German Federal Ministry of Finance issues draft decree on income tax treatment of virtual currencies and tokens

Germany

Until now, the classification of crypto currency revenue into taxation regimes in Germany was based on publications by the Hamburg Tax Authority, the Regional Tax Office of North Rhine Westphalia, tax court proceedings in provisional and protective measures, and research results in the tax law literature. The German Federal Ministry of Finance (BMF), however, is changing this with its issuance of a draft decree on the tax treatment of crypto currency revenue.

Motive: Guidelines on the income tax treatment of virtual currencies and tokens

It is already clear upon first reading of the draft now available that this draft is by no means complete. The BMF has noticed the high speed at which business models in the crypto scene are being developed, resulting in the constantly changing appearance of digital products. As a result, it has set up a national/regional working group to analyse innovations on a regular basis. The cover letter accompanying the draft also explicitly mentions that only those forms of virtual currencies and tokens have been analysed that were known up until the end of 2019.

The draft begins by defining virtual currencies as digitally represented units of value of currencies that are not issued or guaranteed by any central bank or public administration and do not have the legal status of currency or money, but whose units of value are accepted by natural or legal persons as a medium of exchange and can be transferred, stored and traded electronically.

Tokens are digital units of value that can embody claims or rights. They have various functions, are used as payment for services rendered in the network, or are allocated centrally by a project initiator independently of the supply of computing performance.

Mining is an acquisition process

The first surprise comes at the beginning of the tax evaluation of the previously defined processes known as mining, staking, forks, etc. It is expressly stated that mining constitutes an acquisition process, which, among other things, triggers the speculation periods under section 23 (1) sentence 1 no. 2 German Income Tax Act (EStG). This means that the view still expressed in the Hamburg Tax Authority's decree dated 11 December 2017 that "self-generated" units of value do not constitute an acquisition is outdated.

Commercial activity is assumed

Furthermore, according to the draft, there is a refutable presumption in the case of mining – independently of the expenses for hardware and electricity – that it is a commercial activity (section 15 (2) German Income Tax Act (EStG)) with the resulting consequences for trade tax and the retention of this income in the business assets (no applicability of speculation periods under section 23 (1) sentence 1 no. 2 German Income Tax Act (EStG). Depending on the individual case, a distinction must be made from private asset management, according to which mining would fall under 'other income' (section 22 no. 3 German Income Tax Act (EStG).

In this regard, in the BMF's view, a mining pool can establish a co-entrepreneurship (Mitunternehmerschaft).

For the initial valuation of the tokens in the business assets, the average value from the exchange rate of three different exchanges can be taken as the basis for a market price as long as no stock exchange price is available.

Private sales transaction or commercial trader of virtual currencies

Selling virtual currencies held as business assets result in business income. In order to distinguish this from a private sales transaction (section 23 (1) sentence 1 no. 2 German Income Tax Act (EStG)), the BMF uses the criteria of the German Federal Tax Court (Bundesfinanzhof) to distinguish from commercial trading (i.e. behaviour typical of a trader or bank, use of the investment option to optimise returns, etc.). Frequent purchases and sales do not in themselves imply commercial activity, even if a larger volume is achieved in the process.

In the case of private assets, the calculation of the one-year period in which the sale can be made tax-free within the scope of a private sales transaction is based on the date of acquisition and the sale indicated in the wallet for simplicity's sake – although the beginning of the draft refers to the date of trading via an exchange. A choice can be made between both the individual review and the first-in first-out method as the consumption sequence procedure. In particular, the individual review opens up an interesting leeway (i.e. if units of value acquired subsequently can be sold at a loss in order to exploit tax-saving potential).

Valuation of a fork is similar to a stock split

If a taxpayer receives units of a newly created digital currency as part of a fork, the units of the different virtual currencies should represent different assets. The acquisition costs must generally be allocated in relation to the market prices of the units at the time of the fork.

If the forked units are sold, the rules on private sales transactions must be observed, unless they are business assets. In the case of forked units, the acquisition date of the pre-existing currency enacts the speculation periods. 

Initial coin offering: an indication of the application of further taxation regimes

The BMF makes a distinction based on classification (i.e. utility, equity, security, debt tokens) into the taxation regime. Essentially, the usual principles of taxation in business assets for the issuer apply, although it is interesting that the BMF allows for a case-by-case examination of whether income can be equalised by corresponding liabilities or accruals for certain obligations. This has been controversial in many cases and has been handled more flexibly in other jurisdictions (e.g. Switzerland).

Insofar as the right conveyed by a token is a debt security, the capital gains regime may be applicable in individual cases, but in this respect it depends primarily on whether the debt security constitutes a genuine capital claim.

If employees receive tokens at a reduced price or free of charge, this is said to be a cash benefit or a benefit in kind. The benefit in kind is to accrue to the employee when it is entered in the wallet and is generally tax-free up to a limit of EUR 44. (From 2022, it will be EUR 50). In this respect, it is interesting that the BMF states that the benefit in kind is valued with the final price at the point of supply reduced by the usual discounts at the time the claim is granted. In our opinion, this statement enables the interpretation that if the claim is granted early, the employee benefits from a potentially favourable price at this point in time and the non-cash benefit can be kept low, even if the tokens do not accrue until later. This would clarify a common dispute related to employee tokens.

Staking leads to other income and ten-year period

Another essential statement in the draft concerns the topic of staking. Insofar as cold staking or staking in connection with a masternode is conducted, the underlying tokens would be used as a source of income, which extends the speculation period to ten years (section 23 (1) sentence 1 no. 2 sentence 4 German Income Tax Act (EStG)). This also applies to other activities where tokens are used to generate income (e.g. lending).

Furthermore, additional virtual currency units received by the taxpayer for staking constitute business income, provided that the virtual currency units are business assets.

Receiving additional units for staking in private assets should result in other income (section 22 no. 3 German Income Tax Act (EStG)). If the income is less than EUR 256 in a calendar year, it is not subject to income tax.

Airdrop marketing measure results in other income

Receiving tokens from an airdrop should constitute business income if the tokens are also business assets. In the case of private assets, the acquisition is made in exchange for the transfer of data, personal pictures/photos, etc., which is to be qualified as a service of the taxpayer. Other income is therefore deemed to exist. Without consideration, gift tax provisions must be observed.

The BMF has a rebuttable presumption that the value of the data provided corresponds to the consideration's market price. The sale of the tokens from the airdrop as private assets constitutes a private sales transaction.

Duties to cooperate and keep records and accounts are still unclear

It appears that the enforcement deficit of the tax offices, whose only source of knowledge is currently the taxpayers themselves, has been recognised. The BMF is still holding back on the details and has merely provided a placeholder at the relevant point in the draft. Another BMF department (IV B 7: Financial Transaction Tax) informed the IT discussion group on 8 June 2021 that the Ministry was currently in negotiations with the OECD on an automatic exchange of information. At the European level, the negotiations on DAC 8 are currently still at the beginning. A directive proposal by the EU Commission is expected for autumn 2021.

Final decree planned by the end of the year

Associations and stakeholders can comment on the draft until mid-July. A roundtable discussion is planned for August 2021. According to reports, the BMF intends to finally publish the decree at the end of the year.

It is already apparent that the decree will lead to some surprises in the crypto scene, especially regarding acquisition through mining and the extension of the speculation period due to staking. It remains to be seen whether the expert opinions can still bring about changes in this respect.

For more information on this draft decree and crypto currency speculation in Germany, contact your CMS client partner or local CMS experts: