Have you or are you considering buying bitcoin or other cryptocurrencies? And are you unsure about the taxation rules? You're not alone. There are many reasons why you may be unsure about the taxation rules for cryptocurrencies and how they are handled in practice.
Samar Law is Denmark's leading legal advisors in this field, and in recent years we have advised many companies and private individuals on the rules, and we regularly assist in cases against the tax authorities. Our experience is gathered in this guide, which is continuously updated with new practice and new legislation.
There is no specific law regulating the taxation of cryptocurrency gains and losses, and over the years, tax authorities have taken different positions on the issue, which has caused some confusion. In recent years, however, some guidelines have developed through practice that provide a framework for the regulation of cryptocurrency taxation. This guide summarizes the relevant legal rules and rulings and provides you with the answers to many of the questions we typically receive.
This guide is relevant for those who have traded or are considering trading bitcoin and other cryptocurrencies as a private individual. If you want to read about the rules for corporate taxation of cryptocurrency, keep an eye on this website or sign up for our newsletter, where there is an upcoming article on corporate taxation of bitcoin.
**The guide is continuously updated in case of new practices or rule changes - this guide therefore always gives you an overview of the current rules - last updated December 1, 2020**
Tax legislation is structured so that the State Tax Act regulates the taxation of assets, unless there is a special tax law that regulates the taxation of the particular asset. Examples of these special laws are the Capital Gains Tax Act and the Capital Gains Tax Act, which regulate the taxation of shares and real estate, respectively.
In a legal context, cryptocurrency is still a new invention that is not covered by any industry-specific regulation. Therefore, there is no special law regulating taxation on cryptocurrency. Therefore, cryptocurrencies are also considered a capital asset in line with other unregulated capital assets. Thus, it is the State Tax Act of 1922 that "falls back on" and thus regulates the taxation of cryptocurrency.
Few people reading this guide will have any doubts about what a cryptocurrency actually is. But does the law distinguish between a coin, token, stablecoin, non-fungible token, etc. And is there any difference in tax law between these? In fact, it wasn't until January 2020 that a definition of cryptocurrency was introduced in Danish law. This happened with the implementation of the Fifth Money Laundering Directive in the Money Laundering Act, where the definition of a cryptocurrency is now found in section 2, no. 16:
"A digital expression of value that is not issued or guaranteed by a central bank or public authority, is not necessarily tied to a legally established currency and does not have the same legal status as currency or money, but is accepted by natural and legal persons as a medium of exchange that can be transferred, stored and traded electronically."
As can be seen, the law does not actually distinguish between different types of cryptocurrencies. In practice, the tax authorities do not make any assessment of whether a cryptocurrency falls under the above definition or not. This means, for example, that bitcoin, which is a coin, and ether, which is a token, are taxed under the same set of rules. Based on current practice, all cryptocurrencies are therefore taxed the same, regardless of the type of cryptocurrency. It is therefore irrelevant whether it is a coin, token or something completely different.
The rules on the taxation of cryptocurrency can be found in section 5(a) of the Danish State Tax Act. This means that realized gains on cryptocurrency are generally not taxable, just as realized losses on cryptocurrency are not deductible.
Can you avoid paying tax on bitcoin and other cryptocurrencies? You might not be able to, because there are two exceptions to the general rule of tax exemption. If one of these exceptions applies, you are taxable and deductible for gains and losses respectively.
The first exception is if you have acquired your cryptocurrencies as part of a business.
The other exception is if you have acquired your cryptocurrencies as part of speculation.
Commercial activity and speculation are defined as follows in the Danish Tax Agency's Legal Guide (2-2020).
C.C.2.2.1.3.3.2 - link, C.C.2.2.1.3.3.3.3 - link
More about sustenance - when you live off your cryptocurrency winnings, for example
The tax law literature states that the following elements must be included in the assessment of whether it is a business. 1
The list of factors is a non-exhaustive list as it is always a case-by-case assessment. The tax law literature shows that the number and strength of factors can vary from situation to situation and from asset type to asset type. This means that one factor may be given decisive weight in one case, while the same factor may be given less weight in another dissimilar case.
