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Expectations that Israel could become a major center for cryptocurrency trading have been dampened by guidelines published by the Israel Tax Authority that hurt the chance of the industry developing, tax practitioners have warned.
Unlike a regular currency, the Israel Tax Authority will regard an increase in the value of a cryptocurrency as a capital gain rather than an exchange fluctuation, making it subject to capital gains tax. Individual investors will not be liable for value-added tax, but anyone engaging in cryptocurrency mining will be classified as a “dealer” and subject to VAT, according to the circular.
Anyone trading as a business will be classified as a “financial institution” for tax purposes, meaning that they will be unable to reclaim VAT on expenses but will be subject to an extra 17 percent “profit tax” applied to financial institutions.
“That’s the killer,” Yitzchak Chikorel, partner and head of international taxation at Deloitte in Tel Aviv said Feb. 20, since it will “add an additional layer of taxation.”
The Israel Tax Authority’s Circular 05/2018, published Feb. 19—a year after a draft was issued—defines cryptocurrencies as “distributed methods of payment” and classes them as “financial assets” for tax purposes. The circular doesn’t address security and utility tokens, currently the subject of a parallel consultation.
“If you’re a trader, you pay rent, you pay for computers, you pay for advisers. If you are classified as a financial institution, you are not allowed to claim back the VAT. For the token-holders that are considered to be traders, the tax hit and VAT hit are dramatic,” Chikorel said.
If traders decide to go ahead despite the heavy tax burden, “I’m afraid they will try to find ways to avoid it,” he said. “It’s like encouraging someone to develop artificial means in order to hide activities or to reshape it, which I would try to avoid.”
The guidelines also provide practitioners with substantial space for creativity. “The distinction between capital and regular income provides you with a variety of room to negotiate and to speak about court decisions and the differences are huge,” Chikorel said.
The authority doesn’t distinguish between active cryptocurrency miners and people who rent out excess computer capacity for others to mine. “It’s very problematic,” he said. “In such a case, the rental is not business. It’s got the nature of passive activity which may trigger different tax results.”
The authority’s decision to classify cryptocurrencies as financial assets subject to capital gains tax also imposes a burdensome reporting requirement that will further deter traders, said Vered Meller, a tax partner at Shibolet and Co. law firm in Tel Aviv.
“According to the tax ordinance, if it’s a capital gain, you have to report each time you sell within 30 days,” Meller told Bloomberg Tax Feb. 20. “If you have more than one trade and you have to report each currency that you sell then it involves a lot of bureaucracy.”
Tax authority officials have mentioned the possibility of a possible reporting exemption and less frequent semi-annual or annual reporting for cryptocurrency traders at professional conferences, but this isn’t addressed in the circular, Meller said.
The audit guidelines set out in the final section of the circular requires traders to retain copies of all documentation on each trade—including bank accounts of the buyer and seller and computer screenshots—to prove they bought and sold the cryptocurrency at the declared value, creating a burdensome paperwork requirement that will further deter traders.
“The bureaucracy will kill the business,” Meller said.
The tax authority’s insistence that bitcoin and other cryptocurrencies are an asset, even though it recognizes that they can be used for payments and trading is based on “the definition of ‘foreign currency’ as defined in the Bank of Israel Law, though the definition isn’t suited to today’s reality,” said Ayelet Hillel-Birenzwig, senior tax partner at Shekel and Co. law firm in Tel Aviv.
“According to the tax authority, the Bitcoin is neither a tangible currency nor a legal tender in a foreign country. It seems that this position can be disputed—even all our regular deposits in the bank are not tangible—and certainly they are currencies rather than assets,” Hillel-Birenzwig said in a Feb. 20 email. “Bitcoin has also been approved in several countries in certain regulatory procedures, and it appears that at least in Japan it is difficult to say that this is not a legal tender.”
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