III. Tax Treatment of Stablecoins
Income Tax and Currency
As long as currency is used as a medium of exchange and a means of payment, providing currency directly in exchange for goods or services does not constitute a separate transaction and does not trigger separate income tax calculations. In this case, the currency provided and received as the consideration for providing goods or services is only a measure of the value of the goods or services. Therefore, generally, it should not trigger any income tax (or capital gains tax). Conversely, exchanging currency or currency used as an investment for other goods or services is usually considered barter transactions, and any gains or losses will generate income tax (or capital gains tax) obligations, which should be calculated based on the individual’s disposal of currency or currency used as an investment (considered as property) and the disposal of the goods or services provided by the counterparty as a return.
However, if the transaction engaged in by the taxpayer is denominated in a currency different from the functional currency (i.e., the currency of the taxpayer’s main economic environment) of their business activities, there may be issues regarding the appropriate income tax treatment of any gains or losses resulting from fluctuations in foreign exchange rates, particularly the nature of the gains or losses and the timing of recognizing them for tax purposes. As for the nature of the gains or losses, relevant rules usually determine whether foreign exchange gains or losses are of a capital nature or an income nature, which depends on the purpose for which these gains or losses are generated. Regarding the second issue, income tax laws usually contain special timing rules related to the taxation of foreign exchange, which may require the recognition of gains and losses for tax purposes even in the absence of an actual disposal or realization event. This is in sharp contrast to the tax treatment of barter transactions, which is determined at the time of actual occurrence. Therefore, this common distinction between currency and property is crucial for the income tax treatment of stablecoins.
Income Tax and Stablecoins
Although most jurisdictions have not yet explicitly determined the income tax treatment of stablecoins as an asset class, the vast majority of jurisdictions treat crypto assets as property, even if they are used as a means of payment. For example, the Internal Revenue Service (IRS) in the United States treats all crypto assets as property for federal income tax purposes, so all transactions involving crypto assets are treated as barter transactions (IRS, 2014). This also applies to digital representations of value that serve as a unit of account, a store of value, and a medium of exchange, even if these virtual currencies are equivalent to or interchangeable with real currencies (i.e., convertible). Similarly, for income tax purposes, Australia does not consider crypto assets used as a means of payment as (foreign) currency, but treats their use to acquire goods or services as an income tax or capital gains tax event, and accordingly recognizes income or capital gains or losses. The UK Her Majesty’s Revenue and Customs (HMRC) also explicitly states that it “does not consider any type of crypto asset to be money or currency at present,” and “any company tax legislation that relates solely to money or currency does not apply to exchange tokens or other types of crypto assets” (HMRC, 2021, paragraph 41050).
Considering stablecoins as taxable income means that every payment made with stablecoins is a realization event resulting from barter transactions, which will trigger tax liability. Under the general tax system for taxing capital gains, this could significantly increase the tax compliance burden for taxpayers who choose to use stablecoins instead of traditional currencies for payment, as income tax rules usually allow for the calculation of foreign exchange gains or losses at the end of the tax period, rather than on a per transaction basis as is typically done for gains (or losses) from property transactions. In addition to increasing tax burden, different treatment methods may also result in different tax liabilities compared to traditional currency transactions. Although stablecoins are theoretically less susceptible to price fluctuations than other cryptocurrencies, their price stability is still closely related to the value of the underlying assets or currencies they are pegged to. Therefore, in the event of a weakening of the underlying assets or currencies, the total amount of income or loss recorded at the end of the reporting period will be smaller compared to recording it on a per transaction basis. Of course, if the underlying assets or currencies strengthen during the tax period, the situation is reversed, but this results in different tax outcomes for taxpayers who choose to use stablecoins instead of traditional currencies for transactions.
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Given the differences in design between stablecoins and other cryptocurrencies, especially the differences in the types of pegging and stabilization mechanisms used to reduce price volatility, people have started to consider whether a more nuanced approach can be taken in the treatment of stablecoin income tax, rather than treating all stablecoins as property. Assuming, in the simplest case, stablecoins can be fully supported by the issuer and convertible into a single traditional currency (e.g., 1 token equals 1 US dollar), this can be said to be functionally similar to electronic money, and if market practice reflects this, a similar treatment should be applied for tax purposes. It can be said that the operation of uncollateralized stablecoins (i.e., algorithmic or seigniorage-based) is similar to that of traditional fiat currency, with its “monetary policy” hard-coded into the blockchain code on which such stablecoins are based through smart contracts.
If stablecoins are backed and convertible by assets other than traditional currencies, the situation becomes more complex. Stablecoins can be backed by on-chain assets (i.e., cryptocurrencies) or off-chain assets (such as precious metals), or even a combination of both. On one hand, if activities surrounding such stablecoins involve their use as a means of payment, then these stablecoins can be said to be more similar to negotiable instruments in practice, where the bearer is obligated to pay upon demand, functionally similar to representative money, except that it is privately issued rather than by a sovereign state (central bank) and is not legal tender. Despite not having legal tender status, the issuer of redeemable stablecoins still has a contractual obligation to fulfill asset-related obligations upon redemption to stablecoin holders. Given the pre-monetary relationship between currency and gold or silver (i.e., the gold standard), it can be said that, apart from the issuer’s sovereign status, there is almost no difference between redeemable stablecoins and currency. On the other hand, it can also be argued that stablecoins are electronic representations of underlying assets and should therefore be appropriately treated as property. In addition, most asset-backed stablecoins in circulation will require holders to provide additional collateral when the value of the underlying assets decreases in order to maintain stability, and often engage in “overcollateralization” to ensure timely compliance with margin calls. For example, in the case of MakerDAO, users need to create a “collateralized debt position”. This position is essentially an Ethereum-based smart contract that involves pledging Ether as collateral to enable users to generate Dai worth up to two-thirds of the value of the pledged Ether. This arrangement does not fully fall under the traditional concept of currency, as it is neither legal tender from the issuer nor represents a claim on the issuer’s underlying assets. The underlying assets are held in custody but still belong to the user.