At present, there is no practice where the tax authorities have assessed that a person has acquired their cryptocurrencies as part of a business. The Danish Tax Agency has dealt with cases involving people who have traded cryptocurrencies systematically and extensively with a profit over several years without assessing that it was a business. It must therefore be assumed that the tax authorities are restrictive in their assessment of whether a person has acquired their cryptocurrencies for business purposes.
More on speculation - if you acquired your cryptocurrencies to resell them
The crucial question in cryptocurrency taxation cases is whether you have acquired your cryptocurrencies speculatively.
The crucial point when assessing this question is whether there was an intention to resell, cf. the above definition from the Legal Guide. Generally, it is the intention at the time of acquisition that determines whether you have acquired your cryptocurrencies in speculation. In practice, however, it is possible to step "out of" the speculative intent, but it is never possible to step "into" the speculative intent. For example, it may be that the intention of acquiring cryptocurrencies was to invest these cryptocurrencies in an ICO, but that you abandon this idea and instead use your cryptocurrencies for a practical purpose that the tax authorities do not consider to be speculation.
It follows from the tax authorities' practice that the intention to resell does not necessarily have to be "significant" at the time of acquisition.
The question of intent to resell is a subjective assessment. Therefore, the tax authorities' practice has developed a number of objective factors that must be included in the assessment of speculation. These non-exhaustive factors can be listed as follows, noting that, as in the business assessment, it will always be a holistic assessment that is concrete and based on the specific case:
1 Page 251f in Tax Law 1, Jan Pedersen, et al, 8th edition.
If it is assessed that you have acquired your cryptocurrencies as part of either speculation or business, you are taxable on your realized gains on cryptocurrencies, just as you are deductible on realized losses on cryptocurrencies.
Advances are taxed as ordinary salary income, which can be up to top tax, corresponding to approximately 56%. 2 This is also known as "personal income", with the difference that no AM contribution (labor market contribution) is due. Losses trigger a tax deduction corresponding to approximately 30% (2020).
Advances must be reported on the annual tax return in box 20, while deductions are reported in box 58.
Because there is a difference between the tax rate and the right to deduct, there is asymmetrical taxation. In addition, the tax calculation must be based on the realization principle (and thus not the inventory principle). According to the tax authorities' practice, a realization occurs every time there is an exchange of the cryptocurrency in question, regardless of whether it is against another cryptocurrency, fiat currency or a completely different asset. This means, among other things, that tax must be paid on each individual trade. It's a point that often comes as a surprise to our clients, which can be illustrated with the following example:
Example 1:
Person A has bought 1 bitcoin for DKK 1,000 via an exchange on January 1st.
Person A then exchanges 0.5 bitcoin for 100 ether at a rate of 10 DKK/ETH.
This means that the 100 ether at the time of exchange had a value of DKK 1,000.
Person A has thus made a gain of DKK 500, which he is thus taxable on according to the realization principle below.
It is therefore important to emphasize that gains and losses are calculated as cryptocurrencies are traded against other cryptocurrencies and not only when you transfer fiat currency to your bank account as in several other countries.
The asymmetric taxation in conjunction with the realization principle can in many cases lead to a taxation of over 100%. An example of this can be illustrated as follows:
2 The exact tax rate depends, among other things, on the local council tax and whether you are subject to top tax.
Example 2:
Person A owns 1 bitcoin.
A sells half of his bitcoin for a profit of 50 kr.
Later, A sells the other half of his bitcoin with a loss of 80 kr.
A has thus had a total loss of DKK 30.
However, A must pay approximately DKK 25 in tax and receives approximately DKK 10 in deductions.
A's total tax is thus DKK 15, even though A has had a loss of DKK 30.
SKM2018.104.SR was the first decision where the tax authorities assessed that a realized loss on cryptocurrencies should be treated as a tax deduction. This was because the Tax Council assessed that speculative losses were not covered by the deduction rules in section 3(2) of the Personal Tax Act or section 4 of the Personal Tax Act.
