After the VAT circular on virtual currencies issued last June 2018 (circular 787), a new circular (L.I.R. n° 14/5 – 99/3 – 99bis/3) (“the Circular”) was released by the direct tax authorities (Administration des Contributions Directes) in order to clarify the tax treatment of income deriving from the use of virtual currencies, especially upon the exchange/disposal transactions and mining (process consisting in the issuance of virtual currencies).
Virtual currencies are intangible assets for accounting and tax purposes
As an introduction, the tax authorities stated that virtual currencies are not recognized as a “currency” such as EUR or any other FIAT given that they are not a legal tender and no exchange value is backed by any central bank.
In this context, Luxembourg taxpayer cannot use virtual currencies as a functional currency for his tax accounts or declare his taxable income in virtual currencies. It would need to be converted into an authorized currency as further explained below.
For direct tax purposes (i.e. corporate income tax, municipal business tax and net wealth tax) virtual currencies such as Bitcoin are intangible assets.
As a consequence, all revenues, expenses and costs expressed in virtual currency need be determined either in Eur or any other currency the exchange rate of which is fixed and published by the European Central Bank based on a daily rate from a trading/exchange platform approved and recognized by the CSSF.
The existing accounting principles are applicable. This means that the exchange rate to apply is the one at the day the transactions occur (the proceeds were made available and expenses incurred).
The tax authorities further highlighted that the use of virtual currency as a mean of payment shall not affect the nature of income for direct tax purposes. For instance, when rent is paid in virtual currency, it should not affect the nature of the rental income and the tax treatment of such type of income shall be applied.
Tax treatment of disposal/exchange transactions and mining activity of virtual currencies
The Circular then focused on the tax treatment of disposal/exchange transactions and mining activity of virtual currencies. It reminded that any income shall be taxable irrelevant whether they are generated in real or virtual world but rather whether they fall under one of the income categories listed in Luxembourg income tax law.
For instance, income deriving from disposal of virtual currencies or mining activities shall be taxable if they fall under of the two income categories: “commercial income” or “other income” as further detailed below.
1.Commercial income category
Income generated in virtual currencies, including disposal transactions and mining activities would constitute a commercial income only if the conditions of article 14 of Luxembourg income tax law are met (i.e. independent profit driven activity permanently occurred and constituting a participation in the general ecosystem that is not agriculture and forest activity or independent professional). Such conditions shall be often met in case of mining of virtual currencies, exchange/trading platform exploitation or automatic distributor or virtual currencies. To cut the line with private activity (which should not fall under the commercial income category), a case by case analysis would need to be made. However, the Circular provides some elements/criteria that could be used:
- Premises or organization assigned to operations on virtual currencies
- Financing by debt
- Frequent rotation of inventory of virtual currencies
- Trading on behalf of third parties
As a standard principle, operating expenses, such as costs of electricity related to mining or conversion fees incurred on exchange platforms, are only tax deductible if generated exclusively by the enterprise. The same applies to depreciation of computer infrastructure.
The tax authorities remind that activities deriving by corporate entities located in Luxembourg are automatically falling under the “commercial income” category irrelevant of the nature of their activity.
2. Other net income category
In the absence of commercial enterprise (as detailed above), it needs to be determined whether income generated by virtual currencies fall under the “other income” category.
The Circular provides details for the virtual currencies exchange. The tax treatment follows the rules to be applied on intangible assets and thus any virtual currencies exchange against another virtual currency, FIAT currency (e.g. Eur, USD) or as a payment for a service or goods is considered as i) the disposal of the virtual currency ii) followed by the acquisition of the counterpart assets (be another virtual currency, FIAT, goods or expenses for services).
Any gain or loss resulting from such transaction shall be considered as a “speculative” taxable event provided the holding period of such asset was less than 6 months. It is reminded that an annual allowance of EUR 500 speculative income is granted.
The Circular highlights that the taxpayer is required to keep consistent and continuous records including specifically the acquisition or creation dates of the virtual currencies, as well as all related expenses. In case of settling a virtual currency transaction, the burden of proof of its circumstances falls on the taxpayer.
The determination of the acquisition price of the virtual currencies disposed/exchanged or used as a mean of payment, in case no individualization of the virtual currencies is possible, it would be determined based on an adjusted average price method (excluding “first in, first out” and “last in, first out”). The speculation gain is therefore to be determined only where it cannot be excluded that the virtual currency has been held for a period shorter or equal to six months.
Net wealth tax consideration
For entities subject to net wealth tax, virtual currencies shall be assessed based on existing disposition (la loi modifiée du 16 octobre 1934 sur l’évaluation des biens et valeurs).
Key take-away of this Circular
- Very long-awaited Circular that provides some clarifications about the direct tax treatment related to virtual currencies. Many more are needed.
- Conservative approach provided by the tax authorities: virtual currencies considered as intangible assets
- Highlight of the role of CSSF to recognize exchange platform to be used as a reference of the conversion rate of virtual currencies against Eur or any FIAT
- This Circular however mainly focuses on disposal of virtual currencies transactions and mining activities. Many open questions remain outstanding regarding the mining activity, especially the method to capitalize mining assets. What expenses shall be taken into account, …
- ICOs (Initial Coin Offerings) are never mentioned in the Circular while many clarifications are needed
- Circular gives criteria to cut the line between non-professional activity and commercial activity for virtual currency activities
- Consistent records of the virtual currencies transactions are needed for corporate entities and individuals. Any Luxembourg taxpayer tapping into any virtual currency related activity shall make sure to be well organized and equipped as the burden of proof would fall on the taxpayer.