Should exchange of one crypto currency into another count as a taxable income?
This document is a meditation, a socratic dialogue which aims to look at pro-et-contra argument on why exchange of one crypto currency for another should or should not count as taxable income according to Austrian income tax law (Einkommensteuergesetz 1988).
(1) Einkünfte aus Kapitalvermögen sind Einkünfte aus der Überlassung von Kapital (Abs. 2), aus realisierten Wertsteigerungen von Kapitalvermögen (Abs. 3) und aus Derivaten (Abs. 4), soweit sie nicht zu den Einkünften im Sinne des § 2 Abs. 3 Z 1 bis 4 gehören. Bei Tauschvorgängen ist § 6 Z 14 sinngemäß anzuwenden.(2) Zu den Einkünften aus der Überlassung von Kapital gehören:1. a)Gewinnanteile (Dividenden) und sonstige Bezüge aus Aktien oder Anteilen an Gesellschaften mit beschränkter Haftung;b)Gleichartige Bezüge und Rückvergütungen aus Anteilen an Erwerbs- und Wirtschaftsgenossenschaften;c)Gleichartige Bezüge aus Genussrechten und sonstigen Finanzierungsinstrumenten sowie Bezüge aus Partizipationskapital gemäß § 8 Abs. 3 Z 1 des Körperschaftsteuergesetzes 1988;d)Bezüge aus Anteilen an körperschaftlich organisierten Personengemeinschaften in den Angelegenheiten der Bodenreform (Agrargemeinschaften), wenn diese einen Betrag in Höhe von 4.000 Euro im Kalenderjahr übersteigen.2.Zinsen, und andere Erträgnisse aus Kapitalforderungen jeder Art, beispielsweise aus Darlehen, Anleihen, Hypotheken, Einlagen, Guthaben bei Kreditinstituten und aus Ergänzungskapital im Sinne des VAG 2016, ausgenommen Stückzinsen;3.Diskontbeträge von Wechseln und Anweisungen;4.Gewinnanteile aus der Beteiligung an einem Unternehmen als stiller Gesellschafter sowie aus der Beteiligung nach Art eines stillen Gesellschafters, soweit sie nicht zur Auffüllung einer durch Verluste herabgeminderten Einlage zu verwenden sind.(3) Zu den Einkünften aus realisierten Wertsteigerungen von Kapitalvermögen gehören Einkünfte aus der Veräußerung, Einlösung und sonstigen Abschichtung von Wirtschaftsgütern, deren Erträge Einkünfte aus der Überlassung von Kapital im Sinne von Abs. 2 sind (einschließlich Nullkuponanleihen).
The current interpretation of this law by the BMF is that exchange of cryptos back to Euro as well as exchange of one crypto for another both count as taxable capital gains.
This document is written as a dialogue between a Crypto philosopher and a Taxman, each with their point of view, trying to explain their point of view to each other.
Preface
One day, Crypto philosopher decides to try out the emerging crypto market to see what the fuss is all about.
In good faith, the philosopher opens an account at an exchange, provides all personal data, transfers funds and begins their crypto journey.
The philosopher first transfers 1.000,00€ from their bank to crypto exchange. Next, they exchange 1.000,00€ for Stellar Lumens (XLM) at 0,5€ per XLM, ending up with 2.000,00 XLM (for argument’s sake, the philosopher ignores any exchange and transaction costs).
Browsing the stellar network, the philosopher find DOGET asset among the trending crypto assets on stellar network. As they have heard about Doge Coin before (reminder, our philosopher is new to crypto), they decide to invest into this coin exchanging 2.000,00 XLM to 2.000.000,00 DOGET, at 0,001 XLM per DOGET.
To summarise the transactions so far:
1.000,00 € -> 2.000,00 XLM -> 2.000.000,00 DOGET
The philosopher forgets about their investment for a month, then they check their portfolio, und realise that the exchange rate is now 0,02 XLM per DOGET. “That can not be right”, the philosopher thinks, “Doge coin did not grow so much, what is going on”.
