On June 17, 2021, the German Federal Ministry of Finance (BMF) published a draft of a BMF letter on the income tax treatment of tokens in general and virtual currencies such as Bitcoin in particular, which was coordinated with the supreme tax authorities of the German states. The later finalized BMF letter is intended to provide practitioners in administration and business and individual taxpayers with a guideline on the income tax treatment of tokens and virtual currencies.
The content confirms the approaches already taken in the taxation practice of many tax offices, including in particular the taxation of sales or exchanges of cryptocurrencies as private sales transactions and the extension of the holding period in this regard to 10 years if coins are involved in the areas of Decentralized Finance (DeFi). In addition, however, positions are also taken that go beyond the previous taxation practice of some tax offices.
In the following, we summarize the main aspects of the draft BMF letter regarding the income tax treatment of so-called virtual currencies, which in our view are partly untenable.
1. Term “Virtual Currency”
Under section I. (points 1 – 22), various terms are explained in the draft BMF letter. In this framework, the term “virtual currencies” is first defined as digitally represented units of currency value that are not issued or guaranteed by any central bank or public authority and do not have the legal status of currency or money, but whose units of value are accepted by individuals or legal entities as a medium of exchange and can be transferred, stored and traded electronically.
2. Income Tax Classifications
The explanations are followed by section II. with a statement on the income tax classification regarding mining, sale of virtual currency units, virtual currency units received by way of a fork, initial coin offering, staking, lending and airdrop.
According to the draft of the BMF letter, mining is to represent an acquisition transaction and, depending on the circumstances of the individual case, may be private asset management or commercial activity. However, in the case of mining – irrespective of the amount of the expenses for hardware and electricity – it should be rebuttably presumed that a commercial activity exists. However, in the case of high costs for the acquisition of hardware and or high energy costs for the operation of the hardware, the intention to make a profit is to be examined.
The taxpayer’s income is said to include both the units of virtual currency received in connection with block creation and the transaction fees received by the taxpayer from network participants for verification of transaction data. Also included in the income should be the fees received from an operator of a mining pool for providing computer power.
The above statements shall also apply if several miners join together in a mining pool, whereby a mining pool – “depending on the contractual arrangement of the individual case” – may constitute a co-entrepreneurship.
The units of a virtual currency allocated for mining as well as the transaction fee remunerated in units of a virtual currency are to be acquired in the context of a transaction similar to an exchange, whereby the acquisition costs – derived from Sec. 6 para. 6 German Income Tax Act – are to correspond to the market price at the time of acquisition of the units of a virtual currency
If ming is not operated in the commercial but in the private sphere, the income derived from mining is to be taxable in accordance with Sec. 22 No. 3 German Income Tax Act.
4. Sale of Virtual Currency Units
The sale of units of a virtual currency shall also be possible in the private (asset management) as well as in the commercial sphere. In order to distinguish between these types of income, the criteria for commercial securities and foreign exchange trading are to be applied, according to which frequent purchases and sales alone do not constitute a commercial activity, even if a larger volume is achieved in the process.
Units of a virtual currency are to be regarded as “other assets” within the meaning of Sec. 23 para 1 sentence 1 no. 2 of the German Income Tax Act, since they are asset-based benefits that cost the acquirer something to obtain and are amenable to independent valuation.
Gains from the sale of units of a virtual currency held as private assets are – depending on the specific period between acquisition and sale – to be regarded as income from private sales transactions pursuant to Sec. 22 No. 2 in conjunction with Sec. 23 para. 1 sentence 1 no. 2 German Income Tax Act.
The acquisition for consideration required by Sec. 23 para. 1 sentence 1 no. 2 German Income Tax Act shall be fulfilled in particular in the following cases:
- units of a virtual currency are acquired in exchange for units of state currency (e.g. euro) or a good or service;
- the taxpayer obtains units of a virtual currency in exchange for units of another virtual currency, which shall include units of a virtual currency obtained through mining;
- the taxpayer receives units of a virtual currency or tokens as part of an airdrop, which results in income from other performance within the meaning of Sec. 22 No. 3 EStG.
Mirroring the acquisition, the following transactions shall constitute a sale:
- exchange of units of a virtual currency for units of a state currency (e.g. euro);
- exchange of units of a virtual currency for units of another virtual currency, goods or services.
