Israel to Ease Taxes on Bitcoin and Other Digital Currencies

Officials plan to replace the onerous regime imposed a year ago on cryptocurrencies with a capital gains tax, and are counting on taxpayers' honesty to pay the levy

File photo: Stacks of bitcoins sit near green lights on a data cable terminal.
Chris Ratcliffe/Bloomberg

Switzerland, a world financial center, is determined to ensure its status by reducing regulations for digital-currency services and other financial technologies in the hope that more fintech companies and startups will set up shop there.

The Swiss city of Zug has become known as Crypto Valley, perhaps the worlds leading innovation hub for technologies based on blockchain software. Last month the Swiss bank Vontobel said it would start trading Switzerlands first two mini futures to short bitcoin. In October, Lucerne University of Applied Sciences and Arts said it would accept bitcoin payment, and some Swiss cities already accept tax payments in cryptocurrencies.

Now Israel, which is aspiring to add fintech to the list of technologies its Startup Nation excels at, is weighing rules that would make dealing in bitcoin and other cryptocurrencies a lot easier from a tax perspective. The regulations will likely be added to the next budget arrangements law, work on which is due to begin in another month.

Like most countries, Israel hasnt yet articulated an official policy on digital currencies, but doing so has become more urgent as bitcoin reached a record high $11,000 last week as investors pour in money via largely unregulated markets.

So far, the Israeli government has only offered a circular by the Israel Tax Authority. That paper, released about a year ago, declared bitcoin a financial asset and imposed burdensome rules on people investing in it.

Among other things, investors are required to pay any tax due within 30 days after a transaction. Dealers must make monthly reports on prices for all sales and purchases of the currency, and transactions are subject to the value-added tax. At a certain level of activity, bitcoin profits are considered like labor income.

The rules make cryptocurrency trading cumbersome and expensive, certainly in comparison with other financial assets like stocks, where the broker conducting the transactions deducts tax at source.

Now, under an initiative led by the Finance Ministry and tax authority, officials are expected to end VAT on digital-currency trades and impose the same 25% capital gains tax other financial investments are subject to. They are also expected to reduce reporting requirements for investors to once a year instead of 30 days after each transaction.

Meanwhile, the Israel Securities Authority last August formed a committee to recommend regulations for cryptocurrency fundraising by companies, which are known as initial coin offerings. The panel is due to release an interim report by the end of the year.

Officials are acting out of fear that Israel could be left behind in the developing industry of cryptocurrencies and that the government will lose potential tax revenues to other countries that have easier regulations. But there is also the risk that the rules could drive away investors in the famously freewheeling cryptocurrency market.

The fundamental question facing Israeli policy makers is whether bitcoin should be regarded as a currency like any other and therefore not subject to a tax at all, or whether it should be regarded as a financial asset that should be taxed.

Bitcoin believers, of course, argue against any tax, but tax authority officials contend that cryptocurrencies arent real currencies but rather investments that people buy and hold in order to profit.

An Israeli court is currently hearing arguments in two lawsuits by bitcoin investors that taxing bitcoin profits is illegal because it is a currency. But to date no country, no matter how liberal its digital-currency regime is, has gone as far as to make that claim, because digital-currencies arent issued by a central bank or subject to monetary policy.

As it is, the anonymity of digital currencies makes them an attractive way to launder money or buy and sell contraband. Official recognition of bitcoin and other currencies would make them even more attractive as legal tender for illegal transactions.

Israel is already struggling with a black market and its failure to crack down on it by reducing the value of cash transactions in the economy, so it doesnt need the extra headache of bitcoin.

Another problem will be the tax authoritys ability to identify which taxpayers are investing in cryptocurrencies. A basic principle is that no one knows who holds the currency or how much – all the information thats available is an online address thats not tied to the user's identity. There are no intermediaries like banks and financial-service companies that typically provide information on investment transactions for the taxman.

The tax authority has no solution for this problem and is counting on the honesty of average Israelis to report their cryptocurrency income like any other. In any case, the minute they exchange their bitcoin or other digital currency for shekels, their holdings would be there for the taxman to see.