Hearing of BMF dated August 19, 2021 on the Income Tax Treatment of Virtual Currencies and Tokens

On June 17, 2021, the German Federal Ministry of Finance (BMF) had 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 had been coordinated with the supreme tax authorities of the German states.

Subsequently, the BMF received numerous comments from various associations, most of which appreciated the general aim of the BMF letter to improve legal clarity and thus also planning certainty, but at the same time expressed extensive criticism on the partly undifferentiated tax classification of manifold constellations by a uniform attribution to certain generic terms (e.g. staking). In addition, there were concerns about a possible enforcement deficit and the taxpayer’s cooperation and recording obligations, for which the draft of the BMF letter could only provide placeholders.

In view of the strong headwind, the BMF felt the need to hold a hearing on the draft BMF letter on August 19, 2021, during which various representatives from the blockchain and crypto sector were able to comment again on controversial points of the draft and discuss them with representatives of the BMF. The basic willingness to discuss was thus given. However, anyone who had hoped that the BMF would now fundamentally turn away from key points of the draft BMF letter was disappointed. Instead, a finalized BMF letter is expected to be published in the near future, which will adopt the core points already contained in the draft largely unchanged and thus also bind all tax offices accordingly in all open and future cases.

Even if the modifications suggested by numerous parties are only considered to a very small extent, if any, we would like to provide a summary overview of the topics discussed on August 19, 2021 for all those who are interested:


1. Tax Asset Status of Virtual Currencies

The Federal Ministry of Finance maintains the asset status of virtual currency units and in this respect refers to the definition of tax assets used by the Federal Fiscal Court (Bundesfinanzhof, BFH) in its permanent jurisdiction. Unfortunately, there was no willingness to openly discuss a different opinion, e.g. the tax asset status of the respective private key or the problem of economic allocation.


2. Definition of virtual Currencies

In its draft, the BMF defined virtual currencies on the basis of Directive (EU) 2018/843 as

Digitally depicted units of currency that are not issued or guaranteed by any central bank or public agency and do not have the legal status of currency or money, but whose units are accepted by individuals or entities as a medium of exchange and can be transmitted, stored, and traded electronically.”

However, since Bitcoin will be permitted as an official payment instrument in El Salvador as of September 1, 2021, the above-mentioned definition would no longer be met for Bitcoin. The BMF seems to want to solve this “problem” by simply adapting the definition in such a way that Bitcoin is (again) considered a virtual currency.


3. Enforcement of the Taxation Claim

The BMF blocks the numerous objections regarding the lack of ability to enforce the tax claim, especially in connection with the sale of cryptocurrencies, by pointing out that “verification instruments” such as control notifications on the occasion of tax audits at domestic trading hubs would be available and that an international exchange of information is being negotiated at OECD and EU level.

The fact that a significant proportion of transactions are carried out via decentralized platforms, which by their nature do not have an information provider, is thus not taken into account, nor is the fact that with the “verification tools” currently available, at best only a very small proportion of all transactions could be traced in personal terms.


4. Commercial Activity due to Block Creation

In cases of block creation, which is associated with the keywords Proof of Work and Proof of Stake, a commercial activity is to be assumed in principle and a different classification can only be made on the basis of a case-by-case examination.


5. Block Creation as Acquisition Activity

Despite numerous opposing arguments and contrary to earlier statements by state tax authorities, the block rewards generated in the course of block creation are not supposed to be based on a production activity, but on an acquisition activity. In concrete terms, an exchange of computing power (also in the case of proof of stake) for block rewards is assumed. In this way, the possibility of fulfilling the requirements of a private sale transaction within the meaning of Sec. 23 para. 1 sentence 1 no. 2 of the German Income Tax Act (EStG) is enabled.

The BMF argues against a production activity that the block reward is already created in the genesis block and is not generated by the miner/validator. The BMF did not elaborate further on the argument with which a derivative acquisition transaction, i.e. an acquisition from a third party (acquisition), can be assumed in the case of mining.

