20,000 in Bitcoin (BTC) via the platform "bitcoin.de" in the assessment periods 2014 to 2016. In the disputed period 2017, he partially exchanged the BTC into Ethereum (ETH). He exchanged the ETH completely into Monero (XMR) in June 2017. At the end of 2017, he partially exchanged his XMR back into BTC and sold them in the same year. To settle the transactions, the plaintiff had entered into either purchase contracts with providers of certain cryptocurrencies at current rates or exchange contracts using his own cryptocurrencies as consideration via digital trading platforms.

In his 2017 income tax return, the plaintiff declared the gain of approximately €3.4 million generated from the sale as income from private sales transactions. The tax office assessed the income tax in accordance with the declaration. The plaintiff appealed unsuccessfully and brought an action before the Cologne Fiscal Court. In the lawsuit, the plaintiff essentially argued that cryptocurrencies do not qualify as assets under tax law. Moreover, the mere exchange of "virtual" cryptocurrencies among each other lacked an increase in economic performance; this had only occurred with the exchange into a FIAT currency. Furthermore, there is a "structural enforcement deficit" in the taxation of capital gains from cryptocurrencies, which is why taxation would be unconstitutional (what the plaintiff means by this: honest taxpayers who declare their gains from crypto trading in their income tax returns would be disadvantaged because many others would not do so and would therefore hardly be prosecuted).

The Cologne Fiscal Court did not follow this and dismissed the claim. There was no structural enforcement deficit. In particular, this is not justified by the anonymous sale. Moreover, the requirements of a private sale transaction were met. The cryptocurrencies are "other economic assets" within the meaning of Section 23 (1) No. 2 of the Income Tax Act. The cryptocurrencies traded by the plaintiff are marketable and independently assessable. In addition, there was a structural comparability with foreign currencies.

The plaintiff had now filed an appeal against this ruling with the BFH.

3. Oral hearing at the BFH on February 14, 2023 and outlook

In the oral hearing, the judges of the BFH did not yet let their cards show in which direction they are leaning.

In addition to the fundamental question of the economic asset quality of cryptocurrencies, the BFH must also clarify the ownership position of these under civil law. Indeed, the plaintiff argued that cryptocurrencies are mere sequences of numbers ("signature chains") without intrinsic value. The signature chains merely provide a means of access, which can, however, cease to exist at any time.

In addition, the BFH must decide whether there is a structural enforcement deficit. At the time, the topic of "cryptocurrencies" was completely new and largely unknown to the tax authorities. Without the cooperation of the taxpayers, it would not be possible to collect the tax. If the BFH affirms such, this could lead to unconstitutionality and thus to tax exemption. However, this only applies to periods in which such an enforcement deficit can be assumed; at the latest with the publication of the BMF letter issued in this regard, this is likely to be highly questionable.

The ruling is eagerly awaited, as many crypto investors had filed an appeal against their tax assessment with reference to the BFH proceedings. If the BFH rejects the appeal as unfounded, the ruling of the Cologne Fiscal Court will stand and thus the taxation of the plaintiff's profits as private sales transactions.

We will keep you informed of the BFH's decision.

4. Practical advice

For practice, this means the following:

  • Profits and losses from crypto trading should currently be declared as income from private sales transactions to be on the safe side in view of the clear statements of the tax authorities.
  • Otherwise, there is a risk that non-declaration will be prosecuted as tax evasion.
  • An objection should be filed against the income tax assessment notices issued in this regard and an application should be made for the proceedings to be suspended due to the pendency at the BFH.

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