The future of bitcoins in European igaming depends on taxation

The issue of 'double taxation' being applied potentially to bitcoins poses major questions of the business viability of the crypto-currency, according to gaming law and tax experts Matthias Spitz, Gregor Fuehrich  and Jessica Maier.

“I think that bitcoin and blockchain, the technology behind it, in developing our industry, I think that the application of this technology is going to be massive in changing how we view the whole industry.” Thus spoke Calvin Ayre to a packed audience when he shared his perspective on future trends affecting the industry during an igaming seminar last year.

For many European gaming lawyers however, taxation is the issue that has stifled the development of the online gambling sector in their respective countries and some European tax authorities have opined that bitcoin trading is not exempt from VAT under the European VAT Directive.

As a consequence, bitcoin trading would have been subject to a “double taxation” under VAT – first, upon the sale of a service and, second, when exchanging the earned bitcoins for hard currency. Obviously, this would have rendered the activity totally unattractive for any e-commerce and online gambling service.

David Hedqvist owns Bitcoin.se and intended to provide services consisting of the exchange of traditional currency for bitcoin and vice versa through his web portal. He brought a dispute with the Swedish tax authorities to court, which then referred the case to the Court of Justice of the EU (CJEU). 

In its judgment of 22 October 2015, the CJEU decided in favour of the bitcoin businesses in declaring that trading bitcoins is VAT-exempt under article 135(1)e VAT Directive, because it should not be treated differently to more traditional means of payment.

The ruling prevented Europe from 'gambling' away a technology that has the potnetial to massively change how we view of the online world.

This article will first shed some light on the nature of bitcoins, provide a short analysis of the recent CJEU judgment and then enlarge upon the more technical implications of the VAT exemption.

On the nature of bitcoins
Let’s start at the very beginning. Since their alleged invention by Satoshi Nakamoto in 2008,  bitcoins have become increasingly popular for investors and as a form of payment in e-commerce and the online environment in general.

This also includes the online gambling sector: SatoshiDice was one of the earliest betting sites to launch, increasing numbers of bitcoin casinos have opened since, with more coming on stream as we speak.

Entire bitcoin casino solutions are available through software providers like Softswiss. Even in the “real world”, bitcoins have gained some momentum, for example in the UK the first bitcoin cash machine was launched in London in 2014.

But what are they? The answer to this question is not straightforward.

One would say bitcoins are a “cryptocurrency”, i.e. an electronically-created currency which only exists in the virtual world, does not have physical presence and is run on an open, peer-to-peer software.

Unlike traditional bank transactions, cryptocurrencies do not require a central payments processor or bank. They therefore not only allow for prompt, immediate (international) transactions but also avoid the transaction fees which banks would usually charge.

We also need to explain that bitcoins can be “mined”, i.e. created, by users solving CPU-intensive cryptographic tasks and that the bitcoins created through mining are then transferred to a so-called “wallet”, where the addresses and keys necessary for the verification of the transaction (and, consequently, for receiving the money) are stored.

A point of concern in the legal debate on bitcoins, specifically in the context of gambling, is that these addresses verify the transaction but do not provide insight into who the bitcoins actually belong to and consequently bitcoin transactions involve a money-laundering risk.

Another point of criticism raised in the context of bitcoins is that they can get lost or stolen. Reference is often made to the bankruptcy declared in 2014 by Mount Gox, one of the then largest global bitcoin exchanges, as a result of it having become subject to hacker attacks. Some US$473m worth of bitcoins were allegedly lost or stolen during the attacks.

Despite each bitcoin being dividable into 100 million units and it only ever being possible to have a maximum of 24 million bitcoins in the system in total, i.e. despite bitcoins being considered stable in terms of inflation, critics still find there to be financial risks for users given the fluctuation in the value of bitcoins, which in parts can be quite considerable.

Ultimately one would probably come to the conclusion: bitcoins are a form of payment and may be an attractive opportunity for investments.

However, the question of what bitcoins really are depends heavily on how bitcoin transactions and investments are treated in terms of taxation, as the qualification of bitcoin transactions from a tax viewpoint acts as the “make or break” factor with regard to their success in the market.

