Complete a review of the article by writin

767

THE VAT TREATMENT OF CRYPTOCURRENCIES IN SOUTH AFRICA: LESSONS FROM

AUSTRALIA Ruddy Kabwe LLB LLM Doctoral Student, Department of Mercantile Law, University of Pretoria

SUMMARY Cryptocurrencies are revolutionary digital currencies used by people on a peer to peer network. Cryptocurrencies are predominantly used as a payment method in business transactions. However, challenges arise with cryptocurrency borne transactions due to the lack of universal accepted classification of cryptocurrencies, the result of which leads to unintended tax consequences for cryptocurrency users. This article examines the recent amendment to the Value-Added Tax (VAT) 89 of 1991 pertaining specifically to the VAT treatment of cryptocurrencies in South Africa. Currently, transactions in cryptocurrencies are deemed to be financial services in South Africa. This means that a supply of any cryptocurrency in South Africa is exempt from VAT. This article makes a comparison with the Australian legislative framework to determine how cryptocurrencies are treated for VAT/GST purposes in that country. Although the move to regulate cryptocurrencies is welcomed, this article argues that cryptocurrency activities are incorrectly legislated as financial services in the VAT Act.

1 INTRODUCTION Since its inception in 2009, cryptocurrencies have revolutionised money markets, the financial sector and electronic commerce transactions while potentially creating new business models in the process. The idea of using a perceived digital decentralised currency as a payment method in exchange for goods and services has proven to be indispensable for individuals and businesses. However, part of the challenge with cryptocurrency-borne transactions is the seemingly lack of an appropriate uniform legislative framework addressing the risks and tax implications thereof. This is compounded by a lack of universal classification of cryptocurrencies, leading to unintended tax consequences for cryptocurrency users and merchants.

 Paper presented at the 6th Annual International Mercantile Law Conference, University of

the Free State (7 November 2019).

768 OBITER 2020

For any government to do its core functions efficiently, it requires revenue. The revenue collected is generated from taxes with the aim of addressing core functions such as financing public expenditure and promoting socio- economic growth.1 It is trite that states need additional streams of revenue and improved revenue systems.2 The reality is that imposing taxes on economic activity is one of the most efficient ways for governments to raise revenue. It stands to reason that tax authorities should endeavour to broaden the tax base in order to increase the revenue pool.3

The advent of the Taxation Laws Amendment Act 23 of 2018 introduced changes to the Value-Added Tax 89 of 1991 (the VAT Act) in so far as cryptocurrencies are concerned. In terms of the VAT Act, cryptocurrencies are deemed to be financial services and therefore exempt from VAT.4

The purpose of this article is to argue for the treatment of cryptocurrencies as taxable supplies for VAT purposes. To support this argument, the article explores the Australian legislative framework that specifically deals with the VAT/Goods and Services Tax (GST)5 treatment of cryptocurrencies. The way Australia treats cryptocurrencies can be used as a model for the VAT treatment of cryptocurrencies in South Africa. Australia is selected as a comparative country as it currently has the most comprehensive guidelines and legislation pertaining to the VAT/GST treatment of cryptocurrencies.

This article concludes by making recommendations for the treatment of cryptocurrencies as a taxable supply for VAT purposes.

In this article “cryptocurrencies” and “Bitcoin” are used interchangeably.

2 THE CHARACTERISTICS OF CRYPTOCURRENCIES The success and popularity of cryptocurrencies has largely been attributed to two important aspects. Firstly, cryptocurrency transactions are anonymous in nature. Users buy, sell and exchange cryptocurrencies with other users without revealing one’s identity. Secondly, transactions involving cryptocurrencies do not incur any fees.6 The lack of fees translates into significantly lower transaction costs because users transact with each other without the aid of an intermediary.7

1 Croome, Oguttu, Muller, Legwaila, Williams, Kolitz and Louw Tax Law An Introduction

(2013) 8. 2 Bird and Gendron The VAT in Developing and Transitional Countries (2007) 8. 3 There is a caveat to this, however. When considering an expansion of the tax base, it is

important to consider the principles of taxation like certainty, convenience, equity, cost effectiveness and efficiency.