Doing some research the philosopher realises they did not invest into Doge Coin, but completely different crypto currency called Doge Token. They do not know enough to understand the risk, so they decide to exchange DOGET to XLM and do their research.
2.000.000,00 DOGET -> 40.000,00 XLM
The philosopher then holds the XLM over the end of calendar year, thinking nothing of it.
Then, one day, somebody knocks on their door…
The Visitor
knock, knock, knock
“Who is it, at this hour”, the philosopher thinks.
“Good evening Mx. Philosopher, I am the Taxman, a representative of the Finanzamt. Would you let me in?”
“Well good evening Mr. Taxman, of course, please join me in a cup of Viennese coffee. I am surprised to see you though, I have filed all my tax reports, what brings you here?”
“Well, Mx. Philosopher, we have reasons to believe that you failed to report all your capital gains for the previous year”
“Oh, that should be a short visit then, I have done no such thing!” proclaims the philosopher, sipping their coffee.
“But you did, and I will prove it to you. Remember that crypto investment you did last year?”
“Ah, DOGET, yes, that was a strange one. I got it by mistake, exit in panic and I now hold XLM. But what does that have to do with you, Mr. Taxman?”
“Well, Mx. Philosopher, we do not have time for any games. You made profit selling DOGET and you did not report your taxes! I’m here to take what belongs to the government!”
Philosopher spits out their coffee in surprise? “Profit? Me? What profit?”
“Yes, see you exchanged 2.000,00 XLM to 2.000.000,00 DOGET, and then back to 40.000,00 XLM, making a profit of 38.000,00 XLM. I’m here to take the government’s fair share”.
“Uhh… huh… wait, WHAT”, the philosopher chokes. The thought of crypto currency exchange rate differences being tangible gains has never crossed their mind!
The relative crypto gain is tangible profit!
“Mr. Taxman”, the philosopher, said “for sure you won’t mind explaining to me what leads you to believe that I have made any profit through that transaction?”
“Oh Mx. Philosopher, no time to games. You exchanged 1.000,00 € to 2.000,00 XLM, converted those to a speculative investment and converted back to 40.000,00 XLM, the exchange rate of XLM to Euro was 0,55€ per XLM, meaning your XLM was worth 22.000,00€!
start: 2.000,00 XLM = 1.000,00€
after DOGET to XLM exchanged: 40.000,00 XLM = 22.000,00€
profit: = 21.000,00€
“This is going to be a long night” the philosopher thought.
Let’s agree on what we agree
“Mr. Taxman, that is an interesting proposition you have. I am not yet convinced I owe you or the government any money, but if I do, I will gladly pay every last Groschen, for I am a philosopher devoted to the rule of law, which is the most important fibre holding our society together. If Socrates died to honour his believes, I shall have no problem contributing what I must under the rule of law. So here is my first question, Mr. Taxman, do you agree that we both, above all, should respect the rule of law?”
“Mx. Philosopher, I have many more people like you to visit, I do not have time for this, the situation is clear!”
“Well well, Mr. Taxman, the rule of law requires both of us to respect it. If we don’t, the society would fall apart in chaos! If government and its agencies or the people start to enforce their interpretation of the law, we could end up repeating our mistakes from not that long ago, and that is a dangerous predicament”.
“But we are the government, of course we respect the law!”
“So there has been not a single case when a court has turned over your interpretation and execution of a law?”
“That’s not what I meant. We believe our interpretation is correct.”
“That is perfectly fine, I do believe we both act in good faith! I do however believe that the matter is not as clear as it seems. Can we agree that:
- we both respect the rule of law
- we both act in good faith.”
“Well yes, that is what our Republic is built upon and stands for. We must agree on that.”
“Very well put, Mr. Taxman. I will put down another thing that I believe we can both agree on: through the crypto currency exchanges, I gained 38.000,00 XLM. I do not dispute it, it is right there in the ledger.”
“But Mx. Philosopher, how can you agree to that but still try to argue that you have not made any taxable profits!?”
How does the Taxman measure the taxable income?
