On February 19, the government published a joint warning regarding bitcoins and other virtual currencies.It was from the Israel Tax Authority, the Bank of Israel, the Capital Markets Division, the Securities Authority and the Anti Money Laundering Authority. Then on February 28, the Mt. Gox bitcoin exchange reported losing around 750,000 bitcoins due to fraud, representing about 7 percent of the bitcoins in circulation. It has now filed for bankruptcy protection. That is aside from dramatic fluctuations in the value of a bitcoin.The bitcoin is generated by a network of computers and is unregulated. Right now, it seems to be down but not out, or is it? The Israeli government warning lists a number of risks associated with bitcoins. In particular, the bitcoin is not legal tender anywhere and is not backed by any central bank.[email protected] Leon Harris is a certified public accountant and tax specialist at Harris Consulting & Tax Ltd.As it can be transferred anonymously, this creates heightened money-laundering and terrorism-financing risks for financial institutions. Ponzi schemes and other types of fraud are possible. A Ponzi fraud is one in which high investment returns are promised, but they are actually paid out of other investors’ money.Also, virtual-currency transactions cannot be canceled and money cannot be returned to dissatisfied customers.In addition, there have been sharp fluctuations in the value of bitcoins. Generally, the bitcoin players and bitcoin trade are not regulated and can disappear with people’s money without trace.The Israeli government’s warning comes hot on the heels of similar warnings from the US, Canada and the EU.Tax comments On the economic and commercial side, there are clearly risks. On the Israeli tax side, there are uncertainties too, but the Israeli government ruling is silent about them. For example, if the bitcoin is not legal tender, at what value do you record purchases or sales of items in bitcoins? Presumably at their market value on the date of the transaction. It is generally accepted that even illegal transactions are taxable. But if the bitcoin value declined by the time payment was made, do you substitute the payment-date value? And at the end of the year, if you are sitting on a pile of bitcoins that have declined in value, can you recognize unrealized losses in your financial statements and tax return? Similarly, if the bitcoins’ value has gone up, do you have to recognize unrealized gains for tax purposes? If you are a passive investor in bitcoins, you will probably recognize gains or losses in shekel terms on a cash basis. But Section 8C of the Income Tax Ordinance prescribes that you must recognize exchange-rate differences on the accrual basis – when they arise – even if the taxpayer normally reports gains or losses on a cash basis. If you are in business and using bitcoins, you will normally apply the accrual basis anyway.If you are asked to file a capital declaration (hatsharat hon) as of the end of a tax year, you will presumably list bitcoin holdings at cost in shekels, not at market value.So much for income tax. What about VAT? Section 7 of the VAT Law states that the price of a transaction is the agreed upon consideration, including any taxes and expense reimbursements. There are detailed VAT timing rules for recognizing transactions – basically, when goods are delivered or when services are provided.If a transaction is denominated in foreign currency, the shekel figures must be stated on the tax invoice.Will we soon see tax invoices with figures in bitcoins and shekels? To sum up, we are warned that the bitcoin isn’t legal tender, which leaves many open questions on the taxation of bitcoin transactions. Tax planning may ensue.As always, consult experienced tax advisers in each country at an early stage in specific cases.