4 S 2 of the VAT Act. 5 GST and VAT are used interchangeably throughout this article. 6 Bal “Taxing Virtual Currency: Challenges and Solutions” 2015 43(5) Intertax 381. See also

Van Alstyne “Why Bitcoin has Value: Evaluating the Evolving Controversial Digital Currency” 2014 57(5) Communications of the ACM Journal 30 30.

7 Brito, Anning, Friedman, Taylor, Strauss, Brazell, Von Unruh, Brailsford, Cleary and Hoegner The Law of Bitcoin (2015) 7.

THE VAT TREATMENT OF CRYPTOCURRENCIES … 769

The growth of cryptocurrencies has been precipitated by what is known as the network effect.8 What this means in simple terms, is that the more people use and exchange cryptocurrencies (such as bitcoins) in the digital currency sytem,9 the more valuable the cryptocurrency (Bitcoin) becomes.10 The reason cryptocurrencies have value is because people receive and use it as a form of money.11 However, cryptocurrencies have a tendency to fluctuate due to uncertainty regarding its value and the attempts by jurisdictions to regulate it.12 According to Blundell-Wignall, the reason for bitcoins’ volatility is that:

“There is no clear intrinsic value or agreed valuation method, and certainly no Bitcoin central bank prepared to intervene to make the price more stable, which would violate the fixed supply element.”13

The volatility component creates uncertainty for potential users, investors, businesses, governments and tax authorities. Due to its volatility, Nabilou argues that the use of cryptocurrencies as a unit of account will be difficult.14 For this reason, Nabilou also argues that it is preferable for individuals to use cryptocurrencies as a store of value (an asset) as opposed to a unit of account.15

Regulation of cryptocurrencies remains one of the most difficult challenges for governments and tax authorities. This is because transactions involving cryptocurrencies do not require the intervention or facilitation of third parties. Instead, cryptocurrencies are created and exchanged through a decentralised global network.16 The decentralised global network is not controlled by any government or state.

3 UNDERSTANDING THE NATURE OF CRYPTOCURRENCIES

From the outset, it is important to understand and define cryptocurrencies. In as much as governments and tax authorities seek to regulate cryptocurrencies, comprehensive regulation cannot properly take place if the

8 Bashir Mastering Blockchain: Distributed Ledgers, Decentralization and Smart Contracts

Explained (2017) 115. 9 It should be noted that “Bitcoin” with a capital “B” refers to the cryptocurrency as a brand of

digital currency as opposed to other cryptocurrency brands such as Litecoin, Ethereum and Tether whereas “bitcoin” with a lower case “b” refers to the denomination of the Bitcoin cryptocurrency in use.

10 Bashir Mastering Blockchain: Distributed Ledgers, Decentralization and Smart Contracts Explained 115.

11 Van Alstyne 2014 Communications of the ACM Journal 30. 12 Callahan “The Bitcoin Price is Fluctuating: What Are the Reasons?” (6 June 2018)

https://www.coinspeaker.com/bitcoin-price-fluctuating-reasons/ (accessed 2019-06-03). 13 Blundell-Wignall “The Bitcoin Question: Currency Versus Trust-Less Transfer Technology”

2014 37 OECD Working Papers on Finance, Insurance and Private Pensions 8. 14 Nabilou and Prum “Ignorance, Debt and Cryptocurrencies: The Old and the New in the Law

and Economics of Concurrent Currencies” (2018) Journal of Financial Regulation http://orbilu.uni.lu/bitstream/10993/38830/1/SSRN-id3121918.pdf (accessed 2019-07-22) 7.

