Dealing with Cryptocurrency in Business Transactions: Legal and Tax Implications

This article is written by Prasoon Shrivastava, School of Law, Devi Ahilya Vishwavidyalaya, Indore, B.A.LLb, 3rd year during his internship at LeDroit India. 

Abstract: –

This article discusses the legal and tax implications of cryptocurrency in business transactions. It touches on the benefits of cryptocurrency, which include lower transaction costs, security, and expanded payment channels, against the challenges businesses face in an evolving regulatory framework. This article covers issues like compliance with regulations, validity of smart contracts, consumer protection, IP rights, and cross-border transactions. It further explores the tax treatment of cryptocurrencies, capital gains, and reporting requirements. Finally, it gives best practices for legal and tax compliance in cryptocurrency use.

Keywords: – Cryptocurrency, Business Transactions, Legal and Tax Implications, Regulatory Compliance

Introduction to Cryptocurrency in Business: –

Cryptocurrency has emerged as a transformative force in global business transactions, offering numerous benefits such as reduced transaction costs, enhanced security, and expanded payment options. However, the evolving legal and regulatory landscape presents challenges for businesses adopting digital currencies[1]. As governments and regulatory bodies introduce new rules, businesses must stay compliant with tax and legal frameworks, particularly regarding cross-border transactions, anti-money laundering (AML), and consumer protection. This article delves into the legal and tax implications of cryptocurrency in business, offering insights into best practices for navigating this dynamic landscape.

Businesses are using cryptocurrencies to: –

1. Extending Payment Acceptance Channels: With acceptance of a cryptocurrency, the business penetrates the international market successfully, offering their product/service to the tech-savvy consumers in emerging economies without bothering about the constraints that classical banking imposes in terms of conversions or international fees.

2. Lower Transaction Costs: Transactions, in general, incur lesser fee charges compared to conventional banking alternatives, especially cross-border transactions involve heavy fees due to Foreign Exchange and intermediaries associated with traditional systems.

3. Increased Security: A decentralized Block chain means that a transparent, immutable ledger ensures minimal fraud and chargebacks, building trust for businesses.

4. Simplified Transactions: Cryptocurrency enables quick, direct transfers between parties without waiting on slow and expensive international banking systems, improving cash flow and the efficiency of business operations[2].

Even though these benefits make the cryptocurrencies appealing, their regulatory and tax frameworks are still developing, and thus, a legal uncertainty exists.

legal Implications of Cryptocurrency in Business Transactions: –

1.Regulatory Compliance: –

Legal status varies by country. El Salvador recognizes it as legal tender[3], and China bans it. Businesses, therefore, have to align with local laws, in this case, getting exchanges licensed (for example, registering as a Money Services Business in the U.S.). The AML/KYC rules have become strict, forcing businesses to identify suspicious transactions and to look for government-issued IDs before serving customers.

2. Contractual Validity: –

Smart contracts in block chain technology automatically execute transactions, but the application to traditional contract law is quite complex. Key issues include:

• Offer and Acceptance: Parties must agree to use cryptocurrency.
• Consideration: Even though intangible, cryptocurrencies can be considered if accepted by law.
• Enforceability: Courts should recognize these agreements to resolve disputes.

These challenges indicate how hard it is to apply traditional legal frameworks to smart contracts.

3. Consumer Protection

Cryptocurrency transactions have risks such as volatility and fraud, which are usually associated with IT-related crimes like hacking and digital breaches. With the increasing cases of cryptocurrency crimes, regulatory authorities call for more robust consumer protection through proper regulations.

• Transparent terms and conditions for cryptocurrency payments.
• Refund and chargeback policies, especially for fraudulent transactions.

4. Intellectual Property (IP) and Block chain

Cryptocurrencies are increasingly being adopted in IP-intensive sectors such as pharmaceuticals, automotive, luxury, and consumer goods, where traceability and counterfeit goods pose a major issue. Some of the key issues surrounding their use include:

• ownership and authorship of IP.
• control and traceability of IP asset.
• smart contracts for the implementation of IP agreements and licenses.

There is still uncertainty as to who owns block chain technologies and cryptocurrencies. Companies adopting block chain for transactions need to sort out IP rights related to the underlying technology, which can create a multitude of licensing and patent disputes[4].

5. Cross-Border Transactions: –

Block chain technology, which supports cryptocurrencies, provides privacy through the obscurity of ledger locations but creates jurisdictional problems. Nodes in several jurisdictions have conflicting legal frameworks, and a lack of a “residence country” makes law enforcement more difficult.[5] Being a transnational system, block chain creates a problem for the selection of applicable laws in disputes. Businesses engaged in cryptocurrency transactions must face jurisdictional uncertainty and comply with international laws across borders.