“Mr. Taxman”, said the philosopher, “can you please walk me through how you have determined my profits, again”.
“You started with a thousand Euro and converted them to 2.000,00 XLM so those 2.000,00 XLM were worth 1.000,00 €”.
“I tend to agree with that, yes”.
“Then you invested all XLM in some coin, which grew, and you converted all the coins back, ending up with 40.000,00 XLM, which at the time were worth 22.000,00€!”.
“Hold on,” the philosopher asks, “how do you know these 40.000,00 XLM are worth 22.000,00€”?
“Well it’s clear, at the time of transaction, 1 XLM was worth 0,55€, clearly they would be worth 22.000,00€ if you converted them to Euro! This difference of 21.000.00€ is the profit you have created!”
“But, I never got any Euro, all I got are 40.000,00 XLM. Its value in Euro is unknown till the point in time of the actual conversion” the philosopher argued.
“But you could have exchanged it to 22.000,00€, so you made a profit!!!” the Taxman proclaims in victory.
Can the Taxman determine at what value the Philosopher could have exchanged XLM back to Euro?
“Well, I see many problems with that”, the philosopher said calmly, “do you know how crypto exchanges work?”
“yes, you go to exchange and exchange one currency for another, simple”.
“Not so fast. First of all, there are many exchanges. Where does the law says which exchange should I use to exchange my XLM to Euro? The price is not the same across all exchanges at the same time. So what is the standard you use?”
“Well, we use the average data from multiple exchanges”
“But is that exactly the price at which I could have exchanged?”
“Maybe not, but it’s close, perhaps a few cents up or down”
“So you a admit that is no single exchange rate that can be used to determine the value of my XLM if I would exchange back to Euro”
“Ah, as far as I’m concerned, you can find the exchange with the exchange rate which is the most in your favour and we will use that” the Taxman caved in, “surely that is reasonable and fair”.
“That does sound somewhat reasonable, yes, but there is another problem,” the philosopher makes a pause, “that would be the XLM exchange rate if I didn’t exchange my XLM, and we do not know what the exchange rate would have been if I put my XLM on the market!”
“That is nonsense! “ claims the Taxman “your small amount of XLM can not affect its value”.
“Perhaps it can, perhaps it can not. It all depends on the order book. What you see as a reference exchange rate could be a single small transaction that went through at that rate. It is entirely possible that, had I put my XLM to the market, I would need to exchange at a worse exchange rate, or buy at whatever buy orders there were for XLM, and it could be that would result in multiple transactions, each at progressively worse exchange rate for me.”
“In this example, my exchange of 40.000,00 XLM would have resulted in at least 3 transactions, one at 0.55052, one at 0.55051 and last at 0.55050 € per XLM. But one second later, the situation could be very different, as crypto market is very dynamic. So how can you tell for how much I could have exchanged my XLM, when my exchange itself would have altered the history, although in this case probably by a small amount. However, if I were to hold 40.000.000,00 XLM, the market would probably have crashed. So your application of exchange rate at which I supposedly could have exchanged — but did not — is questionable.”
“But you say yourself that 40.000,00 XLM would not crash the market! You agree that is the price at which you could have exchanged!”
“Well yes, it is likely that I could have. Not certain, but likely. However, do you agree that if somebody was to exchange 40.000.000,00 of XLM in a single order, that could have a big impact on the market?”
“I suppose it could, but how is that relevant?”
“It is relevant because then it is clear that you do not know at white price they could have exchanged their XLM. it could be 0.5, 0.4, 0.3. We do not know. It could create a panic and cause a crash.”
“Could have, would have”
“Interesting point, coming from somebody saying that I could have exchanged my XLM for Euro.” the philosopher remarked, “but do you agree that determining the market value of 40M exchange is not possible without actually exchanging them”?
“Well, I guess I could not really say for how much they would really sell that amount. But you only had 40.000,00 so that is irrelevant.”
“I do not see it irrelevant. Justice must be blind, as everybody should be equal before the law. The fact is that you can not really determine for how much I wold have exchanged my XLM for Euro if I did, is it not?”.
