In 1964, the Dave Clark Five pop group raised room temperatures with its foot-stomping hit “Bits and Pieces.”In 2017, the rise in bitcoin prices is again raising room temperatures.To add to the euphoria, some think there is a big Israeli tax loophole.[email protected]With a view to spoiling the fun, the Israel Tax Authority issued a draft tax circular on January 11 that details its position on the taxation of activity in virtual currencies such as bitcoins. We review the draft tax circular below. We do not comment on whether bitcoins are a good thing or a bad thing.The claimed loophole There is a school of thought that says bitcoins are a currency and that private individuals who invest in bitcoins or other virtual currencies are exempt on any appreciation against the shekel according to Israeli tax law.Is the bitcoin a currency? The draft circular concludes that the bitcoin is not a currency, so the above exemption cannot apply. The Bank of Israel Law (2010) only recognizes a currency that is legal tender or money in Israel or abroad, which rules out virtual currencies, according to the draft circular.Income tax treatment of virtual currencies The draft circular also rules out treating virtual currencies as securities, as they don’t meet the definition for this in the Securities Law (1968) or in the Income Tax Ordinance.Instead, the draft circular says a virtual currency is to be treated as an “asset,” which includes any property, tangible or intangible.Therefore, a sale of a virtual currency is generally liable to capital gains tax, which is reportable and payable within 30 days, at rates of 25%-28% for an individual. But if the seller is in business, i.e. trading, the sale is subject to income tax.The resulting income will be taxable at rates ranging up to 50% for an individual. Companies pay company tax at a rate of 24% on both capital gains and business income (in 2017), but dividend distributions therefrom to their shareholders will generally raise the combined Israeli tax burden to around 49%.According to the draft circular, business income may include marketing and sales of virtual currencies, or mining them. Mining in this context means “activity conducted by providing computing power in consideration for virtual coins.”The draft circular goes on to say that selling an asset or rendering a service in consideration for virtual currency amounts to two separately taxable barter transactions – first, income when supplying the asset or service in consideration for virtual currency, and second income from subsequently selling the virtual currency. In other words, the Israel Tax Authority wants tax at each stage, applying fair market value of the virtual currency. This value can be arrived at by looking at the website used to buy/sell the virtual currency or by looking at quoted prices for assets or products purchased. And for good measure, the purchaser must withhold 30% tax at source unless the seller holds confirmation for any lower rate from the Israel Tax Authority.Value-added tax According to the draft circular, virtual currency is an intangible asset that counts as “goods” for Israeli VAT purposes.Someone conducting marketing or mining will be considered as being a business liable to VAT. That means registering as a Dealer for VAT purposes. In the case of a one-time sale or mining transaction, the transaction is still reportable under the rules for one-time deals. The standard rate of VAT is currently 17%.Virtual currency tax audits The draft circular has advice for Israeli tax officials trying to understand what is going on: follow the money or the assets, ask for documents, letters clarifying transaction done, bank statements, screen photos and holding periods Comments Not surprising, the ITA wants it tax. The draft circular is not law or even final policy, but bitcoin holders are now on notice. The United States IRS apparently takes a similar view that bitcoins are property – selling something for a few bitcoins is like accepting diamonds in payment.One question unanswered is where are the bitcoins? On a cloud in Israel or abroad? Do olim get a 10-year tax exemption or not? Nevertheless, the draft circular is flawed in our view, and it remains to be seen if a final version will be issued.Even if this happens, the resulting circular won’t be as strong as a law passed by the Knesset. Stand by for more bits and pieces.As always, consult experienced tax advisers in each country at an early stage in specific cases.The writer is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.