The currency is virtual, yet the tax is tangible

A cryptocurrency transaction may lead to involuntary tax noncompliance.

le bitcoin, une nouvelle monnaie virtuelle (photo credit: DADO RUVIC/REUTERS)
le bitcoin, une nouvelle monnaie virtuelle
(photo credit: DADO RUVIC/REUTERS)
In recent years, a new field has made its way into the economic reality – the field of virtual currencies.
Much has been said on this subject, and it seems to embody multiple advantages and disadvantages, but mainly a lack of clarity.
Is this a passing trend or the “real deal”? Only the future will tell. However, these currencies have a strong presence in many people’s lives and they require proper attention and regulation.
Taxation is one of the most prominent issues remaining vague in this context.
Due to the ambiguity surrounding this field, some of those investing in currencies either don’t report their transactions to the Tax Authority or report in a noncompliant manner that is inconsistent with the income tax provisions. Tax Authority publications indicate that the currency market players “are being watched.”
As a result of the current lack of clarity regarding the classification of virtual currencies for tax purposes, many Israelis engaged in the field of cryptocurrency may find themselves in the exclusive group of “tax non-compliers,” in case they either have not reported or reported in a way that is not aligned with the Tax Authority’s position. Moreover, those market players may even discover that they are obligated to pay taxes and fines they never expected, sometimes even if they have not yet received any cash money.
For example, an individual decides to exchange a previously bought cryptocurrency for another cryptocurrency. In practice, he did not seen the money yet, but still might already be obligated to pay taxes, even if at the end of the day his transactions resulted in a loss.
A large part of the population is not acquainted with all tax-related nuances and most often there is no need for such proficiency, since there are established tax collection mechanisms, such as withholding tax.
The capital market is a good example, since the Tax Authority requires banks to serve as tax collectors. Banks withhold tax at the source from capital gains, dividends and interests of the investors and transfer it to the Tax Authority. In the field of currencies, there are still no suitable mechanisms and market players can play on, without anyone or anything drawing their attention to the existing tax issues.

Position of the Tax Authority
The Tax Authority has been deeply engaged in regulations regarding tax and reporting liabilities stemming from cryptocurrency transaction. Recently, the authority published two professional circulars on this matter, in addition to making a tax decision regarding proper accounting by businesses receiving payments in cryptocurrency. However, there are multiple issues of major significance that have not yet been regulated.
In a nutshell, the Tax Authority’s position is that a cryptocurrency is not classified as a currency but as an asset.
This position has quite a few ramifications, since as a rule, one’s profits resulting from currency exchange-rate differences may be exempt from tax, while profits resulting from an asset’s increase in value are not protected in the same manner. And it seems that treating digital currencies as an asset may impose a serious burden on the market players both in terms of tax liability and in terms of reporting.
For example, an individual decides to buy cryptocurrency and after a while exchange it for another cryptocurrency with another individual. Since cryptocurrencies are classified as assets, the transaction will be classified as an exchange transaction that creates a tax event for both parties. Imagine a situation in which the currency received in exchange for the previous currency is sold in shekels for a lower amount than the original purchase price. It is clear that the entire transaction resulted in a loss. However, if the exchange transaction is not carried out during the year in which the sale is finalized, then the seller is obligated to pay tax.
Another possible case concerns payments via cryptocurrency. If the value of the currencies has increased since the date of their purchase, then the Tax Authority believes that the payment may constitute realization and use of profit embodied in the currency, which is taxable and should be reported. In addition, questions may arise regarding the liability to deduct a withholding tax by cryptocurrency buyers or by those who receive cryptocurrency in exchange for services.
These are only a few examples of possible implications.

Problems in practice
Since this field has not yet been properly regulated, many Israelis who buy, exchange and pay by cryptocurrency, took different positions – some more aggressive and some less – as to the proper taxation method in this regard.
When it comes to private dealers, the problem intensifies, since most of them are not obligated to submit tax reports. The same private dealers who engaged in this market, who pay taxes in compliance with the law, may all of a sudden be considered “tax non-compliers” (or “tax offenders,” if you will), and might one day be presented with harsh accusations that would be completely unexpected.

What can be done?
In either case, we believe that in certain cases it is possible to examine additional ways of proper legal analysis, even if they are inconsistent with the Tax Authority publications. To those private dealers engaged in the field of cryptocurrency, we would recommend to review these issues according to their specific circumstances, and consider approaching the Tax Authority for the purpose of settling their crypto-activity.
With regard to cryptocurrency market players who want to examine the option of making necessary arrangements with the Tax Authority, we would like to emphasize that in our opinion, such step should be taken very carefully, after reviewing all the specific circumstances, which are unique for each player.

The writers are heads of the tax and international taxation departments at RSM–Shiff Hazenfratz & Co. CPA. This article does not constitute a legal opinion. Consulting with a tax expert prior to taking action.