However, this has been questioned in the legal literature, where this has been questioned. This is because the Tax Council only assessed whether the above-mentioned provisions of the Personal Income Tax Act could be applied. Thus, the Tax Council did not assess whether a loss was covered by section 3(1) of the Personal Income Tax Act, which there are certain circumstances that speak for.
If losses are covered by section 3(1) of the Personal Tax Act, a taxpayer will be entitled to calculate their gains and losses as a net amount. In practice, this means that a taxpayer will be taxed on their actual profits and thus cannot risk a tax rate of over 100 percent. However, the issue has not yet been tested by the tax authorities. Keep an eye on this website, where a separate article on the subject is forthcoming.
The Danish Tax Council has published a number of decisions regarding the tax treatment of cryptocurrencies. Two leading decisions on this issue have been published as SKM2018.104.SR and SKM2019.67.SR, which will be discussed separately below.
SKM2018.104.SR - the first case in the Tax Council about bitcoin and tax
SKM2018.104.SR, which is also mentioned above, was the first case in which the Tax Council considered the tax assessment on the disposal of cryptocurrencies.
In the case, with reference to section 5(a) of the State Tax Act, the Tax Council found that losses and gains should be calculated separately based on each disposal and on the difference between the actual acquisition price and the disposal price of the cryptocurrency in question. This principle is called the "asset-for-asset" principle.
The asset-for-asset principle
In relation to partial disposals (i.e. disposals where it is not the entire stock of virtual currencies that is disposed of at once), the Tax Council clarified, based on the above, that section 5(a) of the State Tax Act does not regulate "a calculation method for partial disposals from a stock of uniform or not separately identifiable assets acquired for speculation purposes".
Against this background, the Tax Council found that when it was not possible to identify the virtual currencies disposed of in partial disposals and, as a result, the acquisition cost could not be calculated, the acquisition cost of the bitcoins first acquired in the inventory should be included in the calculation of gain or loss on any partial disposal. This principle is called FIFO (First In First Out).
The FIFO principle (First In First Out)
Decisive for whether the FIFO principle is applied is thus whether the disposed cryptocurrencies can be identified, including whether the exact acquisition price of the disposed cryptocurrencies can be identified. If this question can be answered in the affirmative, the asset-for-asset principle must be applied, while the FIFO principle must be applied otherwise.
Regarding this issue, the decision states the following:
"In SKAT's opinion, the FIFO principle should therefore include an aggregation of all the taxpayer's holdings of bitcoins when these are located in several accounts or wallets.
In other cases where an identification problem does not exist, e.g. where all bitcoins are disposed of at the same time, regardless of whether they are spread over several accounts or wallets, the calculation of gain or loss will be based on the difference between the sale price and the actual acquisition price of the bitcoins sold." (our emphasis)
Thus, it was the opinion of the Tax Council that, pursuant to section 5(a) of the Danish State Tax Act, an asset-for-asset principle applies as a general rule. The exception to this is the cases where there are partial disposals of a holding of cryptocurrency that are not individually identifiable, after which the FIFO principle applies. This was confirmed in SKM2018.130.SR.
SKM2019.67.SR - on the rules for the tax calculation of cryptocurrency
In SKM.2019.67.SR, the Tax Council clarified the calculation principles in SKM.2018.104.SR and elaborated on the circumstances under which the two calculation principles apply.
The Tax Council stated the following in relation to this issue:
"The Danish Tax Agency cannot deny that today or in the future there are methods that make it possible to identify the individual bitcoins, which makes it possible to determine which bitcoins leave the holding upon partial disposal. This must be based on a concrete assessment of the evidence presented to determine whether reliable identification is made. This documentation has not been presented in this case, and the Tax Agency can therefore not relate specifically to the questioner's transactions. If the questioner can demonstrate such a method, the FIFO principle does not apply in the opinion of the Tax Agency. In this case, the main rule of an asset-for-asset principle in section 5(1)(a) of the State Tax Act will apply."
