Blockchain technology and cryptocurrencies are a relatively new concept for us, which is based on the idea of a free market without the intervention of an administrator. According to the Bulgarian law, “virtual currencies” means a digital representation of a value that is not issued or guaranteed by a central bank or a public body, is not necessarily linked to a legally established currency and does not have the legal status of currency or money. or legal entities as a medium of exchange and may be transferred, stored, and traded electronically. Because cryptocurrencies like Bitcoin, Libra, Ethereum (ETH), Litecoin (LTE), Neo and many others do not exist outside cyberspace they are much easier to track for the individual. Investments can be tracked thanks to online portfolios, which serve as a wayward ledger. Blockchain technology is not centralized. It is managed by all users and therefore cannot be compromised unless someone “hacks” all the computers in the world that hold information related to the cryptocurrency.
For a blockchain system to work, it is built on so-called cryptocurrencies. Cryptocurrencies are digital representations of values or rights that can be transferred and stored electronically using a specific technology (known as distributed book technology). Cryptocurrencies come in many forms and with different rights and functions. The crypto asset can serve as a key to access a service, it can be designed to facilitate payments, but it can also be designed as a financial instrument or as transferable securities under the Markets in Financial Instruments Directive.
The new proposal on cryptocurrencies of the European Commission
Due to the ambiguity in the organization of cryptocurrencies and the lack of common rules for all EU Member States, the Commission proposes a pilot regime for market infrastructures that trade and regulate transactions in financial instruments in the form of cryptocurrencies. The pilot regime, which will allow for derogations from existing rules, will allow regulators to gain experience in using distribution book technology in market infrastructure and for companies to try solutions. The idea is to allow companies to test and learn more about how existing rules work in practice.
For other cryptocurrencies, the Commission is proposing a comprehensive practice that will protect consumers and the integrity of previously unregulated cryptocurrency markets. It will cover not only the entities that issue them but also all companies providing services around these cryptocurrencies, such as companies that keep customers’ assets safe (“custodian portfolios”), entities that allow customers to buy or sell real money assets, and much more. This practice will also set requirements for the emerging category of so-called “stable coins”, which are divided into cryptocurrencies used as electronic money (the Commission’s idea of a virtual euro) and cryptocurrencies used in the form of assets.
The main elements of the proposal include:
- Cryptocurrency service providers (trading platforms, exchanges, and portfolio providers) will need to have a physical presence in the EU and be subject to prior authorization by a national competent authority before they can start operations. They will be subject to capital requirements, management standards, and an obligation to separate their clients’ assets from their own assets. These cryptocurrency service providers will also be subject to information requirements to avoid the risks of cyber theft and hacking.
- The new rules will also prohibit the abuse of secondary markets for cryptocurrencies that were not previously covered by the Financial Services Regulation. To ensure market integrity, the initiative also provides for special measures to prevent abuses, such as domestic transactions and price manipulation. For example, cryptocurrency service providers will be required to put in place monitoring and enforcement mechanisms to prevent potential market abuse.
- For cryptocurrency issuers, today’s proposal requires the publication of a “white paper” including all relevant information on the specific cryptocurrency. Such information will include a detailed description of the issuer, the project, and the planned use of funds, conditions, rights, obligations, and risks. Members of the issuer’s management body will have to meet integrity standards, and misleading market communications from cryptocurrency issuers are prohibited. Compliance with all these requirements will be monitored by the national competent authorities (NCAs) or EBA in the case of cryptocurrencies with a reference asset to reduce the risk of ordinary fraud.
- For issuers of asset-related cryptocurrencies, the basic requirements include the obligation to be authorized, management requirements, conflict of interest rules, disclosure of the stabilization mechanism, investment rules, and additional requirements for keeping the so-called “white paper”. For example, the obligation to disclose information about any potential claim and minimum rights over such claim.
- Cryptocurrency diggers will be subject to the regulatory requirements of the Electronic Money Directive and the rules set out in the Cryptocurrency Markets Regulation, which means, for example, that they must sue for possession of cryptocurrencies.
- Cryptocurrency service providers will be subject to organizational requirements, rules for the storage of customer funds, and rules for mandatory complaint handling and conflict of interest procedures. Besides, there will be specific requirements depending on the type of cryptocurrency service provider.
- To ensure effective supervision, Member States must designate a competent authority or several competent authorities to monitor compliance with the Commission’s requirements, as well as to ensure supervision. For issuers of significant assets, supervision will be carried out by the European Banking Authority. Significant amounts in the form of cryptocurrencies will be subject to double supervision by national competent authorities and EBA.
