Does Receipt of Cryptocurrency Within Mining Activity Constitute a Tax Event?
The world of cryptocurrency has gained significant momentum in recent years, and along with it cryptocurrency mining activity. The most widely known method for cryptocurrency mining activity is called “POW” (Proof of Work) and it involves investing in unique computer resources to solve complex mathematical problems from the world of encryption, with extensive use of energy and sophisticated hardware. The user’s payoff for investing efforts in this process could be through new crypto coins generated on the same blockchain network to which they supplied these resources. The Israel Tax Authority’s approach, as published in Circular 5/2018, is that the digital coins received from mining constitute business income.
The monetary and environmental resources required to implement the POW system have caused other projects to promote a shift to another system called “POS” (Proof of Stake). While the result and objective of POS is, like the POW method – verification of blockchain transactions – the process is substantively different and includes locking specific crypto coins as a type of “deposit”. Every time a block is signed and added to the protocol in this manner, new crypto coins are issued from that protocol, which are sent automatically to the participants who contributed to verifying transactions and signing the block. This process can also be executed through “staking pools” where a number of participants combine their resources in order to generate the advantage of size and execute the process together. According to our approach, the aforementioned changes in the mining process require a reexamination of the taxation of the process.
The manner of implementation of the POS technical process raises an interesting question – does participation in the block signature process, and the resultant production of new coins to which the participant is eligible, constitute production of an asset by the miner? The meaning of asset production for tax purposes is that a tax event does not apply on the date of receipt of the coins, but rather only on their date of sale. This question made headlines in the US in the case Jarrett v. United States. This case involved a US Resident, who in 2019 reported income from staking for coins on the Tezos blockchain network. In 2020, the same taxpayer filed a request arguing they had created the coins and therefore they should not be subject to tax on the date of creation and receipt of the coins, but rather only on their date of sale or conversion. The American tax authorities did not respond to his request on time and therefore he referred the matter to the court. In December 2020, the IRS approved the tax refund requested, but Jarrett chose not to accept the refund since the IRS did not provide a reason for executing the refund and left open the matter of a tax event at the time of creation of the coins. The trial on this American taxpayer’s case is expected to be held in March 2023, and it seems the American court will be forced to decide on the matter, which fascinates many people active in the world of crypto.
In our opinion, there is support for the approach the taxpayer adopted in the Jarrett case, even under Israeli tax law, although this is a complex question requiring, inter alia, an understanding of the complex processes at the foundation of cryptocurrency and the blockchain.
However, taxation of activity in the crypto world is a very new field and therefore caution is advised (together with flexible thinking and creativity) with respect to the taxation aspects of transactions executed therein.