It can thus be seen that the above excerpt confirms the legal position as interpreted in SKM.2018.104.SR, see above.
To show how the inventory methods should be used in practice, we have created a few examples:
Example 1:
A buys 1 bitcoin for DKK 1,000 on January 1.
A buys 1 more bitcoin for $2,000 on February 1.
Both bitcoins are stored on the same wallet X.
A sells 0.5 bitcoin for $1,000 on March 1 from wallet X.
As it cannot be identified whether the 0.5 bitcoin that A sells on March 1 originates from the acquisition on January 1 or February 1, A's acquisition price for the 0.5 bitcoin cannot be determined either. Thus, the FIFO principle must be applied.
A must therefore make his tax assessment based on his first acquisition on January 1. A must therefore be taxed on a profit of DKK 500.
Example 2:
A buys 1 bitcoin for DKK 1,000 on January 1.
A buys 1 more bitcoin for $2,000 on February 1.
A's bitcoins are now stored on two different wallets - wallet X and wallet Y respectively.
A sells 0.5 bitcoin for DKK 1,000 on March 1 from wallet Y.
As it can be identified that the 0.5 bitcoin originates from A's acquisition on February 1, the acquisition price can also be established. Thus, the asset-for-asset principle must be applied.
A must therefore make its tax assessment based on its acquisition on February 1.
A has therefore not had any profit or loss and is therefore not taxed.
This example illustrates why it's important to analyze which of the calculation principles apply. If you had used the FIFO principle instead, you would have mistakenly ended up with a tax base of DKK 1,000.
In a case, the tax authorities have ruled on how the tax assessment of bitcoins received as a gift should be treated. The decision is published as SKM2019.78.SR.
The case involved a taxpayer who had received two bitcoins from his girlfriend as a Christmas present in 2013.
In the case, the Tax Council ruled that the taxpayer in question could realize his bitcoins tax-free as they had been received as a gift. The case was based on the fact that the taxpayer had not wanted the bitcoins in question as a gift and that there were persons besides the donor who could witness the transfer.
It is not clear from the decision whether the tax authorities have tested the information or simply used it as a premise in the case. It is our experience from other similar cases that the Danish Tax Agency conducts an intensive review of whether the cryptocurrencies in question have actually been transferred as a gift.
There may be certain situations where a holder of a specific cryptocurrency is allocated new cryptocurrencies simply because they already own that specific cryptocurrency. In other words, the holder does nothing active to be allocated the new cryptocurrencies. In practice, this is referred to as a hardfork or an airdrop. It is important to note that the tax treatment of hardforks, airdrops and staking is, under the circumstances, different from normal cryptocurrency trading.
Hardfork - a decomposition of an existing blockchain
The prerequisite for a public blockchain to function is that there is consensus between the nodes on the blockchain on the rules of that blockchain, including the way new blocks on the blockchain are generated and transactions are validated.
Historically, there have been situations where there has not been this consensus between the nodes. This has resulted in a new independent blockchain with independent rules, a new independent virtual currency, and a continued preservation of the original blockchain using the original rules.
This situation, where a new standalone blockchain is created with a new standalone virtual currency, is called a hard fork.
In a hardfork, a holder of the virtual currency belonging to the preserved blockchain will receive a corresponding number of virtual currencies belonging to the new blockchain free of charge. Examples of hardforks include bitcoin cash and ethereum classic, which were forked out of bitcoin and ethereum respectively.
The tax authorities have in one decision, which is printed as SKM2018.104.SR, specifically addressed the tax treatment of hardforks. The case concerned the tax treatment of bitcoin cash, which the taxpayer had received as part of the bitcoin hardfork. The Tax Council noted the following:
"It is SKAT's opinion that the allocation of bitcoin cash is tax-free for the questioner at the time of allocation, as the allocation must be considered part of the already purchased bitcoins and thus also acquired with the same intention.
