Cryptocurrency and taxation - a comparative study of France, the United Arab Emirates & Canada
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Cryptocurrencies appeared in the digital universe about ten years ago and are currently experiencing significant growth and democratization.
A virtual means of payment usable mainly on the Internet, relying on cryptography to secure transactions and the creation of units, and escaping any control by regulators and central banks, there are now more than 4,000 cryptocurrencies in circulation.
Nevertheless, their legal framework is sometimes confusing and difficult to grasp. The purpose of this article is therefore to study the legislative framework of cryptocurrencies in France, Canada, and the United Arab Emirates, as well as their tax regime. We will then examine, in a non-exhaustive manner, Initial Coin Offerings, a new fundraising phenomenon based on cryptocurrencies.
What are cryptocurrencies in concrete terms?
A cryptocurrency is a virtual means of payment that relies on cryptography to secure transactions and the creation of units, and operates outside the control of regulators and central banks. Cryptocurrencies therefore rely on a computerized protocol of encrypted and decentralized transactions, called a blockchain.
The best known is Bitcoin, which is a virtual unit of account stored on an electronic medium. However, today there are more than 4,000 cryptocurrencies in circulation worldwide, the best known besides Bitcoin being, for example, Ethereum, Ripple or even EOS, XRP, Tether, Cardano, Stellar, Chainlink, Uniswap, Polkadot or even USD Coin.
Cryptocurrencies fall within the broader framework of crypto-assets, which represent "virtual assets stored on an electronic medium allowing a community of users who accept them in payment to carry out transactions without having to resort to legal tender".
The issuance and circulation of digital crypto-assets is notably linked to Initial Coin Offerings (“ICOs”). Unlike an initial public offering (IPO), an ICO is financed on digital media classified as tokens. The ICO thus represents a fundraising operation operating through the issuance of digital assets exchangeable for cryptocurrencies during the start-up phase of a company or project.
I - THE LEGISLATIVE FRAMEWORK OF CRYPTOCURRENCIES IN FRANCE, CANADA AND THE UAE
The law has difficulties in understanding cryptocurrencies, the main question being whether they should be linked to existing legal categories or whether it is necessary to create new ones.
This choice of classification depends on the States.
IN FRANCE
French law decided to create a specific legal framework for cryptocurrencies through the PACTE law, defining the term digital asset in the Monetary and Financial Code (the “CMF”). Article L54-10-1 2° of the CMF defines digital assets as "any digital representation of a value (...) which is accepted by natural or legal persons as a means of exchange and which can be transferred, stored, or exchanged electronically" (emphasis added). Cryptocurrencies are therefore neither a legal tender, nor an electronic currency, nor a means of payment recognized by law. Regarding the regime of cryptocurrencies, the CMF admits that transfer, storage, and exchange operations are carried out using cryptocurrencies through the drafting of legal contracts. For example, it is possible for cryptocurrencies to constitute a contribution in kind (and not in cash, as it is not a currency) in the context of a contribution to a company. The regime established by article L54-10-1 2° of the CMF thus clearly rejects the qualification of cryptocurrencies as a means of payment but admits it as a means of exchange, as consideration for the execution of a contractual commitment.
IN CANADA
Most other legal systems, including Canada, have preferred to link cryptocurrency to existing legal categories, but they are faced with the difficulty of classifying cryptocurrencies. Canadian regulators admit that crypto-assets do not meet the classic definitions provided by Canadian securities laws. For example, some "utility tokens" involve a securities placement in the form of an investment contract, while other crypto-assets called "crypto tokens" are classic securities in the form of tokens. Finally, bitcoin has characteristics that bring it closer to a commodity. Therefore, in Canada, it will be necessary to evaluate on a case-by-case basis the way in which trading is carried out in order to determine the classification of the cryptocurrency.
AT THE EUROPEAN LEVEL
At the European Union level, the European authorities initially estimated that cryptocurrencies as such could not be classified as a payment service, but that the operation of exchanging currency for a cryptocurrency could be classified as a payment service, within the meaning of the Payment Services Directive.
Subsequently, the European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA) clearly stated that cryptocurrencies should be understood as means of exchange rather than as means or services of payment.
In order to qualify and define cryptocurrencies within the meaning of European law, the European Banking Authority and ESMA have developed their own definition of cryptocurrency in 3 points:
an asset that relies on cryptology and a DLT (Distributed Ledger Technology) or equivalent technology as part of its perceived or intrinsic value;
an asset that is not issued or guaranteed by a central bank or a public authority; and
an asset that can be used as a means of exchange and/or for investment purposes and/or to acquire goods or services.
IN THE UNITED ARAB EMIRATES
In any event, as of July 1, 2021, cryptocurrency is still officially and legally banned in the United Arab Emirates.