The tax issues related to cryptocurrency in business transactions: –

1. Tax Treatment of Cryptocurrencies: –

a. Nature of Cryptocurrency: –

Cryptocurrencies do not have a uniform legal classification, and hence, their tax treatments vary. In the U.S. and U.K., they are treated as property or digital assets, and every transaction is a taxable event. For example, using Bitcoin to buy goods requires determining its FMV on the date of exchange to determine capital gains or losses.

• Personal Use: In some places, small-scale personal transactions might be exempt from tax.
• Inventory: Cryptocurrencies held as business inventory are taxed as ordinary income or expense.
• Investment Assets: Cryptocurrencies held as investments are subject to capital gains tax.[6]

2. Business Transactions with Cryptocurrency: –

a. Payments for Goods and Services: –

Bitcoin received as payment is subject to income tax, thus it should be converted for tax purposes. For example, a product sold in exchange for 1 BTC at a FMV of $30,000 creates $30,000 of taxable income. If the bitcoin appreciates later to $35,000 and is used, then a capital gain of $5,000 will be taxable.

b. Compensation for Services: –

Paying employees in a cryptocurrency requires reporting its FMV on the date of payment for taxes on payroll. For payees, the cryptocurrency amounts to income upon receipt subsequently taxed as capital gains to the extent of gains from losses.

c. Cross-Border Transactions: –

Cryptocurrencies facilitate cross-border transactions while making taxes complicated:

• The Currency Conversion: Unstable exchange rates make it challenging to calculate their FMV.
• Transfer Pricing: Tax administrations examine intercompany transaction values, threatening disputes over compliance.[7]

3. Reporting Hurdles: –

a. Vague Guidance: –

The tax frameworks of most countries do not clearly state whether cryptocurrency transactions need to be reported. Some countries only report cryptocurrency transactions when converted to fiat currency, which means risks of underreporting will exist.

b. Non-Traceability: –

It is hard to trace the source and use of pseudonymous transactions. Poor record-keeping results in non-compliance and consequently penalties and audits.

c. Reporting Requirements: –

Transaction details-tax compliance requires businesses to record the transaction details of date, amount in local currency, and transaction purpose (such as purchase, investment, salary). Without these records, audits or fines can result.

4. Capital Gains Tax: –

a. Income Tax: –

Capital gains tax is paid on the sale, exchange, or use of cryptocurrencies. Tax rates depend on the acquisition date. Cryptocurrencies held for less than a year are normally charged higher short-term capital gains rates. Capital gains tax is triggered by the sale of cryptocurrency for profit, and even its use for purchases can lead to taxable gains or losses due to the change in value.

b. Losses Carried Forward in Tax: –

In some areas, losses resulting from cryptocurrency transactions can be carried forward to reduce gains from other investments in the future. Many jurisdictions have capped the amount of losses that can be brought forward.

5. Tax Arbitrage and Tax Avoidance: –

a. Exploiting Loopholes in Regulations: Some firms take advantage of lenient tax policies by establishing businesses in countries with low capital gains taxes or maintaining offshore accounts that help them keep cryptocurrency income secret.

b. Tax Evasion Risk: Cryptocurrencies’ anonymity facilitates tax evasion due to unreported peer-to-peer transactions and converting undeclared income on decentralized exchanges without KYC/AML checks. Governments are tightening their regulations with mandatory reporting and KYC/AML checks.

6. Specific Jurisdiction Issues: –

India flat tax rate of 30% on cryptocurrency income, with a 1% TDS for high-value transactions. No losses available to reduce other income.[8] United States: Cryptocurrency treated as property; businesses have to report FMV and ordinary income from mining. European Union: a patchwork; some member countries apply capital gains taxation while Germany does not, at least not for long-term capital holdings.

Bangladesh- No clear framework set up, and cryptocurrencies are strictly banned but inconsistently followed[9]

Best Practices for Legal and Tax Compliance (Expanded)

Best practices to ensure the integration of cryptocurrency into business transactions successfully are numerous. Below is an expanded discussion with these strategies to ensure businesses remain legally compliant in leveraging the benefits from cryptocurrencies.

1. Cryptocurrency Specialist Consultation: –

Engage with competent experts for advice on complex and changing laws and to maintain compliance with local regulation and optimize taxations.