15 Ibid. 16 The original decentralised global network is known as “Bitcoin” with a capital “B”.

770 OBITER 2020

same governments and tax authorities do not adequately understand the nature and activities relating to cryptocurrencies.17 It is quite likely that jurisdictions interpret the meaning of cryptocurrencies differently and the result is a lack of uniformity on the VAT treatment for cryptocurrencies.

The term cryptocurrency is often used to denote “virtual currency”. A cryptocurrency is a maths-based decentralised convertible virtual currency that is protected by cryptography.18 From this definition, it can be said that a cryptocurrency is a subdivision of a virtual currency.19 The Financial Action Task Force (FATF)20 defines a virtual currency as a digital representation of value that is traded digitally and has one or more of the following characteristics: a medium of exchange, a unit of account and a store of value.21 In other words, the existence of virtual currency is largely dependent on the Internet because virtual currencies are digital in nature. Although virtual currencies may be used as a medium of exchange and they appear to have all the characteristics of money,22 it does not necessarily follow that virtual currency is legal tender23 unless it is duly issued and authorised by a state’s central bank. Virtual currencies on the other hand, are issued by individuals on a peer-to-peer network. In South Africa, legal tender is only issued by the South African Reserve Bank (SARB).24 Although the term “legal tender” is not specifically defined in the South African Reserve Bank Act 90 of 1989, it is generally accepted to mean coins, bank notes and gold coins.25

A distinction must be drawn between virtual currency and fiat money. Fiat money includes bank notes, coins and any legal tender issued by a jurisdiction. Fiat money, however, is often also colloquially referred to as “electronic money” or “e-money” because it is capable of being represented

17 Bal “Developing a Regulatory Framework for the Taxation of Virtual Currencies” 2019 47(2)

Intertax 224. 18 Financial Action Task Force (FATF) “FATF Report Virtual Currencies Key Definitions and

Potential AML/CFT Risks” (2014) https://www.fatf-gafi.org/media/fatf/documents/reports/ Virtual-currency-key-definitions-and-potential-aml-cft-risks.pdf (accessed 2019-05-28) 5; see also Bal 2019 Intertax 219 at fn 2.

19 Bal 2019 Intertax 219 at fn 2. 20 The Financial Action Task Force (FATF) is an inter-governmental body established in 1989

by the Ministers of its Member jurisdictions. The objectives of the FATF are to set standards and promote effective implementation of legal, regulatory and operational measures for combating money laundering, terrorist financing and other related threats to the integrity of the international financial system. The FATF is therefore a “policy-making body” which works to generate the necessary political will to bring about national legislative and regulatory reforms in these areas, https://www.fatf-gafi.org/about/ (accessed 2019-07-15).

21 FATF https://www.fatf-gafi.org/media/fatf/documents/reports/Virtual-currency-key-definitions -and-potential-aml-cft-risks.pdf; see also Brito et al The Law of Bitcoin 2–3; Lyndell Virtual Currencies: Regulatory and Tax Compliance Issues (2014) 7.

22 Characteristics of money include: (1) medium of exchange (2) store of value (3) unit of account (4) legal tender (5) standard of deferred payment (6) liquidity (7) stability of value (8) interchangeable (9) portability and (10) confidence, https://simplicable.com/new/money (accessed 2019-07-15).

23 FATF https://www.fatf-gafi.org/media/fatf/documents/reports/Virtual-currency-key-definitions -and-potential-aml-cft-risks.pdf 4; see also Brito et al The Law of Bitcoin 3.

24 S 10(1)(iii) of the South African Reserve Bank Act 90 of 1989. 25 S 17 of the South African Reserve Bank Act 90 of 1989.

