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KRA should of­fer clar­ity on how to tax bit­coin trad­ing.

Business Daily (Kenya) - - FRONT PAGE - Gatuyu is an Ad­vo­cate of the High Court of Kenya. @gatuyu

Naysay­ers have been wait­ing for the bit­coin bub­ble to burst. In­stead, bit­coin, a de­cen­tralised cryp­tocur­rency, has over the years grown value and gained fame. Pol­icy mak­ers and cen­tral banks are grap­pling to of­fer clar­ity on the place of bit­coins in the fi­nan­cial sys­tem.

How­ever, lit­tle at­ten­tion has been paid to tax con­se­quences in min­ing and trad­ing in bit­coins. Lack of tax­a­tion guid­ance and en­force­ment will lead to non­tax­a­tion of cryp­tocur­ren­cies, even­tu­ally dis­tort­ing com­pe­ti­tion, and caus­ing non­com­pli­ance by the tax­pay­ers and rev­enue loss by the coun­try.

The Kenya Rev­enue Au­thor­ity (KRA) is yet to is­sue any guid­ance. The as­sump­tion is that tax­pay­ers who mine and trade in bit­coins in the coun­try are sub­ject to the gen­eral tax­a­tion rules.

Trad­ing in bit­coins in­volves trans­fer­ring them from com­puter to com­puter through a sys­tem of cryp­to­graphic hashes and keep­ing them se­cure through pub­lic-pri­vate key cryp­tog­ra­phy. Users store their coins in a “wal­let,” this be­ing soft­ware in­stalled on their com­puter or a web-based ac­count. Min­ing bit­coins in­volves gen­er­at­ing new coins by com­put­ers called “bit­coin min­ers” through solv­ing com­pli­cated al­go­rithms.

Be­fore in­ves­ti­gat­ing the tax im­pli­ca­tions, there is need to clar­ify whether, in the Kenyan set­ting, bit­coin may be re­garded as money or com­mod­ity. In eco­nomic sense, money must serve as a medium of ex­change, unit of ac­count and mea­sure­ment, and store of value.

Even though bit­coin may act as a medium of ex­change, it can barely serve as store of value due to its volatil­ity. It can barely be a unit of ac­count as the value must first be trans­lated into a tra­di­tional cur­rency. In the le­gal sense, money must have le­gal ten­der sta­tus, is­sued and man­aged by a cen­tral bank, and phys­i­cal char­ac­ter­is­tics as ei­ther coins or ban­knotes.

Bit­coin does not ful­fil the cri­te­ria of money in both eco­nomic and le­gal sense. It can there­fore be viewed as an as­set or com­mod­ity, even for pur­poses of tax­a­tion. In view of the bit­coin busi­ness model, the main tax con­se­quences would be the in­come taxes and the value added tax (VAT).

In­come tax is im­posed on per­sons who have earned tax­able in­come for a rel­e­vant tax pe­riod. It is charged from, among oth­ers, gains or prof­its from busi­ness and from gains re­sult­ing from trans­fer of prop­erty. In re­gard to trans­act­ing in bit­coins, the ques­tion is whether such is a busi­ness ac­tiv­ity giv­ing rise to busi­ness in­come, hence in­come tax, or it is a trans­fer of prop­erty that would merely give rise to gains sub­ject to cap­i­tal gains tax (CGT).

Whether deal­ing in bit­coins re­sults in a busi­ness in­come or cap­i­tal gain will be de­ter­mined by the ‘badges of trade” tests. When a per­son stores Bit­coins for a long pe­riod wait­ing for their ap­pre­ci­a­tion be­fore dis­pos­ing of them may only be sub­ject to CGT on ac­crued gain. On other hand, traders whose busi­ness in­volves spec­u­lat­ing in bit­coins through buy­ing and sell­ing may be deemed to be en­gag­ing in a busi­ness ac­tiv­ity, sub­ject­ing them to nor­mal in­come tax.

The Kenyan In­come Tax Act does not recog­nise vir­tual as­sets such as bit­coins. In such a case, an ag­grieved tax­payer not in­tend­ing to pay tax on gains em­a­nat­ing from bit­coins could move to the tax tri­bunal to chal­lenge such tax­a­tion, on the es­tab­lished ground that tax should be levied on es­tab­lished statu­tory rules rather than on in­tend­ment.

This there­fore orig­i­nates a case for law re­form. There is need to clearly de­fine vir­tual as­sets in the In­come Tax Act. Fur­ther, due to volatil­ity of bit­coins, it is im­por­tant to des­ig­nate in­come re­sult­ing from trad­ing in them as a spe­cific source of in­come. This will en­sure risk-tak­ing cur­rency spec­u­la­tors do not in­cur huge losses and off­set such losses from their gen­eral in­comes, de­priv­ing the coun­try of rev­enues.

Other is­sues that would ben­e­fit from statu­tory clar­ity are virtue in­come char­ac­ter­i­sa­tion, al­low­able de­duc­tions re­sult­ing from min­ing ac­tiv­i­ties, val­u­a­tion and in­come com­pu­ta­tion, and records to be kept.

The other tax­a­tion is­sue re­sults from the sale of goods and ser­vices for bit­coins. Hav­ing es­tab­lished Bit­coin as a com­mod­ity rather than money, such sale will there­fore con­sti­tute a barter trade. For pur­poses of tax­a­tion, in trans­ac­tions where con­sid­er­a­tion does not in­volve mone­tary amounts, the de­ter­mi­na­tion of value of the ex­changed ob­jects is the mar­ket value, this be­ing the amount an as­set could be ex­changed be­tween knowl­edge­able in­di­vid­u­als at arm’s length.

Trad­ing in bit­coins may also have VAT con­se­quences. In this case, sup­plies of bit­coins may con­sti­tute tax­able sup­plies. How­ever, since bit­coin does not have the sta­tus of a le­gal ten­der, the ex­emp­tion avail­able for fi­nan­cial ser­vices could be dis­ap­plied. It may there­fore be treated as sup­ply of elec­tronic ser­vices, which at­tracts VAT at a nor­mal rate.

Else­where, in the United King­dom, Her Majesty’s Rev­enue and Cus­toms (HMRC) is­sued a brief in 2014 on tax­a­tion of bbit­coins, clar­i­fy­ing that such in­come is sub­ject to the gen­eral rules of in­come tax and cap­i­tal gains tax. For VAT pur­poses, the HMRC brief out­lined that min­ing is out­side the VAT scope.

Fur­ther, ex­changes of Bit­coins into tra­di­tional cur­ren­cies are Vat-ex­empt. Sup­plies of goods and ser­vices for bit­coins are sub­ject to gen­eral VAT rules. If the KRA were to is­sue such a brief, there is a like­li­hood it would adopt the po­si­tion taken by HMRC.

Still, it will be chal­leng­ing to en­force tax on trad­ing in Bit­coins. The re­al­ity is trans­ac­tions take place anony­mously and usu­ally in a mul­ti­juris­dic­tional set­ting. There is no pa­per trail from which to con­duct a tax au­dit. Al­though the en­tire his­tory of Bit­coin trans­ac­tions is pub­licly avail­able, it is ex­tremely dif­fi­cult to trace the earn­ings ac­cu­mu­lated in a par­tic­u­lar wal­let back to a par­tic­u­lar tax­payer. It is un­likely that tax au­thor­i­ties would know about the in­come, un­less the tax­payer vol­un­teers it.

In the United King­dom, Her Majesty’s Rev­enue and Cus­toms is­sued a brief in 2014 on tax­a­tion of bit­coins ...bit­coin does not ful il the cri­te­ria of money in both eco­nomic and le­gal sense’’

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