Cryptocurrencies - Bitcoins and Taxes

What are bitcoins?

Bitcoins can be defined to as digital means of payment which are independent of central banks and which are sold through the internet. They are neither money nor legal tender. Like most other cryptocurrencies, bitcoins are administered in a so-called block chain. In this process, data blocks are attached to a data set in accordance with fixed rules. This stringing together of the data blocks constitutes the block chain. 

Why do we need a wallet (electronic wallet)?

A so-called wallet is needed for the acquisition or sale of bitcoins. The "wallet" is software which is installed on the computer and administers bitcoins and other cryptocurrencies. A so-called "public key" and a so-called "private key" are required for transmission processes. The public key can be compared to an access PIN or a mailbox key; while the private key can be compared with an account number or a mailbox address. After the purchase of cryptocurrencies, the PIN is stored in a so-called exchange. It grants secure access to the coins stored in the block chain. There are so-called "wallets" for safekeeping of private keys. These can be compared with wallets in which the PIN for a bank account is kept. This wallet then contains the access data to the coins which are located in the block chain.

Taxation of cryptocurrencies in private assets

Private mining of cryptocurrencies

If cryptocurrencies are held as part of private assets, both the so-called mining and the sale/purchase of coins can result in tax consequences. In terms of tax legislation, occasional private mining constitutes a hobby in principle. This means that profits are not liable to tax and losses cannot be asserted as reducing tax. However, the sale of self-mined cryptocurrencies does not constitute any taxable private sales transaction according to art. 22 no. 2 in conjunction with art. 23 section 1 sentence 1 no. 2 EStG. The verification of transactions, on the other hand, is liable to tax as other income according to art. 22 no. 3 EStG.

Purchase and sale of cryptocurrencies in private assets

Profits from the sale of cryptocurrencies held as private assets are taxable as income from private sales transactions according to art. 22 no. 2 in conjunction with art. 23 section 1 sentence 1 no. 2 EStG provided less than a year has elapsed between the purchase and the sale. According to art. 11 section 1 sentence 1 EStG, the time of accrual is material for taxation, for which, in turn, economic control - i.e. crediting to the account upon cashing out in Fiat money - is decisive. The profit is defined as the difference between the sales price and the costs of acquisition. In this process, the costs of disposal are based on the sales price (e.g. market platform fees, transaction fees or the price for the services); while the costs of acquisition are based on the purchase price plus any possible ancillary costs of acquisition (e.g. market platform fees and transaction fees). Only the costs connected with the sales transaction can be deducted as professional expenses; however, this does not apply to those costs connected with the acquisition which are not part of the costs of acquisition (e.g. financing costs). As regards profits, there is a tax exemption limit (not a tax allowance) of €600.00 per annum. Losses on disposal from private sales transactions can only be offset with profits from private sales transactions. However, in addition, there is the possibility to deduct losses according to art. 10d EStG with the result that offsetting with income from the following or previous assessment period is also possible. 

Exception from the ten-year period (art. 23 section 1 sentence 1 no. 2 sentence 4 EStG?

