Cryptocurrency: Tax Is Not Virtual

Chong Mun Yew, Tax Executive Director & Michael Cheah, Tax Senior Manager

The COVID-19 pandemic resulted in Malaysia implementing its first Movement Control Order (“MCO”) on 18 March 2020’. Since then, Malaysia has gone through various iterations of MCO which had varying rules and Standard Operating Procedures (“SOPs”) but it had triggered a new norm for employers and employees in Malaysia, which is Working-From-Home (“WFH”).

The WFH culture coupled with the economic uncertainties resulting from the COVID-19 pandemic worldwide has encouraged Malaysians to seriously consider investments as an additional income source or as an alternative to traditional investments such as buying shares, bonds, option, etc. One such investment opportunity is in cryptocurrency. The surge of new investors in cryptocurrency has seen Luno Malaysia’s registering an influx of new users of 588,994 verified users in the fourth quarter of 2020, which represents over 300% quarter-on-quarter customer growth.

Given the upward trend of investing in cryptocurrency in Malaysia, the question then arises on whether the gains from investing in cryptocurrency is subject to tax in Malaysia. Although cryptocurrency has already been around for many years, but regulators are still trying to come to grips with the legal and tax aspects of this asset class.

This article was published in the Tax Guardian (July 2021) by the Chartered Tax Institute Of Malaysia (CTIM).


The rise of digital currency

Prior to 2009, no one seriously foresaw the rise of digital currency. After the financial crisis highlighted the oversight by the central banks and financial institutions which led to losses in monetary reserves, people started looking for a more secure replacement to traditional fractional reserve banking. Then, cryptocurrencies were seen as one such alternative.

Over the past twelve years, cryptocurrencies have steadily grown in value and recognition as a digital currency. Elon Musk, a well-known enthusiast of Bitcoin, through Tesla acquired $1.5 billion of Bitcoin during the first quarter of 2021 and then followed up with an announcement that Tesla’s customers will be able to purchase their cars with Bitcoin. This view has since changed due to the recent announcement by Elon Musk on 13 May 2021 which is discussed further below.

All these together with a myriad of other factors culminated in cryptocurrencies values rising substantially in 2021. Ethereum posted a record high value of $3,616 on 7 May 2021, which represented a price gain of over 385%. On the other hand, Bitcoin posted its record high value of $63,000 on 13 April 2021, which is double the price since the start of 2021. Analysts are forecasting that cryptocurrency, and in particular, Bitcoin still have further potential for growth. However, after the announcement made by Elon Musk, the prices of cryptocurrencies seem to be plunging. As can be seen, the prices of cryptocurrencies are highly volatile. 

What is cryptocurrency?
Cryptocurrency is a form of decentralized digital currency that is based on blockchain technology. They are secured by cryptography, thus making it almost impossible to counterfeit or double-spend. For example, Bitcoins are registered with a Bitcoin address which makes the entire system pseudonymous with transactions being recorded under pseudonyms to that the identities of the parties are kept private. Bitcoins are stored in a Bitcoin wallet. The Bitcoin wallet is basically just a collection of Bitcoin addresses. Each of the Bitcoin addresses was created with a valid private key.

According to CoinLore, there are currently more than 5,000 cryptocurrencies in circulation. 
Cryptocurrencies have the characteristic of a Fiat currency which means that it is not backed by a physical commodity like gold or government guarantees. Currently, most nations utilize fiat currency to drive their economics. The biggest fiat currency to drive their economics. The biggest fiat currency would be the United States Dollar which has been a fiat currency since 1971. The thing that gives fiat currency value is its scarcity, guarantee of value from the issuing state, and the laws of supply and demand. 

Using Bitcoin as an example, assuming the supply and demand remain stable, but the community was to lose faith in the value of Bitcoin, the community would then start to sell their Bitcoin bringing down the price of Bitcoin due to the oversupply of Bitcoin in the market.