However, in May 2021, the launch of Dubai Coin was announced, a cryptocurrency allegedly launched by the United Arab Emirates. In less than 24 hours, the price of this cryptocurrency increased by 1000%, showing the enthusiasm surrounding crypto-assets in the Emirates.
However, the reliability of this cryptocurrency was quickly disputed by the Dubai government, specifying that the currency had not been approved by any official authority. Nevertheless, the Dubai Financial Services Authority (the “DFSA”) announced its intention to implement new regulations for cryptocurrencies as part of its business plan for the years 2021 to 2022.
In an effort to be "open for business" regarding innovation in the financial services sector, the DFSA indicates that it wishes to build on recent financial achievements to develop a "regulatory regime for digital assets (such as token securities and cryptocurrencies)". The authority thus wants to adopt "a regulatory approach that facilitates innovation while requiring strict compliance with DFSA licensing, prudential, and conduct requirements".
II - THE TAX REGIME OF CRYPTOCURRENCIES
**Tax regime for cryptocurrencies in France
a - Taxation of transactions on digital assets during holding**
Crypto loans or cryptoloans The legislator has not yet taken a position on the issue of the taxation of cryptoloans, but case law has had to rule. The Court of Nanterre in a judgment of February 26, 2020 classified the loan of Bitcoin as a consumer loan, a classification which implies a transfer of ownership and therefore a taxable event. It remains to be seen whether this position will be confirmed by other case law, and whether it will be applicable to other types of crypto-assets.
Transfer of portfolio abroad & expatriation
The transfer of tax residence outside France to a state other than the European Union constitutes a taxable event in accordance with Article 167 bis of the General Tax Code, which governs the exit tax regime.
For the time being, the scope of the exit tax does not seem to include digital assets, but given the very spirit of the mechanism, it seems highly likely that the legislator will expand the scope of this article to cryptocurrencies due to the more attractive (or even zero) tax rates on the sale of crypto-assets abroad. Furthermore, a poorly prepared expatriation guided mainly by tax motivations is likely to lead to the application of Articles L64 and L64A of the Book of Tax Procedures, for non-liability of one's asset portfolio with the exclusive or primary objective of evading or mitigating one's tax burden, or the application of the exit tax for the same reason.
The sale of cryptos
Finally, in the event of a disposal of digital assets, Article 150 VH bis of the CGI applies and defines the taxation terms for capital gains on disposals of digital assets realized by individuals domiciled in France and on an occasional basis. This mechanism also applies to disposals made through an intermediary.
The sale of cryptos is therefore taxable when digital assets are sold:
against a sum in legal tender currency, such as the euro or the dollar; or
in exchange for a good or service other than a crypto-asset; or
in exchange for a crypto-asset with a cash adjustment payment (conversely, when a digital asset is exchanged for another asset without a cash adjustment, the unrealized capital gain is not taxable).
Taxable capital gains realized by individuals on an occasional basis are subject to income tax at a rate of 12.8%, to which are added social security contributions on wealth income at a rate of 17.2%. The overall tax rate for these capital gains is therefore 30%.
b - Taxation of donations of digital assets
Cryptocurrencies may be intended to be transferred to an heir or a third party. The donation will have a double interest: an interest in wealth transmission with partial/total erasure of the capital gain. An individual can transfer all or part of their wealth to one or more heirs, by way of donation or legacy:
through a simple donation (article 922 of the civil code), but beware, because if the value of the transferred crypto-asset has increased significantly, an infringement on the hereditary reserve may be observed; or
through a shared donation: under certain conditions, it is possible to retain the value of the transferred property on the day of the donation, which implies that the value of the given crypto-asset would be frozen, regardless of its given value at the time of death.
Finally, donations of digital assets offer the same tax advantages as traditional donations, namely no taxation regarding the donor's unrealized capital gain.
c - The reporting framework for digital assets
Reporting obligations for crypto-assets have not yet been clearly established and affirmed, either at national or European level.
In France, the calculation method for unrealized capital gains must lead to an individualized calculation of the taxable capital gain. This calculation proves complicated for cryptocurrencies, and the likely inability to trace all the acquisition prices of taxpayers' crypto-assets adds an additional difficulty.
Despite these difficulties, taxpayers must declare their cryptocurrencies using Schedule No. 2086-2. If the number of transactions to be declared is greater than twenty, it will be necessary to print Form No. 2086-2 in multiple copies.
2. Tax regime for cryptocurrencies in the European Union
At the Community level, the European Commission has initiated a public consultation to adopt a potential Directive on Administrative Cooperation No. 8 (DAC 8) for greater tax transparency on crypto-assets. This directive would propose strengthening existing rules and expanding the exchange of information currently in force to include crypto-assets and virtual currencies. Nevertheless, this project of Community unification faces the difficulty for Member States to concretely grasp the volume of use of crypto-assets, as well as the disparity of sanctions applied by different States.