In order to generate additional revenue, coins are lent by their holders via so-called lending bots (bitcoin lending). In terms of taxation, we have to differentiate between the taxation of interest income and the possible effects under section 23 EStG here. In the case of terminologically correct designations, lending of cryptocurrencies would not result in any income since lending is effected free of charge so that interest is not paid. Instead, this refers to those cases of lending which are effected via on-line exchanges to other traders. If the taxpayer receives interest for such lending, e.g. in the form of coins in this cryptocurrency, this is not classified as income according to art. 20 section 1 no. 7 EStG since the income would have to result from other capital claims. However, this income is subject to art. 22 no. 3 EStG. In principle, this includes income from services provided such are not classified either as other types of income or as income within the meaning of art. 22 no. 1, 1a, 2 or 4 EStG, which also includes transfers of use. The payment of cryptocurrencies as remuneration can also be included in this. Art. 22 no. 3 sentence 2 EStG provides for an exemption limit of up to € 256.00 per calendar year for this. If income is generated from cryptocurrencies in, at least, one calendar year, e.g. by lending such, the speculation period according to art. 23 section 1 sentence 1 no. 2 sentence 4 EStG might be extended from one year to ten years with the result that profits from the sale of such are only tax-free after a period of ten years instead of one year. In practice, this extension of the speculation period to ten years is frequently overlooked. However, according to the legislator's wishes, the provision of art. 23 section 1 sentence 1 no. 2 sentence 4 EStG should be understood as an abuse-preventing provision to avoid tax saving schemes so that, in our opinion, an extension should probably not apply. However, in the relevant literature, the opposite view is also expressed - albeit without more detailed explanations - that the extended ten-year sales period should also apply to virtual currencies. If cryptocurrencies are bought and sold at different times, this leads to the question of which concrete coins are to be sold in each case. In this connection, the literature largely focuses on the so-called FIFO (first in - first out) method by referring to art. 23 section 1 sentence 1 no. 2 sentence 3 EStG. According to this, it is assumed that the coins purchased first are also sold first. However, there is no FIFO obligation. If the coins can be individualised, in our opinion, an individual assessment is also possible. In addition to this, the possibility of average assessment is also being discussed. However, in our opinion and with a view to the BFH jurisdiction regarding driver's logbooks, keeping of an Excel spreadsheet listing the exchange and the number of coins purchased is not sufficient for individualisation. But, in order to avoid the FIFO method, the existing coins can also be moved to another wallet. To be more precise, it is not the coins in the cryptocurrency which are moved; instead, the private key which provides access to the coins connected with this key is stored in the wallet. If the coins are held at different exchanges, the FIFO method is also not applied. In this context, only the coins of a cryptocurrency which is already at the exchange at which the sale is effected are sold. Therefore, any mixing is excluded.

Private mining of cryptocurrencies

If cryptocurrencies are held as part of private assets, both the so-called mining and the sale/purchase of coins can result in tax consequences. In terms of tax legislation, occasional private mining constitutes a hobby in principle. This means that profits are not liable to tax and losses cannot be asserted as reducing tax. However, the sale of self-mined cryptocurrencies does not constitute any taxable private sales transaction according to art. 22 no. 2 in conjunction with art. 23 section 1 sentence 1 no. 2 EStG. The verification of transactions, on the other hand, is liable to tax as other income according to art. 22 no. 3 EStG.

Purchase and sale of cryptocurrencies in private assets

Profits from the sale of cryptocurrencies held as private assets are taxable as income from private sales transactions according to art. 22 no. 2 in conjunction with art. 23 section 1 sentence 1 no. 2 EStG provided less than a year has elapsed between the purchase and the sale. According to art. 11 section 1 sentence 1 EStG, the time of accrual is material for taxation, for which, in turn, economic control - i.e. crediting to the account upon cashing out in Fiat money - is decisive. The profit is defined as the difference between the sales price and the costs of acquisition. In this process, the costs of disposal are based on the sales price (e.g. market platform fees, transaction fees or the price for the services); while the costs of acquisition are based on the purchase price plus any possible ancillary costs of acquisition (e.g. market platform fees and transaction fees). Only the costs connected with the sales transaction can be deducted as professional expenses; however, this does not apply to those costs connected with the acquisition which are not part of the costs of acquisition (e.g. financing costs). As regards profits, there is a tax exemption limit (not a tax allowance) of €600.00 per annum. Losses on disposal from private sales transactions can only be offset with profits from private sales transactions. However, in addition, there is the possibility to deduct losses according to art. 10d EStG with the result that offsetting with income from the following or previous assessment period is also possible. 

Exception from the ten-year period (art. 23 section 1 sentence 1 no. 2 sentence 4 EStG?