6. Valuation when creating Blocks

With regard to the valuation of the block rewards “acquired” by the miner or validator, the BMF continues to refer to the market price at the time of acquisition, to be determined with the exchange price or, in the absence of an exchange price, on the basis of the average price of three trading platforms or web-based lists.


7. Purchases and Sales as Commercial Activity

The BMF once again confirmed that multiple purchases and sales alone do not constitute a commercial activity. For the distinction between private asset management and commercial activity, the criteria of commercial securities trading and not, for example, those of commercial gold trading are to be applied. The latter are not adequate, since in the case of virtual currencies – in contrast to gold – it is possible to extract earnings, e.g. by means of staking or lending.


8. Sequence of Use

With regard to the principle of case-by-case consideration and the possibility of applying sequences of use for the purpose of simplification, the BMF does not see any need for change.


9. Staking and Lending – Extension of Holding Periods and Other Income

One of the main points of criticism regarding the draft of the BMF letter was the approach to assume the use of cryptocurrencies as a “source of income” within the meaning of Sec. 23 para. 1 sentence 1 no. 2 sentence 4 EStG, in particular in the case of staking and lending, and thus an extension of the disposal periods to be observed to more than 10 years in order to avoid taxation of the capital gains as part of a private sales transaction. On this point in particular, the BMF adheres without restriction.

The BMF rejects the frequently raised argument that the provision in Sec. 23 para. 1 sentence 1 no. 2 sentence 4 EStG was created to avoid so-called container leasing transactions and comparable models, but that no comparable case exists in the case of staking or lending, and in this respect strictly follows the wording of the law, which does not contain any restriction to depreciable assets or tax saving vehicles.

In the hearing, the BMF also commented on a point that is very controversial in practice to the disadvantage of the taxpayer. As such, Sec. 23 para. 1 sentence 1 no. 2 sentence 4 EStG does not provide for a restriction to income generation in the first calendar year. Accordingly, in the case of staking and lending, the BMF assumes an extension of the holding period to be observed to more than 10 years even in the case of units of cryptocurrencies that could already be sold tax-free due to the expiry of the holding period of more than one year. Staking and lending then lead to income according to Sec. 22 no. 3 EStG, provided that there is no commercial activity.

The idea of moving away from taxation according to certain generic terms, such as staking or lending, in favor of taxation on the basis of the specific constellation in the individual case is also not taken into account. This means that the various types of staking are taxed in the same way, regardless of their differences, only because they fall under the umbrella term staking.


10. (Hard) Fork and Air Drop

With regard to these topics, the BMF was not only willing to discuss the matter, but was also visibly willing to give in. In terms of topics, in the case of a fork, the allocation of the acquisition costs of the original units of the virtual currency according to the ratio of the market prices of the new and the original units as well as, in the case of an airdrop, the existence of an acquisition activity and the assumption of income from (other) performance pursuant to Sec. 22 no. 3 EStG with regard to a consideration still assumed in the draft of the BMF letter should be mentioned here.

Next steps: The BMF has indicated that the final BMF letter will be published in the near future. Taking into account the hearing of August 19, 2021, the content of the final BMF letter should largely correspond to the draft of June 17, 2021. An initial addition will be made to include cooperation and recording obligations with prior consultation. In addition, a “further successive supplementation of the BMF letter with new matters” was indicated, with key words such as dead coins, delegated proof of stake, gaming tokens, layer 2 arrangements, liquidity mining, margin trading, non fungible tokens (including commissions on resale), off chain, option trading, stable coins, wrapping, yield farming and loss of keys.

It should be clear that there will be numerous disputes in the future, also with regard to facts that were carried out in the past but have not yet been disclosed to the tax authorities. Litigation before the tax courts, subsequent declarations and voluntary disclosures are terms that will be firmly associated with the income tax treatment of cryptocurrencies in Germany in the future.