“I can not put a precise value on it, no, but I can do a rough estimate”.
“Does the law not say that taxable income are ‘realised increases of value’?”
“It does, but…”
“Can you exactly determine my realised increase of value”?
“No, but I can estimate it”
“But the law does not say ‘estimated’, or ‘approximate’ or any of that. It says ‘realised’, correct?”.
“Correct”
This is philosopher’s first argument:
- According to the income tax law, a realised increase of value is subject to income tax
- The realised value of crypto currency in Euro can not be exactly determined unless the crypto currency is exchanged for Euro
- Therefore, realised increase of value can not be determined if a crypto currency is not actually exchanged into Euro, the realised value can not be determined
- ∴Therefore, the income law tax does not apply
“But that is nitpicking!” screamed the Taxman, “ you clearly made increase of value!”
“I had more XLM than I started with, yes”.
“But that’s profit!”
“No, until it’s exchanged to Euro, it’s just speculation,” proclaimed the philosopher, sipping their coffee.
Is taxman’s premise to claim philosopher’s profit even valid?
“So, you increased your capital from 2.000,00 XLM to 40.000,00 XLM, right?” the Taxman asked.
“I would say I only increased the balance of my XLM wallet from 2.000,00 XLM to 40.000,00 XLM through an exchange to another crypto and back, yes”.
“But that is profit, and it needs to be taxed!”
“It’s a potential for profit, nothing else”.
“What do you mean, you could have exchanged it to Euro and it would have been worth a lot of money.”
“I could and it would, but I did not.”
“Well you should have!”
“With all due respect, Mr. Taxman, I believe that I do have the right to make that decision myself. I have the right to property:
‘Everyone has the right to own, use, dispose of and bequeath his or her lawfully acquired possessions. No one may be deprived of his or her possessions, except in the public interest and in the cases and under the conditions provided for by law, subject to fair compensation being paid in good time for their loss. The use of property may be regulated by law in so far as is necessary for the general interest.’
“It is a fundamental human right in the EU for me to own my acquired possession, in this case, XLM crypto currency. There is no law which requires me to change it to Euro. I have the right to do whatever I want with it, as long as it is in accordance with law.”
The Taxman was furious: “But nobody is violating your rights to own XLM! We just want you to pay tax on the profit you have made!”
“We’ve been through it, haven’t we. I acquired more XLM, but the value of it in Euro can only be determined if I exchange it back to Euro, anything else is taxation based on speculation and projections, not facts.”
“No! You made profit and you need to pay the tax out of it!”
“Let’s suppose for a moment I did (not saying I did). The only tangible realised value that I have created is XLM, correct?”
“I do not agree, but proceed for the argument’s sake”
“I made 40.000,00 XLM out of 2.000,00 XLM. If you insist that I owe you something, you must accept that I pay you with XLM, because, after all, you claim they are worth 22.000,00€”
“No, I argue that the 40.000,00 XLM you had were worth 22.000,00€ when you converted them from DOGET”.
“Which I showed is an assumption, nothing else. Can I pay you with assumed Euros? I have some in my pocket (philosopher shows empty pockets)”.
The Taxman was not amused.
“No! The Taxman protested, i can only accept a legal tender, which is Euro! Besides, I’m not interested in your investment now, I’m interested in the profits you have already made!”
“This is an excellent point! You can only accept Euro, right?”
“Yes, that is correct”
“And you can only measure my exact profits in Euro, as we have determined before. So why don’t we look at the balance on my Euro wallet and agree that I will pay any profit make on that wallet!”
“No, we have to look at your cryptos and you need to pay me in real Euro”.
“Hold on, so according to you:
- I made profit of 38.000,00 XLM
- My Euro wallet balance was and is 0
- You admit that I never held 22.000,00€
- Yet you are requesting me to pay you in real Euro”
“That sounds about right, yes”
“You insist that you have the right to tax my XLM as profit. But I have shown that the only way to determine the realised profit is to turn them back to Euro. So if you insist that I must pay tax on that profit, let me exchange it to Euro and see what profit I have actually created…”
(remember, this was happening in the future calendar year)
Philosopher proceeds to exchange XLM to EUR, ending up with 13.200,00€, as that is the actual value created on the market.