In order to generate additional revenue, coins are lent by their holders via so-called lending bots (bitcoin lending). In terms of taxation, we have to differentiate between the taxation of interest income and the possible effects under section 23 EStG here. In the case of terminologically correct designations, lending of cryptocurrencies would not result in any income since lending is effected free of charge so that interest is not paid. Instead, this refers to those cases of lending which are effected via on-line exchanges to other traders. If the taxpayer receives interest for such lending, e.g. in the form of coins in this cryptocurrency, this is not classified as income according to art. 20 section 1 no. 7 EStG since the income would have to result from other capital claims. However, this income is subject to art. 22 no. 3 EStG. In principle, this includes income from services provided such are not classified either as other types of income or as income within the meaning of art. 22 no. 1, 1a, 2 or 4 EStG, which also includes transfers of use. The payment of cryptocurrencies as remuneration can also be included in this. Art. 22 no. 3 sentence 2 EStG provides for an exemption limit of up to € 256.00 per calendar year for this. If income is generated from cryptocurrencies in, at least, one calendar year, e.g. by lending such, the speculation period according to art. 23 section 1 sentence 1 no. 2 sentence 4 EStG might be extended from one year to ten years with the result that profits from the sale of such are only tax-free after a period of ten years instead of one year. In practice, this extension of the speculation period to ten years is frequently overlooked. However, according to the legislator's wishes, the provision of art. 23 section 1 sentence 1 no. 2 sentence 4 EStG should be understood as an abuse-preventing provision to avoid tax saving schemes so that, in our opinion, an extension should probably not apply. However, in the relevant literature, the opposite view is also expressed - albeit without more detailed explanations - that the extended ten-year sales period should also apply to virtual currencies. If cryptocurrencies are bought and sold at different times, this leads to the question of which concrete coins are to be sold in each case. In this connection, the literature largely focuses on the so-called FIFO (first in - first out) method by referring to art. 23 section 1 sentence 1 no. 2 sentence 3 EStG. According to this, it is assumed that the coins purchased first are also sold first. However, there is no FIFO obligation. If the coins can be individualised, in our opinion, an individual assessment is also possible. In addition to this, the possibility of average assessment is also being discussed. However, in our opinion and with a view to the BFH jurisdiction regarding driver's logbooks, keeping of an Excel spreadsheet listing the exchange and the number of coins purchased is not sufficient for individualisation. But, in order to avoid the FIFO method, the existing coins can also be moved to another wallet. To be more precise, it is not the coins in the cryptocurrency which are moved; instead, the private key which provides access to the coins connected with this key is stored in the wallet. If the coins are held at different exchanges, the FIFO method is also not applied. In this context, only the coins of a cryptocurrency which is already at the exchange at which the sale is effected are sold. Therefore, any mixing is excluded.

If cryptocurrencies are held as part of the business assets, we have to differentiate on the basis of whether the company concerned prepares a balance sheet according to art. 4 section 1 EStG or prepares cash-based accounting statements according to art. 4 section 3 EStG. In principle, the general accounting and valuation principles apply to cryptocurrencies held as part of the business assets according the North Rhine-Westphalian regional fiscal administration (OFD NRW).

a) Taxpayers with balance sheet accounting (art. 4 section 1 EStG)

Cryptocurrencies are not legal tender, which means that there is no obligation to accept these virtual currencies. Moreover, the classification under the accepted meaning of "money" does not apply and it does not constitute book money since there is no claim towards a banking institute in the form of credit. A classification as "e-money" does not apply since there is no claim towards an issuer regarding the execution of payment transactions. 

If mining is found to have a commercial character in this case, this is classified as commercial activity with the result that corporation tax and trade tax and/or income tax are incurred.

Cryptocurrency coins have to be classified as intangible assets or property assets. Because of their high practical marketability these constitute an asset benefit and have to be capitalised in the commercial balance sheet according to art. 246 section 1 sentence 1 HGB [German Commercial Code]. In principle, cryptocurrency coins have to be allocated to current assets since these are assets held for immediate sale or for use as a means of payment or since they are held with speculative intentions so that, in principle, they only remain in the company for a short time. As a result, optional capitalisation according to art. 248 section 2 HGB does not apply. Since, in mining, the machine capacity is more dominant that the human effort, an exchange of computer capacity against an intangible asset having the character of compensation does not apply, even though this view is occasionally found in literature. Therefore, this is a self-made intangible asset which has to be capitalised.

