On January 11, 2017, the Israel Tax Authority (ITA) posted draft regulations relating to the taxation of virtual currencies. We will go over the main points in this article.

Background

Recently, as part of the development of business through electronic devises, there is an expansion of the use of Virtual Currency, such as Bitcoin and Litecoin (hereinafter: “VC”). VC is a computerized digital unit value, which is used for the purpose of a barter trade through the internet per the consent of the parties involved (seller and buyer). VC can be used to pay for goods/services/exchange to other currencies or for investment purposes.

Defining VC as a Currency

The determination of whether VC is classified as a "currency" or as an "asset" may have an effect on the taxation of the income deriving from changes in its value.

1. The definition of "linkage" in section 1 of the Income Tax Ordinance (New Version) 5721–1961 (hereinafter: the Ordinance), includes an exemption of income arising from the difference in currency rate linkage. Clause (13)9 of the Ordinance grants a tax exemption for linkage income that an individual receives. Therefore, If the Ordinance classifies VC as "currency”, the income arising from linkage would be exempt from tax for individuals. But, if VC is classified as an asset, it would be taxed in accordance with the rules applicable for the sale of an asset, and not necessarily exempt from tax.
2. The Ordinance does not have a definition for currency/foreign currency.  Therefore, the definition will be derived from the definition given to it by the Bank of Israel Law 5770-2010 (hereinafter: "the Law").
3. Clause 1 of the Law defines "currency" as the New Israeli Shekel (NIS). In addition, the Law empowers the Bank of Israel to issue the official currency for Israel and states that the currency it issues shall be the legal tender in Israel^[1].
4. The Law defines foreign currency as "bank notes or coins that are the legal tender outside of Israel and that are not the legal tender in Israel^[2]. The definition refers only to tangible assets (bank notes and coins) that are a legal tender in any country abroad, and both conditions need to apply in order for the "asset" to be considered a "foreign currency".
5. VC (such as Bitcoin) are not tangible assets nor do they have the status of legal tender in any country. Accordingly they are not considered a "foreign currency" per the definition of the Law and consequently also not for the Ordinance.

Taxation of VC

The definition of "asset"[3] in the Ordinance includes tangible and intangible assets. VC’s are the property of whom ever owns them, and therefore they meet the fundamental definition of an "asset" as per the Ordinance. Note that VC’s are not included in the definition of securities as defined either in the Securities Law 5729-1968 or in the Ordinance.

A Sale of VC will be taxed as a sale of an "asset" and the gain will be classified as capital income and taxed accordingly to the rates for capital gains as set forth in the Ordinance[4]. Consequently, the seller of VC is required, within 30 days from the date of the sale, to submit to the ITA, Form 1399 that includes the calculation of profit/loss resulting from the sale, the tax calculation and an advanced payment on the tax. In addition, the seller will need to attach documentation proving that the income was derived from a sale of VC as requested by the Assessing Officer of the ITA dealing with his file.

A person, whose income from selling VC is classified as a business, will be subject to the tax rates under clause 121, or 126 of the Ordinance since his income will be defined as business income. It is important to clarify that the revenue of a person that is engaged in marketing and selling VC, will be classified as profit and not capital gain.

One may acquire VC by a “mining” procedure. Mining is the mechanism used to introduce VC into the system. Miners are usually paid a transaction fee as well as a "subsidy" of newly created coins. The mining activity can be a sign of the existence of a business, thus classifying the income as profit.

However, this classification will not be generalized for all purchases of VC. Meaning, if one makes an additional profit through a purchases of other VC’s (not through mining) their classification will be determined separately either as profit or as capital gain.

In transactions in which an asset is sold or a service is provided and the payment is in the form of VC, the ITA will consider this as a barter transaction and the VC that was received as payment for the assets/service on the day of the transaction will be treated as income. The income from the change of its value from the day received and until exchanged further, will be calculated as outlined above.

The payment value will be determined in accordance with the fair market value of the VC in NIS. The fair market value will be based on the internet site that was used to purchase the VC for the barter transaction or other similar sites. However, if the purchased asset/service has a fixed or quoted market price, the value of the VC will be according to the market value of the purchase.   All transactions paid via VC are subject to withholding tax as applicable and according to the Withholding Tax Regulations.

Value Added Taxes (VAT)

VC's are considered an intangible asset and therefore they are defined as "goods" per the Value Added Tax Law[5] ("the VAT Law") in every aspect (transaction price, billing date, tax rates, etc.).

VC's are not considered as securities or negotiable instruments per the VAT Law.

One whose income from selling/marketing/mining VC's is classified as a business, will be liable for VAT [6]

If one carried out a one-time transaction of VC sales or marketing, and the transaction had a commercial nature, he will be required to report it in accordance with the VAT regulations [7]

The use of VC as payment for a service/asset is defined as a barter transaction. Consequently, the value of the transaction will be determined for VAT purposes via the VAT Law [8]

Audit Guidelines

The audit will be based on the documents recording the transfer of VC and the possession of the asset. These documents include a letter from the seller clarifying how the VC was purchased and sold, bank documents from the account the VC was transferred from, a computer screen shot showing the purchase and sale of the VC, and the seller's holding period of the VC.

The above is a loose translation from a publication in Hebrew by the Israeli Tax Authorities Assessment and Review Division and the Unit for Information and Public Relations, January 2017.

The content of this article is intended to provide a general guide to the subject matter and is not a substitute for legal consultation. Specific legal advice should be sought in accordance with the particular circumstances.