From cryptocurrencies to NFTs – when the lack of tax rules is not ideal
We are approached by many investors on the Portuguese position towards taxation of cryptoassets. The main question is always whether Portugal is a true crypto-tax friendly jurisdiction?
The policy challenges posed by cryptoassets – including within this category cryptocurrencies based on distributed ledger technology (DLT) – are enormous and recent international developments demonstrate the importance of this asset class that already has a total market cap above $2 trillion.
This briefing is a technical revisitation of key points we consider as being relevant to provide the tax framework in Portugal and explain why sometimes lack of tax rules may not be ideal for risk-averse investors.
The Portuguese Tax Ruling
The Portuguese tax rules have yet to be amended to include specific rules and regulations for investment in cryptoassets. Much of the crypto hype has come from a single published tax ruling released back in 2016 (only binding to the taxpayer that requested such ruling), where the Portuguese tax authorities officially pronounced on the tax framework potentially applicable to the disposal of cryptocurrencies.
Applying the Portuguese schedular system, which catalogues income into different categories, possibilities for income qualification from disposal of cryptocurrencies would be the following:
Business income category B – if deemed derived as ongoing business activity performed on a regular basis this income would subject to generally applicable progressive rates up to 48% plus surcharges; or
Investment income category E – If deemed passive income and considered as economic benefits arising from assets or rights this income would be subject to a flat rate of 28%; or
Capital gains category G – If deemed derived from the sale of financial products as defined in Portuguese law this income would be subject to a flat rate of 28%.
In the 2016 Ruling, the tax authorities took the interpretative position that:
Disposal of cryptocurrencies should not be taxed under Category G (capital gains) because such provision contains a closed nomenclature list of financial assets that give rise to capital gains. As such list does not specifically include cryptocurrencies and such assets cannot be considered shares, derivatives or financial assets (in Portuguese “valores mobiliários”), the proceeds from the sale of cryptocurrencies would not qualify as taxable capital gains;
Disposal of cryptocurrencies should also not be taxed under Category E (investment income) as this aims to tax the “fruits or other economic benefits received directly or indirectly from the application of capital”, including interest and dividends. As income in question derived from the sale of cryptocurrency and not income from an asset, this qualification would also not be applicable;
Disposal of cryptocurrencies may in certain cases fall under Category B (business income) as this is structured as covering any type of income arising from a reiterated business activity, undertaken towards obtaining profits, and has priority over other categories. Therefore, if an individual trades cryptocurrency within the concept of a business activity, income derived from its sale would be taxable.
Looking beyond the 2016 ruling
The ruling was clearly beneficial for certain taxpayers who dispose cryptocurrency not as a business or trading activity but as a private asset class. For several tax experts, the ruling was nonetheless debatable from several angles.
The first area of discussion is the lack of clear rules on the borderline between mere investment and business/commercial activity. We all know that trading means carrying on a commercial activity, providing services to third parties or deriving income from intellectual/industrial property when the taxpayer is the creator of such property. Whilst a simple buy-sell strategy is not a business activity, crypto-trading has raised several practical challenges because: (i) frequency of trades or even holding period may differ from normal financial portfolio positions; (ii) there may be an unbalance of the crypto income versus any other professional or employment income; or (iii) there could be the use of complex crypto algorithm strategies to trade. Bottomline is that crypto investors are most often not open to manage other people’s money and therefore unless the income is derived from regular mining, staking or services to third parties the existence of a commercially driven activity should not exist, but clarification of the limits of Category B would be welcomed.
The second area of interest is the interaction with investment income (Category E). Indeed, through DeFi (decentralized finance) transactions, investors may deposit or pledge their cryptocurrencies to an exchange platform that mints a token in return of the assets. Crypto interest-earning accounts are examples of possible passive income. For those novel income streams, it is important to refer that the broad Category E (investment income) may be called to apply as a residual taxable provision as this includes “economic benefits received directly or indirectly, whether in cash or in kind and irrespective of their nature or designation, from assets, property, rights or legal positions”.
Finally, taxation of NFTs would be an area that deserves its own clarification. An NFT is instead a non-fungible cryptoasset, whose uniqueness and ownership can be demonstrated and verified via a DLT. NFT is a unique digital certificate that functions as proof of ownership, or authenticity, of a digital artwork or asset (such as images, videos or other digital content). When a creator mints an NFT, they create a digital version of the work as a data file using blockchain. One could argue that it is important to distinguish the possible income derived by the NFT artist or creator as professional income or original holder of any royalty income (Category B) from income derived from the mere buy and resell of NFTs as private assets (likely within 2016 tax ruling reasoning).
The NHR backstop
The non-habitual tax regime (NHR) may become relevant in some instances and serve as a backstop for certain type of tax consequences from income derived from cryptoassets. The rules and their application may be very briefly summarized as follows:
Business income: Artistic activity is considered self-employed work and creative and performing artists are one of the listed professions (code 256 of the HVA list). This should include NFT visual artists and creators. For those qualifying as NHRs, foreign income is exempt if it may be taxed abroad under the provisions of an applicable double tax treaty. A 20% reduced flat rate may be available with respect to non-exempt foreign and domestic income derived from business income from listed HVA professions.
Investment income: Cryptoasset investors deriving foreign source income do not need to be framed under one of the listed HVA professions. For this category, the foreign income is exempt for the NHR if it may be taxed under the provisions of an applicable tax treaty (or OECD Model). For passive income linked to cryptocurrencies, it will be critical to undertake a qualification analysis and be able to determine the source of income and/or payor of income (exercise to be undertaken on a case-by-case basis).
Capital gains: For this category, the NHR regime is less relevant because most tax treaties allocate full taxing rights to Portugal and therefore exemption of foreign income is likely not applicable. In any case, as mentioned gains from trading in cryptocurrencies or NFTs that would not go beyond mere private asset management should fall outside the current income tax rules. Indeed, the current scope of the capital gains provision does not include certain mobile assets such as art, gold or collectible items. Cryptoassets would be then similar tangible assets.
The NHR therefore may well provide useful backstop in certain cases for the tax consequences of cryptoassets.
The evolving international crypto landscape
As more and more investors buy, hold and trade cryptoassets, it comes as no surprise that there is a growing consensus that regulatory landscape and some tax systems will need to be adjusted to address the taxable events associated with cryptoassets.
Developments are expected in 2022 with a new OECD framework to exchange information on cryptoassets and the further regulations on the revised US cryptocurrency tax reporting requirements. Also in the EU, 2022 will likely see the rollover of DAC8 Directive to cover areas of cryptoassets and e-money.
As the landscape moves, local developments are expected, Portugal should take also the opportunity to clarify within the law the respective taxable events and outcome. For risk-averse investors, the rule is that it is better legal certainty than no clear guidance.
Key takeaways
1. The tax ruling released in 2016 is only binding to the taxpayer that requested it.
2. Disposing of cryptocurrencies as a private asset class may not be taxable in Portugal.
3. Care should be taken for borderline cases when crypto trading may become business activity.
4. No tax clarity yet on DeFi related transactions or taxation of NFTs but NHR may serve as backstop.
5. International landscape may well spillover to Portugal and lead to changes.
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© Kore Partners, 2021
This briefing provides for general information and is not intended to be an exhaustive statement of the law. Although we have taken care over the information, this should not replace legal advice tailored to your specific circumstances. This briefing is intended for the use of Kore Partners clients and is also made available to other selected recipients. Queries or comments regarding this including joining our mailing list can be directed to kore@korepartners.com