What can cryptocurrency be used for?
Cryptocurrency can be spent just like any conventional currency at any merchants that accept it. One such example is Tesla, which has recently announced that it will be accepting Bitcoin as a payment method for its customers to purchase their cars. However, on 13 May 2021, Elon Musk said that Tesla would no longer accept bitcoin due to the fossil fuel issue. He has not indicated whether Tesla would accept other digital coins to replace Bitcoin. Alternatively, it can be sold to people who wish to purchase the cryptocurrency for whatever purpose.
How Can You Own Cryptocurrencies?
One way to own cryptocurrency, which is the easiest way is to purchase it at one of the many new cryptocurrency exchanges registered with the Securities Commission of Malaysia which are Luno Malaysia Sdn Bhd, SINEGY Technologies (M) Sdn Bhd, and Tokenzie Technology (M) Sdn Bhd.

The alternative is cryptocurrency mining. Let us use Bitcoin mining as an example. Mining Bitcoin involves adding Bitcoin transaction data to Bitcoin’s global public ledger of past transactions. Each group of transactions is called a block. Blocks are secured by Bitcoin miners and built on top of each other to form the blockchain. The blockchain confirms the transactions as having taken place to the rest of the network. Bitcoin nodes running the Bitcoin program use the blockchain to distinguish legitimate Bitcoin transactions from those transactions that attempt to re-spend coins that have already been spent elsewhere. However, Bitcoin mining is getting more expensive as more and more processing power is required to compute the hash functions required to secure a block to the blockchain. This has led to many Bitcoin mining pools being set up to share in the costs of mining Bitcoin. This is akin to a joint venture with many miners from all over the world to contribute to a mining pool.

Digital currency

Is Cryptocurrency the next tax frontier?

Different jurisdictions across the world have taken a different approach in respect of the taxation of cryptocurrency. We will examine a few of the approaches below. 
United States
The United States Internal Revenue Service classifies virtual currency as property for United States Federal tax purpose. Therefore, capital gains taxes are applicable for gains on the value of virtual currency in the United States. 
In Singapore, the Inland Revenue Authority of Singapore has held that businesses that buy and sell virtual currencies in the ordinary course of their business will be taxed on the profits derived from trading in the virtual currency. Profits derived by businesses which mine and trade virtual currencies in exchange for money are also subject to tax. 
However, like Malaysia, there is no capital gains tax in Singapore. Hence, long term investment in cryptocurrency would not be subjected to tax.

In Europe, there is no consensus on whether cryptocurrency is a currency. However, the European Court of Justic has held that Bitcoin exchanges should be exempted from Value Added Tax (“VAT”) on the basis that the only purpose of Bitcoin is as a means of payment, the court concluded that the “currency” exemption in Skatteverket v David Hedqvist Case C-264/144 should apply.


What is Malaysia's Stance on Cryptocurrency? 

Bank Negara has held that digital currencies are a payment instrument that is not regulated by Bank Negara and therefore cannot be considered legal tender in Malaysia. However, the Securities Commission of Malaysia (“SC”) recognises digital currencies as an investible class of assets and has prescribed digital assets as securities that is regulated under the SC’s laws. 

Is cryptocurrency subject to Malaysian income tax?
The Inland Revenue Board of Malaysia (“IRBM”) has yet to issue definitive guidelines on how to subject the cryptocurrency transactions to tax. However, the IRB has cited Section 3 of the Income Tax Act 1967 (“ITA”) and indicated the said provision can be applied to active cryptocurrency traders. Therefore, the current provisions of the ITA can be applied to active cryptocurrency traders. 

The IRB went on to say that the determination of whether the profits from cryptocurrency activities is taxable would depend on the facts and circumstances of the case to determine whether there is a pattern of the badges of trade. If one is determined as an active trader of cryptocurrency, then the net gains from the cryptocurrency activities would be subject to income tax and would be required to be disclosed in their income tax returns under the “any other income” section. Therefore, they would need to keep proper books of accounting and business records in Malaysia for the purpose of being audited by the relevant law enforcement agencies. 