“So I invested 1.000,00€ last year and today I turned that investment back into 13.200,00€, do we agree on that?”
“Uhm, well, I suppose we do?”
“So the realised increase of value is 12.200,00€, do we agree on that, too”?
“No, wait, it was supposed to be 22.000,00€ and 21.000,00€ profits!”
“I told you that was an assumption, a speculation. This now is reality! We have something we can both easily measure and agree upon.”
“But I’m not concerned with the value today! I’m concerned with your profit in the previous tax year!”
“The value of my Euro wallet was 0. There was nothing tangible to measure or agree upon, there was just speculation, or if you want, opportunity to convert that to profits”
“You would have to convert that to Euro back then!”
“I am at liberty to choose not to.”
“You are tricking me!”
“No, Mr. Taxman, you are trying to trick me! See, you are saying that I made a profit of 21.000,00€, when my Euro wallet balance was 0. Indeed I had an opportunity to turn that to approximately such profit (remember, we can never know what the exact profit would have been), but I chose not to, which is my right! You are trying to trick me by using assumed as an actual value. But the actual value and hence profit is here on the table in front of us, now!”
“But… you had 22.000,00€, where are they?”
“I never had 22.000,00€, please, you need to understand that. Let me give you another example: Let’s say that I converted 1.000,00€ to 2.000,00 XLM, and let’s say that the exchange rate grew to 1€ per XLM at the end of calendar year. I now have potential to exchange that to 2.000.00€ at the end of calendar year, is that correct?”
“Yes, that is correct”
“But would you tax me on that?”
“No, we only tax realised profits, here you did not realise the profit, so you would not pay any tax.”
“So you are saying that somebody who converted 1.000,00€ to 2.000,00 XLM and held that would only have an opportunity, not profit, right?”
“Well yes, they did not do any trade, so it’s not realised yet.”
“Excellent, so we agree on something, opportunity does not equal profit, is that correct?”
“In this case it does not, but that is a totally different case!”
“Is it really now? I held 40.000,00 XLM, I had an opportunity to convert them to tangible profit, but I did not. How does that make me different from somebody who has an opportunity to exchange their crypto currency at a better exchange rate, but does not?”
“But you made profit!”
“I made as much profit as somebody who is holding the same amount of crypto at better exchange rate! You said yourself that value = quantity * exchange rate, have you not?"
“Well yes, that’s how we determined value of your profit”
“But in essence, you are taxing me because my quantity grew. So even if exchange rate stayed constant, you would claim that quantity * exchange rate equals tangible value, would you not?”
“Yes, because you made profit when you created a transaction.”
“At the same time, if somebody holds constant quantity, but the exchange rate grows, you do not consider that profit?”
“That is correct, because there was no transaction.”
“What difference does a transaction make?”
“Well, that person invested in XLM and is speculating on its future value. You invested in DOGET, speculating on its future value, and you changed back to XLM, gaining 38.000,00 XLM in the process as we both agree! Clearly you created profit where as the other person did not!”
“I gained 38.000,00 XLM, nothing else!”
“That’s profit!”
“So how do you determine how much tax do I owe?”
“Well, I calculate that gain to Euro..”
“Sorry to interrupt, but I would have perhaps made that gain had I exchanged my XLM to Euro. Why are you converting my potential gain to Euro, but not the person’s who would have gained from just the exchange rate increase? On top of that, we have determined that you can only determine Euro value by actually converting to Euro, everything else is speculation.
But first, answer this: can you calculate my tax without doing a virtual Euro conversion which did not actually take place?”
Mr. Taxman thinks for a while: “No, I can not value your XLM without first converting them to Euro, because I do not know what value to account for as your income. Because speculation profits are taxed progressively, I can’t even say that you owe me a certain amount of XLM, because I do not know what that amount is.”