3. **Tax regime for cryptocurrencies in Canada
a - Taxation of transactions on digital assets during holding
Taxation of income derived from holding cryptocurrency** : the Canada Revenue Agency treats cryptocurrency as a commodity. Income from cryptocurrency is therefore treated as business income or as a capital gain depending on the circumstances (frequency of transactions, circumstances, intention of the taxpayer, commercial nature).
Taxation of income derived from the use of cryptocurrency as a payment method: the use of a cryptocurrency to pay for goods or services, or to acquire another cryptocurrency is considered a barter transaction which is generally not taxable.
However, the taxpayer may be taxed if the barter is accompanied by one of the following operations:
Selling or donating cryptocurrency; or
Trading or exchanging cryptocurrency, including to obtain another one; or
Converting cryptocurrency into government-issued currency; or
Using cryptocurrency to buy goods or services.
The income must then be classified as business income or capital gain.
Finally, when a taxable good or service is exchanged for cryptocurrency, the Goods and Services Tax (GST)/Harmonized Sales Tax (HST) applies to the exchanged good or service. The GST/HST is calculated based on the fair market value of the cryptocurrency at the time of exchange.
If a business accepts cryptocurrency as a payment method for taxable goods or services, the value of the cryptocurrency for GST/HST purposes is calculated based on its fair market value at the time of the transaction.
b - The reporting framework for digital assets
Regarding cryptocurrencies held in Canada, any gain generated by the sale or exchange of cryptocurrencies must be declared as business income or as a capital gain. If the cryptocurrency belongs to a business, the profits are considered business income, even if the purchase of a cryptocurrency with the intention of selling it is an isolated event.
Conversely, if the sale of a cryptocurrency does not constitute running a business and the amount sold is greater than the purchase price, the taxpayer has realized a capital gain. 50% of this gain will be included in the taxpayer's income and subject to tax at the taxpayer's tax rate.
All Canadian taxpayers are subject to the obligation to keep books and records of accounts in order to establish information that allows calculating the amount of their taxes. For cryptocurrency, the CRA recommends that taxpayers periodically export their various cryptocurrency transactions, in particular to record the date of the transactions, the receipts for purchasing or transferring cryptocurrency, the value of the cryptocurrency in Canadian dollars, etc.
Regarding cryptocurrencies held outside Canada, any taxpayer who, at any time during the year, has total holdings of more than $100,000 CAD in foreign property must file Form T-1135 in addition to their federal income tax return. Failure to file subjects the taxpayer to a penalty.
In any case, whether the cryptocurrencies are held in Canada or not, the taxpayer must evaluate them and determine whether they are considered capital assets or inventory:
A capital asset represents a durable investment for the business;
An inventory refers to the description of goods whose price or value is included in the calculation of income that a taxpayer derives from a business for a taxation year.
When cryptocurrencies are held as capital assets, it will be necessary to record and track the adjusted cost base in order to accurately report the capital gain.
When cryptocurrencies are considered inventory, calculation methods must be used to value the inventory consistently from year to year.
III. THE LEGAL FRAMEWORK OF ICOs
ICOs are, as we defined in the introduction, a new form of financing given to companies, and more particularly to SMEs. As with cryptocurrency, States have had to set up a legal framework in order to regulate these ICOs and public token offerings.
IN FRANCE
France has set up a regulatory framework specific to ICOs through Article 26 of the PACTE law, creating a non-binding legal framework for token offerings in order to encourage their localization in France. This regime is based on an optional visa, issued by the AMF to token issuers. This visa is an approval of a public token offering operation. It is optional but carries the very competitive advantage of the serious and verifiable nature of the public offering.
There are several conditions for obtaining the visa:
Conditions relating to the actors: the procedure is intended for any token issuer referred to in Article L552-1 of the CMF which must be constituted as a legal entity established in France.
Conditions relating to the operations: the visa only covers the structure of the offer and not the quality of the project, an offer which must be open to more than 150 people. An information document presenting the token emission project must also be drafted.
The PACTE law also imposes a system to safeguard the assets raised within the framework of an ICO; issuers must therefore have the means to ensure the safeguarding and monitoring of the assets. A backup system for technology failures is also put in place.
To obtain this visa, the issuer must submit an application to the AMF. Within 20 days, the AMF will notify its visa on the basis of all the mandatory documents sent. After obtaining its visa, the issuer undertakes to disclose the amount of funds and digital assets collected, the total number of identical tokens issued, etc.
IN CANADA
In Canada, if an ICO involves the distribution of securities, companies may need to be registered as a dealer or qualify for a registration exemption. This condition will depend on whether the company trades coins or tokens for business purposes.
Registration as a dealer involves compliance with a wide range of obligations, including rules relating to know-your-client and investor suitability verification.
It should be noted that issuers conducting ICOs may engage in various activities that could trigger a registration obligation, such as soliciting a broad base of investors, including retail investors, over the internet or at public events like conferences for example.