THE VAT TREATMENT OF CRYPTOCURRENCIES … 771

digitally.26 Because of this digital representation, virtual currency and fiat money are often referred to as “digital currencies”. By definition, a digital currency is a digital representation of virtual and fiat currencies.27 A virtual currency can further be subdivided into convertible and non-convertible virtual currencies. For instance, bitcoins can have a value in South African Rand (the Rand) and it can be exchanged for the Rand at any given time. For this reason, bitcoins is an example of a convertible virtual currency. On the other hand, a non-convertible currency “is intended to be specific to a particular virtual domain or world”.28 Typical examples of non-convertible currencies include World of Warcraft Gold and Q Coins.29

Furthermore, convertible virtual currencies can be divided into centralised and decentralised virtual currencies. A virtual currency is centralised if it has a central administrator that is responsible for issuing the currency; the administrator establishes the rules of the currencies’ use and the administrator maintains a payment ledger.30 A decentralised currency, as the name suggests, has no central authority and no central monitoring oversight.31 The most well-known decentralised currency is bitcoin.

4 WHAT IS BITCOIN? Introduced in 2009 by a programmer using the pseudonym Satashi Nakamoto, bitcoin is an international, decentralised, convertible, virtual currency.32 Bitcoins consist of units of account comprised of numbers and letters that constitute units of the currency.33 Bitcoins, as a form of cryptocurrency, is traded digitally between users and they can also be exchanged into fiat currency (real money); bitcoins can be exchanged for other virtual currency; and bitcoins can be exchanged for goods and services.34 Brito et al summarise the characteristics of Bitcoin as a system that is peer to peer and computationally impractical to reverse; cryptographically secure and uses proof of work.35

Anyone can create bitcoins through a process called “mining”. The mining of bitcoins involves creating new bitcoins by using computational power in

26 FATF https://www.fatf-gafi.org/media/fatf/documents/reports/Virtual-currency-key-definitions

-and-potential-aml-cft-risks.pdf 4; see also Brito et al The Law of Bitcoin 3. Fiat money can also be represented digitally. For example, money can be transferred electronically by means of an electronic funds transfer (EFT).

27 Ibid. 28 Ibid. 29 Ibid. 30 FATF https://www.fatf-gafi.org/media/fatf/documents/reports/Virtual-currency-key-definitions

-and-potential-aml-cft-risks.pdf 5. 31 Ibid. 32 Brito et al The Law of Bitcoin 7. 33 FATF https://www.fatf-gafi.org/media/fatf/documents/reports/Virtual-currency-key-definitions

-and-potential-aml-cft-risks.pdf 3–6. 34 FATF https://www.fatf-gafi.org/media/fatf/documents/reports/Virtual-currency-key-definitions

-and-potential-aml-cft-risks.pdf 6. 35 Brito et al The Law of Bitcoin 5.

772 OBITER 2020

order to solve complex algorithms or puzzles.36 Once a miner37 has created new bitcoins, that miner is rewarded with what is known as “block reward” and transaction fees. The block reward consists of a specific number of bitcoins.38

One of the interesting aspects of utilising the Bitcoin system is that one does not need to register or provide their identity in order to conduct a transaction. All Bitcoin transactions are stored in the Bitcoin blockchain stored in a free and open-source software that is often known as the Bitcoin protocol.39 One merely accesses the Internet on a compatible device, downloads the free software and then stores, sends, receives and monitors Bitcoin transactions.40

Currently, the Organisation for Economic Cooperation and Development (OECD) has not prescribed any universal regulations or guidelines on the classification and VAT treatment of cryptocurrencies. However, the OECD,41 in its 2018 Report to G20 Finance Ministers and Central Bank Governors, stated:

“Given the availability of big data, international co-operation among tax authorities should be enhanced, in particular, as regards the information on the users of online platforms as part of the gig and sharing economies, to ensure taxes are paid when they are due. The forum on tax administration, working with the inclusive framework, will develop practical tools and cooperation in the area of tax administration and will also examine the tax consequences of new technologies like cryptocurrencies and blockchain.”42

This implies that the OECD is of the view that transactions involving cryptocurrencies should be subject to tax. However, the report does not specifically state how such transactions should be taxed. Nor does it give a pro forma legal framework for the taxation and VAT treatment of cryptocurrencies. The “how” is left to individual states to consider and establish appropriate regulatory framework for the tax consequences of cryptocurrencies.