In terms of tax legislation, there is a capitalisation ban for self-made intangible assets of capital assets according to art. 5 section 2 EStG. Since, however, cryptocurrency coins have to be allocated to the current assets, in principle, capitalisation of these is mandatory. The ban on capitalisation on applies in cases in which the coins are intended to permanently serve the business operations with the result of their allocation to capital assets.

Initial recognition is effected at production costs according to art. 253 section 1 HGB R 6. 3 EStR [Income Tax Directive], art. 6 section 1 no. 2 sentence 1 EStG, which are based on art. 255 section 2 HGB, art. 5 section 1 sentence 1 clause 1 EStG. In detail, this includes material costs, production costs, the special costs of production as well as adequate parts of the material overheads, the production overheads and the depreciation of capital assets in as far as this was caused by the production (art. 255 section 2 sentence 2 HGB).

The taxable profit established according to art. 4 section 1 EStG by balancing of accounts is subject to both corporation tax according to art. 1 section 1 no. 1 KStG [German Corporation Tax Act] and trade tax according to art. 2 section 1 sentence 1 GewStG [Trade Tax Act].

b) Taxpayers with cash-based accounting (art. 4 section 3 EStG)

Taxpayers with cash-based accounting determine their profits on the basis of the surplus of operating revenue over operating expenses according to art. 4 section 3 EStG. Costs incurred in the framework of mining can be deducted as immediately deductible operating expenses, including the electricity costs incurred, the rent for the server room and the depreciation of the hardware needed. Operating revenue includes any and all revenue resulting from mining.

The restrictions in art. 4 section 3 sentence 4 EStG according to which, in certain cases, the costs of acquisition or production can only be considered as operating expenses at the time of accrual of the sales proceeds or, in the case of withdrawal, at the time of withdrawal does not apply here since cryptocurrencies are neither securities nor comparable securitised claims or rights. 

a) Taxpayers with balance sheet accounting (art. 4 section 1 EStG)

In terms of commercial legislation, a capitalisation requirement arises under art. 246 section 1 sentence 1 HGB (as in the case of mining) since cryptocurrencies are intangible assets.

Under tax legislation, cryptocurrencies as intangible assets have to be capitalised in the tax balance sheet if they are allocated to current assets - which is generally the case. If, as an exception, they are allocated to capital assets, balance sheet recognition is only possible if the cryptocurrency was acquired against payment - as in the case of a purchase, art. 5 section 2 EStG.

Initial recognition is effected in accordance with art. 253 section 1 sentence 1 section 4 HGB, art. 6 section 1 no. 2 sentence 1 EStG at costs of acquisition based on art. 255 section 1 HGB, art. 5 section 1 sentence 1, clause 1 EStG. This also frequently includes ancillary costs of acquisition, such as e.g. transaction fees or fees for using trading platform, while so-called wallet fees are not included since there is no individual allocation in this respect. However, these fees have to be considered as operating expenses which can be deducted immediately. Purchase price reductions can be deducted in accordance with art. 255 section 1 sentence 3 HGB.

As regards subsequent assessments, the provision regarding cost assessment according to art. 253 section 4 section 5 sentence 2 HGB, art. 6 section 1 no. 2 sentence 2, e EStG is material in case of price fluctuations. In terms of trade law, a lower partial value has to be assessed according to art. 253 section 4 HGB (strict lower-of-cost-or-market principle) if the value declined between the date of receipt and the balance sheet date regardless of whether this is a permanent or a probably temporary reduction in value. Reversely, according to art. 253 section 5 sentence HGB, there is a prohibition on reversals of impairments provided these reasons have ceased to apply. This is the case if the price has recovered by the next balance sheet date.