Difficulties and challenges arise when stablecoins are pegged to certain currency reserves but there are no assets in these reserves to provide direct support. For example, according to the Diem proposal, holders of Diem stablecoin will not be able to directly interface with the reserves, but can only redeem them on secondary markets integrated with authorized resellers, which obtain liquidity from authorized resellers. Therefore, some critics liken Diem to exchange-traded funds (ETFs) based on foreign exchange. The equity in an ETF can be seen as proprietary and different from currency.
In other words, it is meaningless to compare different types of stablecoins based on the actual characteristics of stable mechanisms and existing types of financial arrangements. Although the effectiveness of the stable mechanism may affect the possibility of stablecoins being used as a medium of exchange and a means of payment, it does not determine whether taxpayers objectively use stablecoins as a medium of exchange and a means of payment. If something is widely used as a medium of exchange and a means of payment in its primary economic environment, it should be treated as currency for income tax purposes, with the primary policy objective being to ensure neutrality and avoid tax distortions between tools or transactions that are objectively equivalent. However, a subjective approach based on the use of something may give rise to serious issues and may create tax uncertainty for taxpayers and tax administrations. In addition, a purely subjective approach may also impose additional compliance and administrative burdens. Therefore, another possible administrative solution is to establish a rebuttable presumption that broadly defined stablecoins are treated as currency and to support the implementation of this presumption by applying relevant anti-tax avoidance rules when stablecoins are found to be abused. Tax authorities can also utilize any existing regulatory framework on stablecoins when determining whether such rebuttable presumptions should apply. That is to say, if stablecoins are not regulated or supervised as deposits, electronic currency, or payment instruments that can be expressed in official currency units within the tax jurisdiction, they will not be considered as currency.
Secondly, taxation issues related to transactions involving stablecoins should also be considered internationally, especially in situations where different jurisdictions take different tax positions on the classification of stablecoins. For example, Country A and Country B exchange traditional currency with stablecoins. Assume that Country A treats stablecoins as property, meaning that capital gains tax must be paid on the realized gains, while Country B considers the transaction as providing exchange services. Also assume that there is sufficient connection between Country A and Country B, so Country B has the taxing rights over the portion of income obtained by Country A from the transaction. This could potentially result in double taxation of the income generated from the exchange of stablecoins between Country A and Country B. The same situation of no taxation in both countries may also arise due to the different tax classifications of stablecoin income in each jurisdiction. For example, Country A may consider the gains from exchanging stablecoins as business profits sufficiently connected to Country B, so the taxing rights belong to Country B, while Country B classifies stablecoins as property, so the main taxing rights over the income belong to Country A.
Assuming that stablecoins are not decentralized, in order for Country A to correctly apply and manage capital gains tax based on residency, information sharing is required between the tax authorities of Country A and the jurisdiction where the stablecoin issuer is located. Relying on third-party information is a traditional practice for the international tax system to address compliance challenges. However, if stablecoins are decentralized and private peer-to-peer transactions are not recorded by centralized or intermediary institutions, then relying on third-party information becomes impractical or ineffective. The recently released Cryptocurrency Asset Report Framework (CARF) by the Organisation for Economic Co-operation and Development (OECD) aims to address these issues. CARF supplements and utilizes the existing international standard for automatic exchange of financial account information for tax purposes, known as the Common Reporting Standard, to provide for similar exchange of transaction information for cryptocurrency assets (including stablecoins) relying on reports from defined cryptocurrency asset service providers (OECD 2022). Implementing this new framework requires the establishment of new rules and procedures at both domestic and international levels.
In order for stablecoins to fulfill their potential and become a convenient alternative payment method (including cross-border payments), both taxpayers and tax authorities need certainty and predictability in tax treatment related to stablecoin transactions and activities. Under the current tax law frameworks of various countries, issuing clear taxpayer guidelines by tax authorities, ideally with binding force, can even achieve multiple tax-related objectives. However, given the countless potential economic functions of tokens, whether it is possible to establish comprehensive stablecoin tax guidance remains a question. This also makes tax issues more complex, and if not dealt with on a case-by-case basis, more detailed classifications and approaches may be needed to determine tax responsibilities in different situations.
In addition, in order for stablecoins to compete with traditional currencies, similar tax treatment must be provided when stablecoins are primarily used as a payment method. Although there is some imbalance in methods, the trend of value-added tax and goods and services tax systems is moving in this direction, but the situation is not the same for income tax and capital gains tax.
Finally, international coordination and cooperation need to be strengthened in substantive tax treatment to avoid cross-border tax arbitrage and to enhance tax administration and enforcement, providing necessary tools for tax authorities to ensure compliance with tax obligations by all parties. In this regard, improving the consistency of regulatory treatment for stablecoins can serve as a common language and reference framework, providing information for discussions between tax policy makers and administrators regarding tax treatment and compliance frameworks. However, without higher tax certainty and tax neutrality than currently exists, stablecoins will not be able to function properly as alternative payment methods. Even if stablecoins may prove to be a more stable store of value compared to other cryptocurrencies, disparities and mismatches in tax treatment between tax jurisdictions, including asymmetries in information exchange arrangements between tax authorities, may result in distortions and abuses.