36 FATF https://www.fatf-gafi.org/media/fatf/documents/reports/Virtual-currency-key-definitions

-and-potential-aml-cft-risks.pdf 7; Bal 2015 Intertax 381. 37 An individual or entity that has special computer software that enables them to “create” new

bitcoins. 38 De Filippi and Wright Blockchain and the Law: The Rule Code (2018) 25. 39 De Filippi and Wright Blockchain and the Law: The Rule Code 21. 40 FATF https://www.fatf-gafi.org/media/fatf/documents/reports/Virtual-currency-key-definitions

-and-potential-aml-cft-risks.pdf 6. 41 South Africa is currently not a member of the OECD but interacts with subsidiaries of the

organisation; see http://www.dirco.gov.za/foreign/Multilateral/inter/oecd.htm (accessed 2019-11-30).

42 OECD “OECD Secretary-General Report to G20 Finance Ministers and Central Bank Governors” (March 2018) http://www.oecd.org/ctp/OECD-Secretary-General-tax-report- G20-Finance-Ministers-Argentina-March-2018.pdf (accessed 2019-12-02) 9.

THE VAT TREATMENT OF CRYPTOCURRENCIES … 773

5 THE VAT TREATMENT OF CRYPTOCURRENCIES IN SOUTH AFRICA

5 1 A modern VAT system Before discussing the VAT treatment of cryptocurrencies in South Africa, it is important to understand how VAT works. VAT is a form of consumption tax. Although VAT is collected at each stage of production, the consumer is ultimately responsible for paying VAT. While the VAT liability is on the consumer, VAT is charged at each stage of production and distribution making it possible for businesses in the chain to deduct the VAT paid.43 The VAT deducted is also known as input tax. VAT is due when a consumer “pays” for the goods or services that they have acquired for personal use.44 Usually, a consumer receives an invoice with the purchase price that is inclusive of VAT. The VAT displayed on the invoice affords businesses the opportunity to recover VAT on their own purchases.45 This is known as the invoice method of accounting for VAT.

The conventional approach is for a seller to charge VAT on his or her taxable supplies (output tax) and then subsequently claim a credit for the purchase of the goods or services (input tax). The difference between the output tax and input is the VAT payable. If the input tax exceeds the output tax, then a refund can be claimed. The collection of VAT during the various stages of production indicates that VAT is a form of tax introduced with the objective of raising revenue.46

In South Africa, VAT is levied on the importation of goods; on the supply of imported services and on the supply of goods and services by a vendor in the furtherance of his or her enterprise.47 Although not explicitly stated in the VAT Act, South Africa adopts the destination principle as opposed to the origin principle48 as means to tax consumption. In terms of the destination principle, the taxation of goods and services takes place in the country where these goods are services are “used”. In other words, all exports are free from VAT while imports are subject to VAT.

The destination principle is particularly important where services (electronic services) are purchased and thereafter supplied from traders that

43 Silver and Beneke Deloitte VAT Handbook 10ed (2015) 3. 44 Ibid. 45 Kerrigan “The Elusiveness of Neutrality – Why is it so Difficult to Apply VAT to Financial

Services?” 2010 Munich Personal Research Papers in Economics Archive https://mpra.ub. uni-muenchen.de/22748/1/MPRA_paper_22748.pdf (accessed 2019-12-01) 4.

46 Bal Taxation of Virtual Currency (PhD thesis, University of Leiden) 2014 202. 47 S 7(1)(a) to (c) of the VAT Act. An “enterprise” is defined as “any enterprise or activity which

is carried on continuously or regularly by any person in the Republic or partly in the Republic and in the course or furtherance of which goods or services are supplied to any other person for a consideration, whether or not for profit, including any enterprise or activity carried on in the form of a commercial, financial, industrial, mining, farming, fishing, municipal or professional concern or any other concern of a continuing nature or in the form of an association or club.”