Tax treatment in Bulgaria
As early as 2012-2013, the National Revenue Agency (NRA) issued instructions according to which it accepts cryptocurrencies as a financial asset, the profits of which are subject to declaration and taxation. In its Explanation № 3-580 dated March 19, 2018, the NRA provides answers, albeit under the stipulation of their conditionality, to some basic questions regarding the tax treatment of virtual currency transactions.
According to the Value Added Tax Act (VAT), the “extraction” of bitcoin through computational activities is a supply of a service that will be taxable insofar as it is performed by a taxable person (i.e., any person acting within his independent economic activity) and has a place of performance on the territory of Bulgaria.
According to the case-law of the European Court of Justice, there will be an exemption from VAT if the virtual currency bitcoin can be defined as a payment instrument and its mode of operation involves the transfer of sums of money (as in payments, transfers and checks). Therefore, even if cryptocurrencies do not represent money in the classical sense and have no face value, since they are used in exchange for money, goods, or services, trading in virtual currency will be a supply of financial services.
Thus, according to the case-law of the Court of Justice, the sale of cryptocurrencies will fall within the scope of exempt (from VAT) supplies of financial services.
However, now when the tax bases of these supplies of financial services, when they represent the main activity (together with other revenues from supplies of financial and taxable services or goods), exceed BGN 50 thousand for 12 months before the current month there is an obligation for registration under the VAT Act. “When the turnover is reached for a period not longer than two consecutive months, including the current one, the person is obliged to submit the application within 7 days from the date on which the turnover was reached,” the NRA said.
As we have already established, according to the tax authorities in Bulgaria, the income realized by individuals from the sale of bitcoin should be treated as income from the sale of a financial asset. The Personal Income Tax Act (PITA), on the other hand, offers the exact opposite interpretation, namely that such income is taxable. They are declared in Table 2 of Part 1 of Annex № 5 of the annual tax return of the year following the year of its realization, as no special documents proving the income are required to be attached. There is taxable income when a profit is made – the selling price is higher than the acquisition price. If no transactions have been made during the tax year, the obligation to declare is waived.
To determine the taxable income, the amount of the profits realized during the year, determined for each specific transaction, is considered, decreasing by the sum of the losses realized during the year, determined for each specific transaction. The realized profit/loss is determined by reducing the selling price by the acquisition price of the financial asset.
From the point of view of CITA, transactions with cryptocurrencies also belong to the operations with financial assets. However, whether they are taxed depends on the economic purpose of the acquired virtual currencies.
We know that for corporate income taxation the tax financial result is determined by conversion for tax purposes of the accounting financial result. At the same time, when there are no special provisions for the tax treatment of the accounting income arising from the sale of virtual currency, then this income is considered for corporate taxation, without the need to convert the accounting financial result.
From what has been said so far, in theory, transactions with cryptocurrencies are subject to income tax. The question, however, is how the tax administration will monitor them and will control the declaration of the income thus realized, provided that both the currency and the transactions and consumers are encrypted. The tracking can be done only within the framework of a tax audit when the financial flows from the liquidation of the virtual currency are detected.
When and what should I declare to the NRA if I trade in cryptocurrencies?
The main goal of investing in cryptocurrencies is profit. As the investment in shares, the one in the virtual currency works on the same principle, namely – profit when the price of a certain amount already purchased by us increases. But when exactly is this profit declared before the NRA and how is it taxed?
- when the profit is used for personal needs: In case the purchase value of the purchased cryptocurrency increases after a certain period and the profit is used for personal needs and is one-time, then the profit is not subject to VAT, similarly when we buy foreign currency and its cost increases.
- when the profit is for commercial purposes: Again, if the purchase value increases after a certain period, but the profit is used for commercial purposes and the entire investment is for commercial purposes, then the profit must be declared to the NRA and it is VAT benefit.
- when we “dig” cryptocurrencies: The digging of cryptocurrencies can happen through the purchase of video cards or special machines with which the “diggers” receive a small part of the cryptocurrency. In this case, according to the explanations of the NRA, the person is considered a sole trader and his profit is taxed at 15% if he is an individual.
What exchange rate is taken when calculating the tax base?
To determine the tax base, in BGN, the reference rate of the respective platform on which the cryptocurrency is traded and the days of the realized transactions or the conversion is taken.
Is it necessary to declare the acquisition of cryptocurrency before the Bulgarian national bank?
No. At present the acquisition of bitcoin and other cryptocurrencies is not regarded as “e-money transaction”. Therefore, such transactions are neither controlled by the BNB, nor controlled by the Financial Supervision Commission unlike financial instruments.