2. AML/KYC Compliance: –

Implement Anti-Money Laundering and Know Your Customer protocols, such as identifying users’ identity along with tracing suspicious transactions.

3. Effective Contracts: –

Establish a strong contract that defines cryptocurrency terms, conversion rates, payment timelines, and dispute resolution, especially with volatile assets or smart contracts.

4. Invest in Security: –

 Use both cold wallets and hot wallets to securely store your digital assets; enable two-factor authentication (2FA), periodically audit, and use multi-signature wallets on larger transactions.

5. Watch Regulatory Developments: –

Cryptocurrency regulations change every day. To remain compliant, business organizations should subscribe to updates from regulatory bodies such as the SEC or RBI.

• Consult industry associations for input on regulatory changes.
• Adjust their operations on time to be in sync with new rules.

The Future of Cryptocurrency in Business: –

For instance, an Indian firm must follow RBI announcements and modify payment systems or reporting structures if necessary for updated laws.

With growing acceptance and block chain advancements, the future of cryptocurrencies in business is promising, but more clarity on regulations and tax frameworks are needed for wide-scale adoption.

Some key developments are: –

• Central Bank Digital Currencies (CBDCs): – Governments exploring CBDCs might impact the regulation of private cryptocurrencies.[10]
•  Integration with Traditional Finance: – Crypto platforms if collaborated with traditional finance will help in mainstream adoption.
•  Technological Advances: – Better scalability and security could indeed overcome current issues, thus making cryptocurrencies much more workable for businesses.

Conclusion: –

Cryptocurrencies offer significant opportunities for businesses, especially in reducing transaction costs, enhancing security, and expanding payment options. However, they also introduce complex legal and tax challenges. Businesses need to navigate an evolving regulatory landscape, adhere to compliance standards such as AML/KYC, and understand the intricacies of tax treatment across different jurisdictions. Best practices such as seeking advice from experts, having contracts in place, security investment, and keeping updated on developments in regulations help businesses properly manage risks and ensure the proper benefits of cryptocurrencies in transactions.

[1] Cenoa, ‘Integrating Cryptocurrency Payments into Your Business’ (Cenoa, 2024) https://www.cenoa.com/blog/integrating-cryptocurrency-payments-business accessed 1 December 2024.

[2] FinTech Weekly, ‘Integrating Cryptocurrency Payments into Your Business: Benefits and Challenges’ (6 August 2024) https://www.fintechweekly.com/magazine/articles/integrating-cryptocurrency-payments-into-your-business-benefits-and-challenges accessed [date you accessed the article].

[3] National Bureau of Economic Research, ‘El Salvador’s Experiment with Bitcoin as Legal Tender’ (2022) National Bureau of Economic Research https://www.nber.org/digest/202207/el-salvadors-experiment-bitcoin-legal-tender accessed 1 December 2024.

[4] Freeman Law, ‘Legal Issues Surrounding Cryptocurrency’ (Year) Freeman Law https://freemanlaw.com/legal-issues-surrounding-cryptocurrency/ accessed 1 December 2024.

[5] John Doe, ‘Title of the Article’ (2019) International Journal of Reviews and Research in Social Sciences https://ijrrssonline.in/HTMLPaper.aspx?Journal=International%20Journal%20of%20Reviews%20and%20Research%20in%20Social%20Sciences;PID=2019-7-2-13 accessed 1 December 2024.

[6] Bloomberg Tax, ‘Cryptocurrencies: Legal and Tax Considerations in India’ (Year) Bloomberg Tax https://news.bloombergtax.com/daily-tax-report-international/cryptocurrencies-legal-and-tax-considerations-in-india accessed 1 December 2024.

[7] Deloitte, ‘Using Cryptocurrency in Business: Legal and Tax Considerations’ (Year) Deloitte https://www2.deloitte.com/content/dam/Deloitte/us/Documents/audit/us-corporates-using-crypto-pov.pdf accessed 1 December 2024.

[8] ClearTax, ‘Cryptocurrency Taxation Guide’ (Year) ClearTax https://cleartax.in/s/cryptocurrency-taxation-guide accessed 1 December 2024.

[9] Freeman Law, ‘Legal Issues Surrounding Cryptocurrency’ (2023) Freeman Law https://freemanlaw.com/legal-issues-surrounding-cryptocurrency/ accessed 1 December 2024.

[10] World Economic Forum, ‘What Are Central Bank Digital Currencies? Advantages and Risks’ (2023) World Economic Forum https://www.weforum.org/stories/2023/10/what-are-central-bank-digital-currencies-advantages-risks/ accessed 1 December 2024.