48 In terms of this principle, taxation of goods and services takes place in the country where they are produced.

774 OBITER 2020

are located outside the borders of South Africa (cross-border electronic commerce transactions). Sometimes, it is impossible to establish the location or the area where the services49 are consumed.50 This is due to various reasons, but the most crucial aspect is the inability to identify the consumer. As a result of this, tax authorities insert proxies in legislation as aids to determine the location of the consumer.51

5 2 Cryptocurrencies and the VAT Act Currently, the VAT Act does not define cryptocurrencies. It appears that the relevant policy makers did not consider the importance of including a legal definition of cryptocurrencies in the VAT Act. A lack of a definition in the VAT Act creates uncertainty for taxpayers and the general public because compliance with any tax legislation is dependent on the understanding of the relevant legal provision in any tax legislation. By the same token, if a taxpayer does not understand the meaning of the terms in a tax legislation or if the term is vague; it is difficult for a taxpayer to comply with the necessary legislation. This challenge is compounded by the fact that there is a plethora of information about cryptocurrencies on the Internet. Accessing different websites may result in a taxpayer formulating his or her own opinion about what constitutes cryptocurrencies; in the absence of any legislated definition of the said term in the VAT Act. For example, the word “cryptocurrency” can often be used interchangeably to denote “bitcoin”, “currency”, “money” and even “tokens”.52 All these terms have different connotations which may or may not necessarily be attributed to a legal definition of cryptocurrencies. Furthermore, Bitcoin is not the only form of a decentralised cryptocurrency.53 To avoid uncertainty, a definition of cryptocurrency must be adopted in the VAT Act.

5 3 Financial services and cryptocurrencies Section 2 of the VAT Act defines the term “financial services” as:

“(1) For the purposes of this Act, the following activities shall be deemed to

be financial services:

(a) The exchange of currency (whether effected by the exchange of bank notes or coin, by crediting or debiting accounts, or otherwise);

(b) the issue, payment, collection or transfer of ownership of a cheque or letter of credit;

(c) the issue, allotment, drawing, acceptance, endorsement or transfer of ownership of a debt security;

49 This is because services are intangible in nature making the traceability thereof impractical. 50 Kabwe Consumption Tax Collection Models in Online Trade in Digital Goods (unpublished

LLM mini-dissertation, UNISA) 2017 27; Bal Taxation of Virtual Currency 204. 51 See s 1 part (vi)(aa) to (cc) of the definition of “enterprise” in the VAT Act. Currently, South

Africa uses the bank details, address and residency status of the consumer as proxies for the supply of electronic services.

52 Bal 2019 Intertax 225. 53 Others include Litecoin, Ethereum, Dash and Monero.

THE VAT TREATMENT OF CRYPTOCURRENCIES … 775

(d) the issue, allotment or transfer of ownership of an equity security or a participatory security;

(e) …..

(f) the provision by any person of credit under an agreement by which money or money's worth is provided by that person to another person who agrees to pay in the future a sum or sums exceeding in the aggregate the amount of such money or money's worth;

(g) …..

(h) ….. </

Collepals.com Plagiarism Free Papers

Are you looking for custom essay writing service or even dissertation writing services? Just request for our write my paper service, and we'll match you with the best essay writer in your subject! With an exceptional team of professional academic experts in a wide range of subjects, we can guarantee you an unrivaled quality of custom-written papers.

Get ZERO PLAGIARISM, HUMAN WRITTEN ESSAYS

Why Hire Collepals.com writers to do your paper?

Quality- We are experienced and have access to ample research materials.

We write plagiarism Free Content

Confidential- We never share or sell your personal information to third parties.

Support-Chat with us today! We are always waiting to answer all your questions.