One of the biggest developments in recent times within the world of cryptocurrency has to be the announcement by President Nayib Bukele regarding the adoption of Bitcoin as legal tender in El Salvador. The fundamental implication of this announcement, which is geared to come into effect in September of this year, includes the fact that Bitcoin will become an acceptable currency in the country for paying for all types of services and goods. On the level of cryptocurrency taxation, the President of Central American mentioned that all capital gains tax on Bitcoin will be waived off once it becomes legal tender in the region. Other than this fundamental tax exemption on Bitcoin, the President has also promised crypto-entrepreneurs the possibility of obtaining immediate permanent residence in El Salvador in order to drive Bitcoin-based investments into the region. Coupled with the lack of any form of property tax, these particular scenarios put forward to the brave new world of cryptocurrency seems too good to be true.
For countries like the USA and India, economies that are still struggling to identify ways to integrate this new so-called financial panacea smoothly (and morally) into the existing systems, there might be a few lessons to learn from El Salvador’s bold move.
Cryptocurrency Tax Structures Need Reassessment
At the moment, countries like the USA tax cryptocurrency-based transactions as capital assets, placing them in the same vein as bonds or stocks. The problem with this particular taxation structure is that even if you buy an item or object or service using a cryptocurrency, you are taxed as if you sold your “asset” rather than having spent it, like a currency.
“Let’s say you bought $20 worth of Bitcoin and held it as it rose in value to $200. If you used the bitcoin to buy $200 worth of groceries, you’d owe capital gains taxes on the $180 in profit you’d realized—even though it seems as if you spent the Bitcoin, rather than sold it.” – David Rodeck and John Schmidt, Forbes Advisor
Similar to capital assets, you owe taxes to the IRS only if you make a profit off of selling it (or spending it). The reason behind the emergence and implementation of such a taxation structure, according to experts, seems to be due to the fact that the most common purchase behavior around cryptocurrencies seems to be the holding of coins as an investment, similar to how bonds and stocks are held.
With the elimination of capital taxes on cryptocurrencies such as Bitcoin as is the case of El Salvador, the complexity of cryptocurrency taxation structures is removed. Even though the government would be missing out on a significant amount of tax revenue due to the lack of any adequate structure around the “capital asset”, this move would clear away several other investor-oriented issues.
Some of the core taxation issues around cryptocurrencies such as Bitcoin include the following:
- Unlike stocks or bonds, and even any other form of property upon which capital tax is usually levied, such as a car or a house, planning ahead when it comes to potential taxes to be paid is fairly easy. However, in the case of cryptocurrencies where the fluctuations can be massive and unexpectedly volatile over a short period of time, taxpayers can have an extremely hard time planning out their tax cuts and financial journey as a whole.
- Volatile movements in Bitcoin and cryptocurrency values, in general, make record-keeping a horrendously difficult task. For instance, while using one wallet, if an investor buys a specific amount of cryptocurrency during a bear-ish streak, while also acquiring another amount of the same type of cryptocurrency during a bullish streak at a later period in the same wallet, it becomes extremely difficult to identify their “fair market value”. Consequently, it becomes extremely difficult to identify which portion of the cryptocurrency in the wallet of the user was purchased and which was received, making taxation a mind-boggling riddle.
- The ever-changing technological landscape of blockchain means that users will often shift from one platform to another and even from one currency to another, making it difficult to track transactions and thereby, causing a considerable amount of taxation roadblocks. Moreover, with the myriad proprietary wallets as well as the high number and diversity of crypto-exchanges present in the digital world today, tracking becomes a nightmarish task. Moreover, with decentralized exchanges rising in potential and plausibility, auditing becomes virtually impossible, making taxation much more difficult.
- The potential for hacking and illegal use of Bitcoin and other cryptocurrencies is a definite possibility that cannot be ignored, especially due to the fact that the high degree of privacy and the sheer complexity of tracking transactions make it difficult to identify the culprits. The original owner might have to pay taxes on transactions he/she never made as to the culprit/hacker hides behind the intricate web of obscurity surrounding such cryptocurrencies.
Potential Solution and Benefits
The removal of capital tax structures can help investors in managing their crypto-assets in a simpler and more convenient fashion, while also ensuring that the volatile consequences of these cryptocurrencies do not spill over into the fiat economic systems of the country. Hence, the potential solution of tax-free cryptocurrencies can have several consequences for countries like the USA and India, including foundational benefits such as:
- Due to the complexity involved in taxation of cryptocurrency, several investors refuse to disclose their complete asset history and also consider it unnecessarily difficult to report their earnings. The dissolution of the tax structure can enable such collective lapses to be solved, thereby bringing more transparency into the blockchain. The resulting transparency, borne out of the collective need to maintain security standards rather than adhere to taxation measures can further help governments to impose highly specific taxes on crypto-traders under particularly special circumstances.
- One of the core elements of the Bitcoin Empire that El Salvador is slated to develop is the establishment of satellite infrastructure that allows citizens in rural areas without bank accounts to use this new legal tender through dedicated internet access. This is a powerful move that can be replicated in the rural regions of countries like India, where several individuals and families currently have no access to bank accounts or the internet. The more significant lesson, in this case, is that as and when such rural and marginalized individuals are included in the blockchain system of a cryptocurrency like Bitcoin, lack of any stringent taxation structure can help them grow small businesses and attain financial stability that has been missing till date.
- A major development since the announcement of the “Bitcoinization” of El Salvador was a four-fold increase in remittances into the country in the form of Bitcoin, with transfers of amounts below $1000 hitting a total of $2.5 million in May of this year. As compared to last year’s $424,000 two years ago, it seems Bitcoin has helped the remittance market to grow by leaps and bounds. This is an especially important lesson for countries like India, which is one of the largest remittance markets in the world. Tax-free cryptocurrencies offer a much more convenient and faster way to transfer remittance from abroad to one’s home country, specifically for individuals without bank accounts or digital banking access. The development of crypto-remittance networks in India could contribute considerably towards the economy without having to develop and enforce complex taxation structures around the tender.
As one of the first countries to make the move towards legalizing and normalizing a cryptocurrency as legal tender, El Salvador has set an example for other nations willing to embrace this volatile form of financial freedom. As discussed above, a tax-free cryptocurrency system fuelling a nation’s economy can have multiple advantages, especially if tax structures are more diligently established. The fundamental point, in this case, is that cryptocurrencies require a special tax structure of their own, specifically due to the fact that their decentralized nature was built specifically to ensure non-compatibility with overarching revenue siphoning methodologies. In other words, nations need to consider this futuristic digital asset as a stand-alone economic element that deserves a taxation structure of its own.
Even though it might seem prudent to follow in the footsteps of El Salvador and relinquish taxes completely, it is also to be noted that the Salvadorians do not risk losing out on monetary autonomy, economic sovereignty, or “seignorage” (difference between the face value of banknotes and the cost of producing them). This is specifically because El Salvador was a dollar-fuelled nation much before it advocated the use of Bitcoin, a consequence of economic instability that resulted in the vanquishing of its indigenous currency, the Colon. For countries like India and the USA, the complete embrace of cryptocurrency does mean a risk to the native currency and the economic independence enjoyed by the nation due to the same. This further begs consideration of taxation structures that are built around the principles, platforms, technologies, and ethos of the cryptocurrency infrastructure and the community that uses it. Merely imposing normal taxation structures around this new digital coin type can only further exacerbate the potential legal issues that tend to constantly hound the perception of this digital cash.