How Ukraine can adopt crypto regulation

The regulation and tax policies of cryptocurrencies and operations associated with them are actively being discussed in all countries. And it’s no wonder – a huge and dynamic market with no limits and capitalisation of $133 bln (according to the Coinmarketcap on December 21, 2018) is now in a “gray zone” where legislative uncertainty in the area of cryptocurrencies and blockchain regulation is a considerable threat to the world’s financial stability.

European practices

Willing to get an opportunity to collect additional taxes and influence the market, some countries defined cryptocurrencies as a payment method. Some of them defined cryptos as financial instruments and securities.

In the United Kingdom, for example, cryptocurrencies do not fall under specific regulations. However, if the crypto asset becomes a derived financial instrument in its classic sense- like an instrument of stock trading, ICO, crediting, insurance, factoring or investing, then the individuals that implement any corresponding activity have to abide by all the rules and regulations imposed in European directives MiFID II (regulation of financial markets).

According to the Ukrainian Blockchain Association, a similar approach has to be applied in Ukraine. To implement this, first of all, it is necessary to determine the status of a crypto asset: is it a product, security paper, payment instrument or anything else. Today, none of the existing objects of civilian law in Ukraine are suitable for determining the status of cryptocurrency. Therefore, in Ukraine, it is necessary to create new regulatory norms that would meet the requirements of the industry.

Approaches to cryptocurrency regulation in Ukraine

Work on the concept of regulating cryptocurrencies started at the beginning of 2018. The team at Blockchain Association of Ukraine and the industry specialists who collaborate with the Association defined a set of principles which correspond with world trends and have to be applied in Ukraine.

• Exchange and turnover of cryptocurrencies should not be regulated or licensed until they are used as a financial instrument.
• The use of VAT for crypto assets is not possible since the place of supply of this asset is not in Ukraine.
• At the same time, only the tax on income delta will be beneficial.
• Since the crypto mining basically means the same as the development of any software code, this activity cannot be classified as “other monetary intermediation”, so it should not be regulated or licensed.
• Tokenization of business within the framework of existing legislation cannot be regulated or licensed.

The draft law which is the most closely related to these principles is the Law of Ukraine “On Amendments to the Tax Code of Ukraine regarding the taxation of transactions with virtual assets”, a bill No. 9083 dated 09/14/2018 regarding taxation (the initiators were a group of deputies, who supported Alexey Mushak).

This bill can be considered a compromise between the interests of the state and the business community. It involves the introduction of a new type of asset for tax purposes – a virtual asset that includes cryptocurrencies and token assets. The draft law proposes the temporary application of a 5% tax rate on profits from transactions with virtual assets for legal entities – until December 31, 2024 (after the specified date, the standard 18% rate of corporate income tax will apply). According to the authors of the draft law, the tax base will arise only if withdrawing cryptocurrency to fiat money, when transactions on the issuing and sale of virtual assets will not be subject to VAT.

It is worth recalling why other types of assets can not be applied to the status of cryptocurrency. In the case of an intangible asset, the fact that cryptocurrency might be considered as software code is rather controversial. However, in this case, there would be a VAT (until 2023 there will be a grace period with a rate of 0%). Moreover, the intangible asset can not have delta revenues: the tax is applied to 100% of the assets in the amount of 18% + 1,5%. Consequently, in 2023 the tax from the whole amount will be 38%. It is possible to argue that, because there is no definite place of product delivery, the VAT may not be applied. Regardless of whether the cryptocurrency is defined as a program code or not, in 2023 VAT will not appear. But even in this case, there will be no tax deductible expenses.

If the cryptocurrency will be defined as a financial instrument, VAT will not be applied, there would be a delta of income taxed at a rate of 18% + 1.5%. But then all market participants will be regulated and a tax agent can only be a licensed participant, which in the case of cryptocurrency, is currently impossible to implement.

Prospects for the adoption of legislative norms

According to the Association, a new bill which proposes the introduction of a virtual asset is the most viable, and its adoption (subject to refinement to the second reading) could be a major breakthrough in comparison with the scenario of a total lack of rules. The question is how much time will it take for the parliament to review and proceed the bill. On the basis of this, there are several scenarios that can be implemented in terms of the legal regulation in 2019.

1. A bill may be adopted after several readings.
2. No law will be adopted and the market will continue to exist, but outside of Ukraine.
3.  A basic regulation will be created in the form of a General Tax Advice.

A general tax advice is a document that expresses the position of the executive authorities, in this case, the Ministry of Finance, which has regulatory legal force and which is based on the State Fiscal Service in determining the tax status of assets.

Adoption of the General Tax Advice for the regulation of transactions with cryptocurrencies has its advantages and disadvantages. One such advantage will be the absence of VAT for an asset whose place of delivery is not defined, and also affirm that the tax agent should be the user himself. Also, such a document will provide an opportunity to capture the declarative nature of the principles used in the regulation of cryptographic assets, when the basic legal framework will be created in parallel.

However, the negative consequences of the adoption of this document are critical. Taking into account that the interpretation can determine the cryptocurrency as an intangible asset, there will be no tax deductible expenses; the personal income tax will remain at 100% of the asset at a rate of 18% + 1.5%, since the delta tax will not be possible to be introduced without changing the legislative base. This option is unacceptable since the tax on the difference and the absence of VAT are not just desirable points, but those without which regulation does not make sense.

Thus, the adoption of the proposed bill number 9083 and the introduction of a new type of asset is a necessary measure to create a legal framework that will allow the market to grow in Ukraine and attract capital. Without new effective tools, clear rules of the game and transparent tax conditions, the market will continue to exist outside of Ukraine, rather than within, where it could stimulate the development of the economy and innovation in the country.