For reasons of simplification, the acquisition and disposal date resulting from the wallet shall be decisive for the determination of the one-year period, whereby this period shall start anew after each exchange. In the event that the annual period is determined by an obligatory transaction under the law of obligations, the taxpayer shall have to prove the date of the conclusion of the contract by appropriate documents. For the determination of the annual period, the first in first out (FiFo) method on the units of a virtual currency shall be permissible, whereby an individual choice shall be made per wallet.
In particular, in the case of Lending and Staking, the divestment period under Sec. 23 para. 1 sentence 1 no. 2 sentence 4 German Income Tax Act is to be extended to 10 years as the units of a virtual currency or token are to be used as a source of income in these cases: Lending, Staking and Air Drop.
In the context of the determination of profits, the individual – if applicable amortized – acquisition costs of the sold units of a virtual currency shall in principle be decisive in each case. If the individual acquisition costs of the units of a virtual currency cannot be determined and individually allocated in a particular case, they shall be valued at the average acquisition costs.
The method chosen once – FiFo method or individual consideration – is to be applied to each individual wallet and is to be maintained until the units of a virtual currency in this wallet have been completely sold.
With regard to the cooperation and recording obligations, the draft of the BMF letter has not yet taken a position.
5. Units of Virtual Currency received by way of a Fork
In the case of a fork, the taxpayer shall have acquired for consideration the units of a new virtual currency as part of the units of the virtual currency existing prior to the fork. The acquisition costs of the units of the virtual currency existing prior to the fork shall be apportioned, whereby the apportionment standard shall generally be based on the ratio of the market prices of the units of the various virtual currencies at the time of the fork.
For units held as private assets, it should be ensured that the acquisition date of the units of the new virtual currency corresponds to the acquisition date of the units of the virtual currency existing prior to the fork.
6. Initial Coin Offering
The tokens issued in the context of an ICO should – depending on their structure – be able to represent both equity capital (provision of capital in perpetuity) and debt capital (provision of capital for a limited period of time) for the issuer and should be assessed in the balance sheet according to their legal content and recognized accordingly. In addition, tokens are to represent internally produced assets for the issuer, which are generally to be capitalized at production cost. If the terms of issue of the tokens result in contractual obligations to the holders of the tokens, these should be recognized as a liability or provision, if applicable.
In the case of a balance sheet acquirer, the issued tokens are to be recognized – depending on the legal position – either as assets under financial assets or as receivables.
For tokens held as private assets, the income tax classification of the income is to depend on which rights and claims the issued tokens convey in the individual case. In the case of Utility Tokens, the mere redemption shall be irrelevant under income tax law. In the case of the sale of Utility Tokens, the gain/loss from the sale – depending on the holding period – shall result in income from private sales transactions pursuant to Sec. 22 no. 2 in conjunction with. Sec. 23 para. 1 sentence 1 no. 2 German Income Tax Act, whereby the use of the token as a means of payment is also considered a disposal. If a Security Token is a kind of debt security in the form of a capital claim within the meaning of Sec. 20 para. 1 no. 7 German Income Tax Act, income received during the holding period shall lead to current income from capital assets. A sale of the token shall fall within the scope of Sec. 20 para. 2 sentence 1 no. 7 German Income Tax Act. If tokens are provided to employees free of charge or at a reduced price, in individual cases a cash benefit within the meaning of Sec. 8 para. 1 German Income Tax Act or a benefit in kind within the meaning of Sec. 8 para. 2 sentence 1 German Income Tax Act may exist. In the case of a payment in kind, an inflow is to be assumed as a rule at the time of entry in the wallet, but at the earliest at the time at which either the tokens are traded on the stock exchange or can be used as a means of payment or are assigned to third parties against payment.
If the taxpayer receives units of a virtual currency by way of staking or as a masternode, he shall generate income with it, which shall be qualified in the private sector as income from other performance according to Sec. 22 no. 3 German Income Tax Act. This shall also apply in the case of cold staking.
Income generated by the taxpayer in the private sphere by way of lending shall (also) be qualified as income from other performance pursuant to Sec. 22 no. 3 German Income Tax Act.
If the taxpayer receives units of a virtual currency by way of an airdrop, it shall generate income which shall be qualified as income from other services in the private sphere pursuant to Sec. 22 no. 3 German Income Tax Act. In the context of an airdrop, a service provided by the taxpayer within the meaning of Sec. 22 no. 3 German Income Tax Act is to be assumed in any case if the taxpayer provides personal data to the issuer for this purpose.