EU dispute on VAT treatment of bitcoins 
Before the October 2015 judgement, the qualification and applicability of VAT exemption rules on bitcoins was unclear and there was no uniform opinion across the EU.

In Germany, the legal assessment of bitcoin transactions was predominated by the assessment provided by the Federal Financial Supervisory Authority (BaFin) in 2013. 

The BaFin defined bitcoins as “financial instruments in the form of accounting units” and suggested regulating bitcoins in a similar way to other financial products in the banking sector.

However, it would not allow bitcoins to be defined as a functional currency or as electronic money. As a result, the BaFin came to the conclusion that transactions involving bitcoins were not to be taxed in the same way as other financial products.

But – since bitcoin transactions were to be understood as a kind of swap or exchange – both the giving and the later sale/purchase of bitcoins were each to be considered subject to VAT.

Effectively, bitcoins were therefore stuck in the middle: they qualified as a financial product in terms of regulation but at the same time would be subject to a highly unattractive double taxation.

In the UK, the exchange of bitcoins into a currency was considered not taxable at all. In a policy paper of  March 2014, HM Revenue & Customs provisionally concluded that bitcoin transactions are exempt from VAT under art. 135 para. 1 d) of the VAT Directive as falling within the definition of ‘transactions, including negotiation, concerning deposit and current accounts, payments, transfers, debts, cheques and other negotiable instruments’. 

In a subsequent parliamentary inquiry of May 2015, Germany's Federal Ministry of Finance then stated that the British interpretation is “not relevant and not binding for the rest of the Members States” and denied VAT exemption.

All the more important in the eyes of critics of this legal assessment was the awaited CJEU decision in the case C-264/14 of Mr David Hedqvist.

CJEU: Bitcoins transactions are VAT exempt!
The CJEU ruled on the Hedqvist case that transactions “which consist of the exchange of traditional currency for units of the ‘bitcoin’ virtual currency and vice versa, in return for payment of a sum equal to the difference between, on the one hand, the price paid by the operator to purchase the currency and, on the other hand, the price at which he sells that currency to his clients, constitute the supply of services for consideration”.  

The judgment clarifies that this exchange is in fact a service against remuneration where the remuneration is not equal to the value of the exchanged bitcoins but only equal to the realised margin/spread in return for the exchange.

Moreover, the CJEU decided that this margin is exempt from VAT, since “Article 135 para. 1 lit. e of the VAT Directive also covers the supply of services […] which consist of the exchange of traditional currencies for units of the ‘bitcoin’ virtual currency and vice versa”.

The CJEU thereby accepts that bitcoins fall within the meaning of the above art. 135 VAT Directive because they are a means of payment. By applying the VAT exemption rule on the exchange of bitcoins, the use of bitcoins as means of payment has been facilitated by the CJEU.

But what does this mean for payments with bitcoins and what are the consequences for the igaming operator who wants to convert hard-earned bitcoins into hard currency?

Bitcoin payments not subject to VAT
The question of VAT taxability first arises when bitcoins are used as payment for services, such as online gambling services. As an example, the German tax authorities assume that the payment of services via bitcoins results in two supplies: (1) the obvious taxable supply of the service and (2) in return the taxable supply of the bitcoins.

According to the Federal Ministry of Finance, it is yet to be decided whether or not the restrictive opinion preceding the CJEU judgment will be amended or reversed, since the judgement did not cover the case of paying with bitcoins.

However, it is more convincing to consider the payment via bitcoin – the second supply – to be not taxable at all. Since the CJEU acknowledged in the Hedqvist case that bitcoins are used as a means of payment comparable to a legal tender, the payment itself may not constitute a taxable sale. 

Solely paying the remuneration via bitcoins thus may not trigger VAT taxability, unlike the later (tax-free) exchange of bitcoins into currencies against remuneration (see below). 

Even if two supplies were to be assumed in the payment of the service following Germany’s Federal Ministry of Finance, the bitcoin sales should now be exempt from tax pursuant to the judgment (art. 135 para. 1 lit. e) VAT Directive).

Consequences for the exchange of bitcoins
As mentioned above, the further question arises how the judgment impacts on the VAT taxability of earned bitcoins the gaming operator intends to exchange.