Notwithstanding, there are a few arguments that taxpayers can raise to argue against the imposition of tax on their gains from cryptocurrency as we will discuss below.

Taxpayers can argue that the income gained from the cryptocurrency transaction is foreign-sources income, and therefore not subject to tax i.e. that it is derived from outside Malaysia. This argument will likely be challenged by the IRBM – in which case the taxpayer would need to prove that the transaction was indeed performed outside Malaysia. With travel restrictions on account of the pandemic, this task is made that much more difficult for the taxpayer. 
The nature of cryptocurrency is such that the transaction can be performed at a click of a button on a laptop or smartphone anywhere in the world. As such, the taxpayer would have a hard time proving that the location of the transaction or the originating source of the cryptocurrency lies overseas. 

The taxpayer can move around the world to avoid being classified as a tax resident in Malaysia. As mentioned, given the global nature of the cryptocurrency in general, these Malaysian taxpayers can sell their Bitcoins from anywhere without the hefty cross border transaction fees. These taxpayers could argue that they are not tax resident of Malaysia and therefore are not subject to Malaysia income tax. However, one should take guidance from the case of Hii Yii Ann v Deputy Commissioner of Taxation of the Commonwealth of Australia & Others [2017] MLJU 2302 a Malaysian taxpayer derived income from Australia and was taxed on the said income by the Australian revenue authorities. The taxpayer however claimed he is not chargeable to income tax in Australia. His appeal against the assessment was rejected by the Australian court. 
Another issue to consider is who is actually making the profits. In the age of Virtual Private Networks, the identity of the person making those gains may not be clear. The money when remitted back from utilisation is an ancillary issue.

The taxpayers can argue that they brought cryptocurrency merely as a hobby or as a long0term investment. However, if a business arises as a by-product of a hobby or other non-commercial activities, its profits could also be subjected to tax. 

This is seen in the tax case of Hawes v Gardiner (37 TC 671) where a taxpayer bred and trained dogs as his hobby. The General Commissioners found that the selling of puppies for substantial prices by the taxpayer was in the nature of trade and subjected the profits from the sale of puppies to tax. 

Applying this principle, in the current circumstances, the trading of cryptocurrency may be subjected to tax. The taxable transactions occur every time the cryptocurrency is traded in virtual exchanges. The blockchain ledger will have records on the transacted prices and time of transfer. The taxpayers have to subtract the cost of the cryptocurrencies against the selling price to determine the gain or loss. In this regard, the taxpayers must keep track their cryptocurrency transactions continuously to report the gain or loss one each cryptocurrency transaction properly.

The application of the 40-year-old principles of the badges of trade from NYF Realty Sdn.Bhd. v Controller of Inland Revenue could still be applicable in determining whether there is an intention to trade: 

i. Subject matter of the transaction 
Cryptocurrency is a speculative instrument that is extremely difficult to value and as such is normally the subject of investment. However, even gains from investment can be subject to income tax if they are performed actively.

This is seen in the tax case of Dr.Zanariah Binti Ramli v Ketua Pengarah Hasil Dalam Negeri Civil Appeal No. W-01-711-12/2011, where the Court of Appeal held that the gains made from the bond market is subject to income tax based on the grounds that the appellant had in fact been actively trading in bonds during the period.