Philosopher’s second argument:
- Value of crypto currency can not be directly determined without converting it to Euro
- Taxable income and tax rate can not be calculated without converting the underlying crypto currency to Euro
- Taxable income can only be determined once the crypto currency is actually exchanged back to Euro
- Tax agency is applying calculations of assumed Euro value to determine actual gained value, even when no conversion to Euro actually took place, because they are not able to calculate profit without this manipulation
- The fact that tax agency needs to apply calculation of assumed realised value in Euro instead of simply asking for actual balance of Euro before and after transaction indicates that the tax agency is applying tax to potential profits, not realised profits
- Tax law only applies to realised profits
- ∴Exchange from one crypto currency to another is not taxable income
Philosopher’s third argument:
- Tax agency is using the logic
value = quantity * exchange rateto determine taxable income in case of crypto currency exchange - Currency exchange is an event
- Exchange rate change is an event
- The same calculation could be applied to calculate assumed profit in case an investor held a crypto currency where exchange rate grew
- In fact, a change in exchange rate is no different than a change in quantity. Every movement of exchange rate could be tracked by the tax agency, and applying the same calculation, they could argue an investor has made profit as soon as each exchange rate event took place by calculating assumed value to Euro
- Tax agency does not consider profit created by exchange rate movement to be realised income which is subject to tax
- Gains by increasing quantity, exchange rate, or both - all affect value in the same way
- Exchange of one crypto currency for another only affects the quantity of crypto currency in that wallet, which affects value in the same way as every movement of exchange rate does
- All profits should be taxed equally
- ∴If treated equally, the value created by increasing quantity of crypto currency through exchange is not realised, taxable income
- Tax agency is treating investors who create value by gaining quantity different to those who are creating value by increasing exchange rate
- That puts investors in an unequal position
- All investors should be equal before the law
- ∴Such different taxation approach for the two different ways of creating potential profit is not permissible and is illegal
“But that is madness, quantity gain and exchange rate gain are totally different!” protested the Taxman.
“How so? Do you not use the formula value = quantity * exchange rate to tax my supposed gains?”
“I do, but…”
“And does that formula not have two components which can change:
- quantity
- exchange rate”
“It does, but you made a transaction!”
“So if an investor buys 2.000,00 XLM for 1.000,00€, is that not a transaction?”
“Umm…”
“Are you not saying that each transaction counts? You yourself claim that if I do not touch those 2.000,00 XLM for a year, I’m free of any tax obligations, correct?”
“Yes…”
“And if, after a year, I converted XLM to some other crypto currency and left that other currency untouched for another year I could again do whatever I wanted with it without any tax obligations?”
“Uh yes, but that’s different”
“Do you see that you just agreed that the transaction from EUR to XLM is essentially the same as transaction from DOGET to XLM.”
“Well yes, but there’s no profit in converting EUR to XLM, it’s just a starting point.”
“But do we agree, that in both cases, there is a transaction involved”?
“I guess we do”
“That is good. So let’s say that I exchanged 1.000,00€ to 2.000,00 XLM at 0.5 Euro per XLM. My value is value = quantity * exchange rate = 1.000,00€. Tomorrow, the exchange rate is 0.6 Euro per XLM so the value is 1.200,00€, is that the case”
“Yes, but we have been through it. You changed XLM to DOGET and then DOGET back to XLM, which is entirely different!”
“But Mr. taxman, where does the law mention any transactions or how the profit is created? It just says tax needs to be paid on realised income. Here you completely arbitrarily decided that value gained due to quantity increase through transacting crypto currencies is realised income, where as value gained due to increase in exchange rate is not. The law does not prescribe that. Further, the two have fundamentally the same effect, they are just created differently, one through my active currency exchanges and the other through other’s exchanges on the same crypto market! There is no sound reason to treat the two differently!”
“Do you want me to tax gains based on exchange rate growth alone!?”
“Could you, Mr. Taxman? Tell me, could you look me straight in the eye and argue that is realised income?”
Taxman sat silently thinking what his answer should be….
…TBC