This means that the taxation of bitcoin cash only takes place at the time of disposal, cf. section 5(1)(a) of the State Tax Act." (our emphasis)
It is thus seen that the cryptocurrencies that have been allocated in connection with a hardfork must be treated in the same way as the cryptocurrencies they are hardforked "out of". In the specific case, this means that the specific taxpayer is tax-exempt on realized gains obtained on bitcoin cash provided that he is also tax-exempt on realized gains obtained on bitcoin.
If you are taxable on realized profits on the cryptocurrencies you have been allocated in connection with a hardfork, the tax calculation must be made based on an acquisition price of DKK 0.
Airdrop - an allocation of new cryptocurrencies
An airdrop occurs when the people behind a specific cryptocurrency allocate this cryptocurrency to typically all wallets that are already in possession of another cryptocurrency. For example, the people behind cryptocurrency A may decide to allocate 10 cryptocurrencies A to everyone in possession of cryptocurrency B.
An airdrop is typically done for promotional reasons, as it is often a new cryptocurrency.
The tax authorities have not yet addressed the tax treatment of cryptocurrencies received as part of airdrops in printed practice. As the purpose of an airdrop is typically promotional, the allocated cryptocurrencies are allocated to a (very) wide circle of people, and as the cryptocurrencies typically have a very low value at the time of allocation, it is our assessment that this is a promotional gift covered by section 4 of the State Tax Act. In such a case, the value of the allocated cryptocurrencies at the time of allocation is taxable if this value is not modest, while a subsequent increase in value will not affect the income assessment.
In practice, it is very difficult to determine whether the value is modest. This is because the cryptocurrencies in question are still in an establishment phase where they are not yet traded on an established market. This also makes it difficult to get the market price of the cryptocurrencies and thus assess whether the value is modest or not.
As mentioned above, cryptocurrencies are considered a capital asset for tax purposes and must therefore be treated according to the rules of the State Tax Act.
Depending on a number of factors, a trade in cryptocurrencies may be considered a financial contract and must be treated for tax purposes accordingly, cf. SKM2018.130.SR.
Financial contracts are regulated in section 29(1) of the Capital Gains Act. From this provision, three conditions must be met before a financial contract can be considered a financial contract:
These are cumulative conditions that must all be met before there are financial contracts under section 29(1) of the Capital Gains Act.
The following decision tree can be used when assessing whether a financial contract is involved.
What about margin trades?
The Danish Tax Council has in the above-mentioned SKM2018.130.SR the Danish Tax Council has assessed that margin trades constitute a financial contract in accordance with section 29(1) of the Danish Capital Gains Act. The consequence of this is that a separate tax calculation of gains and losses on the contracts must be made, and these must be calculated according to the inventory principle, cf. section 33 of the Capital Gains Act. This is an important remark, as it means that you must pay tax on gains on your margin trades on an ongoing basis, regardless of whether a gain has been realized or not.
It is important to note that there are different types of margin trades, and it always depends on a specific assessment whether or not these are covered by the rules on financial contracts, cf. section 29 of the Capital Gains Act. The specific assessment can advantageously be made based on the above decision tree.
The tax authorities always have the opportunity to verify tax assessments. This means that the Tax Agency has the opportunity to verify the accuracy of the information the company submits in connection with trading in its cryptocurrencies.
In this connection, we have some experience with the type of documentation that the Tax Agency typically requests. This is particularly relevant in connection with the declaration of losses. It should be noted that it is most likely possible to obtain deductions even if you cannot provide all the documentation requested by the Tax Agency.
The Tax Agency typically asks for documentation for the following:
It is not uncommon for us to receive questions from Danes who, in order to optimize their taxes, want to leave Denmark and move to a country that has a more lenient capital gains tax on cryptocurrency.
The tax assessment of cryptocurrency in connection with moving out of Denmark is regulated in section 10(1) of the Danish Withholding Tax Act (also referred to as "exit taxation" or "offshore taxation").
First and foremost, it should be noted that the application of the rules presupposes that you have left Denmark and thus given up your full Danish tax liability in accordance with section 1(1)(1)(1) of the Withholding Tax Act (the "global income principle"). The conditions for this will not be further assessed in this guide, but it should be noted that the tax authorities have a relatively restrictive practice in this matter.