Numerous or repetitive acts done by the appellant would suggest the action was in the nature of a trade. In view of the above, holding cryptocurrency would likely have the characteristic of an assert held for the trading in the eyes of the IRB. 

ii. Period of ownership
The period of ownership of the cryptocurrency is one aspect which is in total control by the taxpayer. The benefit of holding cryptocurrency is that there are virtually no holding costs unless the taxpayers has borrowed money to purchase this cryptocurrency. If a taxpayer has held the cryptocurrency for a long period of time, he could argue that he is a long-term investor of the currency. However, for all recent transactions, it would likely be considered an adventure in the nature of a trade and be subjected to tax. 

iii. Frequency of transactions

This is a significant consideration to identify speculators of cryptocurrency. There will be multiple cryptocurrency transactions to and from the same address or wallet within a short period of time. Most cryptocurrency transactions are public, traceable and stored on a network base don blockchain technology. In the present case, if the IRB can look behind the cryptocurrency pseudonyms and identify the owner of the cryptocurrency wallet, the IRB can further investigate the owner of cryptocurrency and tax them accordingly.

iv. Alteration of property to render it more saleable 
Due to the nature of cryptocurrency, the taxpayer is unlikely to be able to alter the cryptocurrency to make it more saleable. 

v. Methods employed in disposing of property
If special exertion was made to find or attract purchasers for the cryptocurrency, it might indicate an intention to sell it for profit. However, in the case of cryptocurrency, the taxpayer has easy access to buying and selling of cryptocurrency via the numerous cryptocurrency exchanges available. Further, cryptocurrency is currently a very liquid asset that can be spent on goods and services just like conventional currency, albeit it not being recognised as legal tender by Bank Negara. Arguably, this badge of trade may not paint a clear picture of the intention of the taxpayer. 

vi. Circumstances responsible for sale 
The principle here is that if the sale of cryptocurrency is occasioned by a sudden emergency or unanticipated need for fund, such facts will tend to indicate that the cryptocurrency was not acquired for the purpose of resale at a profit and that the sale was no pursuant to a profit-making undertaking or scheme. 
This principle involves a subjective study into the surrounding circumstances relating to the sale of cryptocurrency and will be determined according to the merits of each individual case. 

vii. Financing
Generally, the source of financing can indicate whether an asset was purchased with the intention to trade. If the taxpayer has taken a short-term loan to purchase the cryptocurrency, it will tend to indicate that the cryptocurrency was acquired for the purpose of resale for profit and subject the gains to tax. 

Based on the analysis of badges of trade above, the cryptocurrency speculator may be considered as engaging in an adventure in the nature of a trade and their gains will be taxable. 

Is there an upside?
On the bright side, if the taxpayer is held to be engaging in an adventure in the nature of a trade, all expenses wholly and exclusively incurred in earning that income will be deductible under Section 33(1) of the ITA provided that they are not specifically disallowed under Section 39 of the ITA. Therefore, taxpayers may even claim the interest costs or any directly related costs incurred to hold the cryptocurrency. 

However, it is difficult to draw the line between capital versus revenue in an actual situation, a person may initially purchase cryptocurrency for investment purposes but subsequently uses it to settle debts. The question that arises would be – will this still be a capital transaction? If not, which value to be used for tax purposes?
Cryptocurrency Staking
An alternative method to getting returns on cryptocurrency is by staking. Staking is the holding of cryptocurrency in the cryptocurrency wallet to support the security and operations of the blockchain network. By locking the cryptocurrency, the cryptocurrency exchange will provide rewards which are usually in the form of a cryptocurrency of choice of the wallet owner. 

This concept would be similar to that of placing a fixed deposit with a licensed bank to earn the interest income. However, individuals earning interest income from deposits placed with licensed banks are exempted from tax on the interest income. The same cannot be said for the returns earned from cryptocurrency staking where there are no specific provisions in the ITA nor any rules that exempt it from tax in Malaysia. Therefore, similar to the trading of cryptocurrency, individual and corporate taxpayers alike earning rewards from cryptocurrency staking may potentially be required to bring it to tax under Section 3 of the ITA. 
So, what’s next?
How to tax a decentralized currency powered by blockchain technology is still very much the question of every government regulator’s mind. One thing for certain is that they have to update their respective tax laws or potentially continue losing out on a digital gold mine of tax revenue. 

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