In terms of tax legislation, on the other hand, the current cost method requires a probably permanent reduction in value according to art. 6 section 1 no. 2 sentences 2 and 3 EStG. According to BMF letter dated 02/09/2016 (IV C6-S2117-B/09/10002 002), additional facts providing information on the value are required in this respect. According to this, a probably lasting reduction in value applies if the reduction persists until the time at which the balance sheet is prepared or the previous date of sale or consumption. In this process, additional findings providing information on value until that date have to be included as of the balance sheet date. In the case of securities listed or traded on an exchange or based on a share index, a probable permanent reduction in value applies if the exchange value on the balance sheet date has fallen to below the value at the time of acquisition and the price loss has exceeded the de-minimis limit of 5% of the price on acquisition. Because of the comparability of cryptocurrencies with securities outlined above, the existing provision for securities has to be applied accordingly here. However, one problem is, that there is no fixed value for cryptocurrency (as e.g. in the case of gold) since this value fluctuates from one on-line exchange to the other. Therefore, it is advised that the values of wallets be compared with each other in all cases.

The gain or loss on disposal is established on the basis of the difference between the accounting value and the sales price. If coins of a cryptocurrency are bought and sold in several tranches, this leads to the question of which concrete coins are to be bought in each case. In this context, the so-called LIFO (last in - first out) method according to art. 6 section 1 no. 2a EStG applies under which it is assumed that the last coins purchased will be sold first.

a) Companies with cash-based accounting (art. 4 section 3 EStG)

In contrast to the determination of profits according to art. 4 section 1 EStG, there are only a few particularities regarding the sale and purchase of cryptocurrencies by companies with cash-based accounting: 

In this process, the costs of acquisition incurred in the purchase of cryptocurrencies can be deducted as immediately deductible operating expenses. During the sale, operating revenue is generated in the amount of the sales proceeds. For the reasons outlined above, the restriction under art. 4 section 3 sentence 4 EStG does not apply here either. The sequence of use is immaterial in this case, since there is no accounting value.

In addition to the purchase or sale of cryptocurrencies and the mining of such, there is a third tax-related situation - the use of cryptocurrencies as a fee for the acquisition or sale of goods or services.

a) Taxpayers with balance sheet accounting (art. 4 section 1 EStG)

aa) Commodities

The use of cryptocurrencies as the price for the purchase of goods constitutes the exchange of two assets according to art. 6 section 6 EStG since - as outlined above - cryptocurrencies are also classified as assets rather than legal tender.

In terms of trade law, the fair value of the performance provided is material for the costs of acquisition of the asset received. In terms of tax law, the fair market value of the asset provided during the acquisition process is material (art. 6 section 6 EStG); however, in this case, a potential cash payment with regard to this has to be taken into account.

The sales price is based on the value of the asset provided; as a result of this, the value of the coins of a cryptocurrency is material if an asset is purchased against payment in a cryptocurrency.

In accordance with art. 6 section 6 sentence 1 EStG, the sales proceeds are determined on the basis of the difference between the book value of the cryptocurrency coins and the fair market value. However, to ensure comparability, the values of the same on-line exchange should always be used.

bb) Services

The exchange of cryptocurrencies for services also constitutes a trade-off according to art. 6 section 6 EStG. The revenue corresponds to the amount of the fee agreed. The time at which the service is performed and, as a result, the time at which the receivable is recognised is material for profit realisation. Apart from this, the same rules apply as in the case of the acquisition of an asset.

a) Taxpayers with cash-based accounting (art. 4 section 3 EStG)

aa) Commodities

In the case of a company/taxpayer with cash-based accounting, the acquisition or sale of goods against cryptocurrencies also constitutes a trade-off within the meaning of art. 6 section 6 EStG. Operating expenses are incurred in the amount of the fair market value (art. 9 BewG [German Valuation Law]) of the asset provided, while the operating revenue corresponds to the fair market value of the asset purchased. If the asset acquired is allocated to current assets, the operating expenses can be deducted immediately. Moreover, art. 4 section 3 sentence 4 EStG does not apply here (cf. above with regard to this). If the cryptocurrency is exchanged into Fiat money later on, operating revenue is generated that is the amount of the revenue less any fees incurred.

bb) Services

If a company/taxpayer with cash-based accounting trades cryptocurrencies for a service or receives a fee in cryptocurrency for a service, this also constitutes a trade-off within the meaning of art. 6 section 6 EStG. The operating expenses or operating revenue each amount to the fair market value of the consideration received. In the event of a later exchange of the cryptocurrency into Fiat money, operating revenue to the amount of revenue less any fees incurred is generated