Taking into account the reasoning of the judgment, it has to be concluded that the repeated acquisition and sale of bitcoins is an entrepreneurial activity. The exchange of bitcoins constitutes a taxable, but tax-free service against remuneration.

The taxable amount is equal to the margin/spread. As for Germany, the Federal Ministry of Finance is planning on implementing the CJEU jurisprudence in this respect.

Entrepreneurs thus would have to declare tax-free sales. It has to be noted that such tax-free sales restrict the right to deduct input VAT (on a pro-rata basis), unless these sales are carried out to a recipient resident in a third state (art. 169 lit. c) VAT Directive).

If the restriction of the input VAT deduction of such tax-free EU sales is disadvantageous compared to the tax exemption of the sales, entrepreneurs might opt for taxation in respect to these sales to other entrepreneurs.

Germany for exmaple has made use of the EU Member States’ option granted by art. 137 para. 1 lit. a) VAT Directive which allows taxable persons a right of option for taxation in respect to these transactions.

Occasional traders will most likely be exempt from tax in any case, because the special scheme for small enterprises might apply (art. 281-292 VAT Directive).

However, it should be noted that the above tax-free sales are relevant for calculating the sales threshold up to which small enterprises may benefit from the special scheme (for example, in Germany: €17,500 currently, compared with €50,000 in the preceding year), unless the bitcoin sales are ancillary transactions.

As a consequence, start-ups in the gaming sector will have to check their tax planning if they intend to open their business to bitcoins.

Cross-border VAT on bitcoins
In cross-border cases, the above described bitcoin sales to other entrepreneurs result in B2B services, which are taxable in the recipient’s state (art. 44 VAT Directive).

Given the tax exemption of such sales, however, the reverse charge mechanism cannot apply (art. 196 VAT Directive). Accordingly, the supplier of the service would generally have to declare tax-free sales in the other EU member state.

The VAT treatment of bitcoin sales to entrepreneurs in third states would depend on the third state’s qualification of those sales and whether or not the tax exemption or the reverse charge mechanism applies.

Bitcoin sales to EU customers generally constitute B2C services being taxable in the supplier’s state (art. 45 VAT Directive). Yet, the qualification of bitcoin sales as electronically supplied services seemingly is very plausible and would imply that the place of supply is shifted to the state of residence of the customer (art. 58 VAT Directive).

Again, the entrepreneur would face additional declaration and compliance obligations in other EU member states (and possibly in third states).

It remains questionable whether the MOSS procedure for electronic sales – which helps to avoid the registration and compliance burden in other EU member states – applies to bitcoin sales.

For the time being, it does not seem possible to declare tax-free sales via the MOSS procedure, as the forms only provide boxes for sales at the general VAT rate or the reduced VAT rate.

Conclusions
The fact that the highest court in the EU has referred to bitcoins as an “alternative to legal tender” and applied the tax exemption for traditional means of payment arguably is a huge boost for bitcoin lobbyists in their discussions with financial market authorities.

Further, the CJEU judgment has helped to solve practical problems for the exchange of bitcoins into currencies. Applying the tax exemption for means of payment helps avoid an extra VAT burden on such transactions and enhances the transferability of bitcoins.

The direct payment via bitcoin should not constitute a taxable event either. As a consequence, the main obstacles for using bitcoins as a means of payment in online gambling, and the subsequent exchange of the bitcoins into real money by the igaming operator have been removed.

The Hedqvist judgment can be seen as the go-ahead for the European igaming sector opening up to bitcoin transactions.

Still, a lot of practical questions resulting from the use of bitcoins as a means of payment are yet to be solved. The tax-free bitcoin sales could result in an additional registration and compliance burden.

From a practical point of view, the compliance burden could be disregarded if only tax-free sales are supplied in the other EU state.

Given the still diverse views across the EU, guidance from the European Commission in an opinion on bitcoins would be welcome so as to eliminate the remaining issues.

Matthias Spitz is a member of the International Masters of Gaming Law and partner at MELCHERS law firm, Gregor Fuehrich is a tax advisor at FALK GmbH & Co; Jessica Maier is a gaming attorney with MELCHERS law firm.