If a person leaves Denmark and relinquishes their full tax liability to the country, it follows from the rules in section 10(1) of the Withholding Tax Act that "assets that are not still subject to Danish taxation [are] deemed to be disposed of at the time of departure. The assets are deemed to be disposed of at the market value at the time of departure."
In practice, this means that cryptocurrency is considered to be realized in connection with the move. It is usually possible to defer payment of the calculated tax.
The exit rules can be illustrated with the examples below, where it is assumed that A has acquired his bitcoin as part of speculation.
Example 1:
A buys 1 bitcoin for 1,000 kr. on January 1, 2020.
A moves out of Denmark on February 1, 2020, in which connection A also gives up his full tax liability to Denmark.
The trading value of 1 bitcoin is 2,000 DKK at the time of moving out.
A must therefore be taxed on a profit of DKK 1,000 at the time of moving out.
Example 2:
A buys 1 bitcoin for 1,000 kr. on January 1, 2020.
A moves out of Denmark on February 1, 2020, in which connection A also gives up his full tax liability to Denmark.
The trading value of 1 bitcoin is 500 kr. at the time of moving out.
A thus obtains a deduction right on his loss of DKK 500 at the time of moving out.
Example 3:
A has now lived abroad for many years and wants to move back to Denmark.
On January 1, 2030, A moves back to Denmark, in which connection A's full tax liability to Denmark resumes.
The trading value of 1 bitcoin is $100,000 on January 1, 2030.
On February 1, 2030, A sells his bitcoin for $101,000.
It is the value of A's bitcoin at the time of moving in that is considered A's acquisition cost.
A must therefore be taxed on a profit of DKK 1,000.
It is common knowledge that cryptocurrencies are built around a decentralized nature, where the person in possession of each wallet's private key also has access to it. If you lose your private key, you also lose access to your cryptocurrencies. There is no centralized entity that you can apply to restore your wallet, and as a general rule, you will permanently lose access to your wallet - and your cryptocurrency will be permanently lost.
It is not uncommon for us to receive inquiries from people who have typically lost their phone or computer where their private key has been located. It could also be that they have lost their master seed for their hardwallet or that an exchange has been hacked.
But how should this be treated legally? Is this a deductible loss?
Section 5 of the Danish State Tax Act cannot be used as a legal basis for a deduction. The question is therefore whether the loss is covered by the right of deduction in section 14 of the Capital Gains Act. SKM2018.104.SRwhere the Tax Council stated:
"In this connection, it should be noted that losses incurred as a result of lost codes for a virtual wallet do not constitute a tax deductible loss in SKAT's opinion.
This is partly because the content of the virtual wallet has not been lost, which is why the ownership of it continues to exist, and partly because a tax loss deduction on assets acquired for speculative purposes requires that the asset in question has actually been traded/sold."
Thus, it appears that the tax authorities attach decisive importance to the fact that a lost private key only constitutes a loss of access to your cryptocurrencies and not lost cryptocurrencies. Based on the consideration that you still have legal ownership of the cryptocurrencies in question, the assessment is thus that there has not been a deductible loss. The view seems to be highly theoretical, as a permanent loss of a private key de facto constitutes a permanent loss of a holding of cryptocurrencies.
In addition, through the practice of the tax authorities, a view has emerged according to which a debtor must be identified as a condition for deductions to be obtained under section 14 of the Danish Capital Gains Act. For cryptocurrencies, this creates a de facto legal situation where it will not be possible to obtain a right to deduct lost cryptocurrencies, but only stolen cryptocurrencies.
The above views have been criticized in the legal literature, and it cannot be denied that tax authorities will eventually come to a different assessment in specific cases.
***
Is there an area that you think this guide is missing? Or do you have any questions that you would like our help with? Then write an email to lawyer Payam Samarghandi at payam@samarlaw.dk or call him at 60793777.
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