Malta has set its sights on becoming the blockchain hub of the world, and was the first country to establish a regulatory framework for the booming industry. The Malta Digital Innovation Authority Act, the Innovative Technology Arrangements and Services Act, and the Virtual Financial Assets Act come into effect on November 1, 2018, following a period of consultation. On the same date, the Inland Revenue issued guidelines for the Income Tax Treatment of transactions or arrangements involving Distributed Ledger Technology (DLT) assets.

The guidelines provide definitions of coins and tokens, the latter split in two categories, utility and financial. It also emerges from the guidelines that generally applicable tax principles will apply to DTL transactions. In particular, the nature of the transaction, the statues of the taxpayer and the specific circumstances of the case at hand would all need to consider in arriving at a decision as to whether the transaction is taxable or not. The use being made of the DTL asset will be fundamental to determine the Malta tax treatment

Classification of DTL Assets

According to the guidelines coins are similar to any other means of payment, in that they serve as a medium of exchange and are in no way connected to the issuer.

The characteristics of financial tokens are similar to those of equities, debentures, units in collective investment schemes, or derivatives including financial instruments, in that they may grant rights to dividends, rewards based on performance, voting rights, ownership or rights secured by an asset as in asset-backed tokens.

On the other hand, the value and application of utility tokens is restricted to the acquisition of goods or services within the DLT platform, within a limited network of DLT platforms or in relation to which they are issued, but they have no connection with the equity of the issuer.

A token can contain the features of both financial & utility tokens, referred to as a Hybrid token. Where a hybrid token is used in a particular case as a utility token then it is to be treated as such. If the same token is used as a coin, then it is treated as a coin.
 
Reference Value

Values expressed in cryptocurrencies will need to be converted to the reporting currencies in which the taxpayer presents its financial statements, in order for the chargeable income to be calculated. The market value of a DTL asset is determined by the rate established by the relevant Maltese authority or where such is not available by reference to the average quoted price on reputable exchanges, on the date of the relevant transaction or event, or such other methodology to the satisfaction of the Commissioner for Revenue.

It has yet to be determined what can be considered as a reputable exchange for DTL assets. For example, Coinbase is one of the most popular bitcoin exchanges in the United States of America.  One of the reasons is that it charges a relatively small fee for exchanges.[1] Would this be considered a reputable exchange for Malta tax purposes?
 
Application of the General Tax Principles

Profits realised from the trading of coins are treated like the profits derived from the exchange of fiat currency. Therefore, proceeds from the sale of coins held as trading stock in a business are taxed as ordinary income. It must be noted that gains or profits from the mining of cryptocurrency also represent trading income. However, capital gains derived on the disposal of coins held as capital assets fall outside the scope of capital gains taxation.

The return derived from the holding of a financial token such as interest, premiums, payments equivalent to dividends whether in cryptocurrency or in kind is treated as income for tax purposes.

When dealing with the transfer of either financial or utility tokens it needs to determine whether such tokens are being held for trade or whether the intention was to hold such tokens for capital appreciation.
 
If the tokens are deemed to be capital assets in order to determine whether there is a capital gain on sale of such assets on needs to refer to article 5 of the Income Tax Act Chapter 123 of the Laws of Malta (ITA). Article 5 provides an exhaustive list of what is taxable.  Anything which does not fall under this list would be outside the scope of Malta taxation. The list under article 5 includes the crystallisation of capital gains on:

• Any immovable property;

• Any securities, business, goodwill, business permits, copyright, patents, trademarks and trade-names;

• Any interest in a partnership;

• The beneficial interest in a trust.

The question which needs to be answered is whether these tokens fall under the definition of securities.  Article 5 ITA defines securities as shares and stocks and such like instrument that participate in any way in the profits of the company and whose return is not limited to a fixed rate of return. The definition includes units in a collective investment scheme as defined in article 2 of the Investment Services Act, and units and such like instruments relating to linked long term business of insurance.

There is a valid argument that certain tokens would have the characteristics similar to those of shares and stocks. However, few tokens grant rights to participate in the companies profits. Also, very few tokens grant a limited rate of return in a similar fashion to bonds or preference shares.

For most tokens which are held for capital appreciation, it can be argued that these do not fall within the definition of securities as per Article 5 ITA.  Any capital gain derived from such assets would this fall outside the scope of Malta taxation and not be taxed in Malta.  Any equivalent capital loss would also fall outside Malta taxation and cannot be taken into consideration for Malta tax purposes.

Where on the other hand a taxpayer trades in tokens, this would be considered as his trading activity. Any income derived from such activity would be trading income which falls within the scope of article 4 ITA and taxed accordingly.  It stands to reason that any losses from such an activity would be considered as trading losses. 

In determining whether a particular transaction is of a trading or capital nature the same procedure as with any other transaction would need to be adopted.  The Badges of Trade would be applied to the particular transaction in order to determine whether this is a transaction of a capital or trading nature. The fact that one would be dealing with DTL assets does not envisage a different treatment in assessing whether a transaction is of a capital or trading nature.

Finally, a small note on initial coin offerings (ICO’s). Where an ICO involves the raising of capital, the proceeds of such an issue are not treated as income of the issuer.  If an ICO of utility tokens entails an obligation of the issuer to perform a service or to supply goods or benefits to the token holder, the gains or profits realised from the provision of the services or the supply of the goods will represent income for the issuer and be taxed accordingly.
 
Conclusion 

The Inland Revenue guidelines on the taxation of DTL assets have helped to shed some light on the taxation of these assets but especially have confirmed that the most important aspect of any transaction is its use to which the general tax principles under the ITA need to be applied.
 

• How to Buy Bitcoins in the United States, Accessed online at https://bitcoinexchangeguide.com/bitcoin-exchanges-in-the-united-states/ on 23 November 2018

About the Author: 

Dr Jeanette Calleja Borg is a practitioner in the area of tax compliance. She obtained a Bachelor of Commerce, a Bachelor of Accountancy (Hons.), a Masters in Financial Services from the University of Malta and subsequently a PhD in Taxation from the School of Law, within the Centre for Commercial Legal Studies at Queen Mary, University of London. Her area of research was Cross Border Group Loss Relief in the EU. Dr Jeanette Calleja Borg has also been a guest researcher at the Institute for Austrian and International Tax Law in Vienna during 2011 and 2012/2013. Dr Jeanette Calleja Borg is a member of the Malta Institute of Taxation Council.  She is also a member of the Malta Institute for Accountants.