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Dr Silvio Cilia

 

Corrieri Cilia, Malta

silvio@corriericilia.com

The blockchain bubble

Bitcoin has been around since 2009, gradually increasing in value over the years under most people’s radar. In a timespan of barely two years, however, the world witnessed the meteoric rise and subsequent price correction of bitcoin and hundreds of other cryptocurrencies, altcoins and tokens. With the crypto bubble having come and gone, at least for the time being, the debate on whether or not the story of cryptocurrency and blockchain is one of success or one of failure is still ongoing. Admittedly, in spite of the hiatus, bitcoin and some other crypto assets are still highly valuable. As a result, a class of crypto-high net worth individuals has emerged, many of whom are young, globally mobile and eager to consolidate and enjoy their newfound wealth.

Consider Mr X, a so called ‘early adopter’, still in his twenties, who quietly accumulated a portfolio of tens of thousands of bitcoin, as well as a number of other ‘altcoins’ and tokens – buying them for cents or mining them on his PC back when this was still possible. Although worth significantly less than in December 2017, his portfolio would still make for a sizeable fortune at the time of writing. Now, consider Mr X wants to cash in on his ludicrous gains and diversify his wealth into more traditional and stable financial and real estate assets? Where to enjoy and solidify such a windfall in a tax-efficient manner?

That is indeed a tough question. As our colleagues on the ‘New Assets, New Planning’ panel at the IBA Annual Conference in Seoul highlighted, the world is awash with tax pitfalls and minefields for the ingenuous crypto geek. From hefty capital gains and transfer taxes in some countries to excruciating wealth and estate taxes in others, or all of the above in some others still; the opportunities for making Uncle Sam happy are endless. Also, while many crypto-millionaires may be young and hardly concerned about their passing, their sudden demise may be expropriative if occurring in the wrong place.  

Assuming relocating to a more tax-efficient jurisdiction is possible, what would be the jurisdiction of choice? Malta jumps to mind for two main reasons; its crypto-friendly legal environment and its generous remittance basis tax regime for non-doms. Aside from that, there are no wealth, inheritance, estate or gift taxes in Malta. It may also be the case that many crypto-assets are immune to capital gains tax in Malta.

About Malta

Malta is a small island in the centre of the Mediterranean Sea, situated 93km south of Sicily and roughly 300km north-east of Tunisia. With a total area of roughly 320 square kilometres and a population of around 450,000, this former British colony is, since 2004, also the smallest state in the European Union. With English as an official language, the island has a rich multicultural heritage, mainly as a result of centuries of colonisation.^[1] After independence in 1964, the Maltese built an economy based on tourism, manufacturing and services. In more recent years, the Maltese economy has experienced a sustained stretch of strong growth thanks mostly to a boom in tourism and real estate as well as an invigorated financial and internet-based services sector. This boon has attracted much foreign investment and talent that has transformed the island to a buzzing multicultural hub that is an attractive proposition for the new, globally mobile jet set.

Malta, the blockchain island

Unlike most other jurisdictions, Malta saw the crypto boom as an opportunity to welcome a new and innovative industry to complement its already burgeoning services sector. Keen to have the first-mover advantage, Malta was the first jurisdiction to enact a comprehensive legislative package aimed at creating a regulatory ecosystem in which the industry could operate and proliferate. The new legislative package is made up specifically of:

• the Virtual Financial Assets Act (VFAA), legally defining classes of cryptocurrencies and regulating both the offering of virtual financial assets to the public, as well as services based around such assets;

• the Innovative Technology Arrangements and Services (ITAS) Act, which provides for a voluntary regulatory system for a number of technological arrangements and services including distributed ledger technologies (DLT); and

• The Malta Digital Innovation Authority Act, setting up a Malta Digital Innovation Authority as the competent authority for ITAS.

This regulatory and legislative package addresses a regulatory lacuna for coins and tokens that did not classify as either pure utility tokens, e-money or securities but were still capable of having financial characteristics. This led to the creation of the term virtual financial asset (VFA), being an asset that went beyond pure utility (in that it was exchangeable for a negotiable value) but fell short of being a security. A main feature of these rules is the financial instrument test, and respective guidelines, issued by the Malta Financial Services Authority, which aims at establishing whether a DLT asset qualifies as electronic money, a financial instrument, a virtual financial asset or a virtual token.

These initiatives certainly did not go unnoticed in the crypto space. For a while, Malta became a Mecca for the crypto community and many players, including some big names, made Malta their base. Alas, the timing was not right. The dawn of 2018 saw bitcoin plunge towards the abyss and, when the new legislation came into force by November 2018, the industry was in the grips of a so-called ‘crypto winter’ that still endures.

Revenue Guidelines on the tax treatment of crypto-assets

In November 2018, the Commissioner for Revenue also issued a set of guidelines on the income tax treatment of transactions or arrangements involving DLT assets. No specific tax rules were created for the crypto-world; instead, existing rules were interpreted in the context of this new asset class.

In principle, DLT assets are categorised by the Revenue, in line with the VFAA, as being either ‘coins’ or ‘tokens’. Tokens are then further categorised into ‘financial tokens’ or ‘utility tokens’. Coins are not considered as having any characteristic of a security and are functionally the cryptographic equivalent of fiat currencies. Financial tokens, on the other hand, are defined as being similar to equities, debentures, units in collective investment schemes or derivates (including financial instruments).

Utility tokens are categorised as DLT assets whose utility, value or application is restricted solely to the acquisition of goods or services either solely within the DLT platform in relation to which they are issued, or within a limited network of DLT platforms. This would include all DLT assets that are tokens whose utility is restricted solely to the acquisition of goods or services, whether or not listed on a DLT exchange, may be transferred on a peer-to-peer basis, or may be converted into another type of DLT asset: however, the latter only applies until such time as it is so converted. There is no connection to the equity of the issuer and there are no characteristics of a security.

The Revenue also considers that some DLT Assets may take the form of hybrid tokens. In the case of a hybrid token, the Revenue looks at the use of the asset. If the asset is utilised in one instance as a utility token, then it is treated as such. However, if on another occasion the hybrid is utilised as a coin, then it is treated as a coin for tax purposes. It is important to consider therefore that the tax treatment of any DLT asset will ultimately depend on its purpose, and the context for which it is used, and not on pure categorisation alone.

The implications may be significant for income tax purposes in that coins and utility tokens are not on the list of capital assets in the Income Tax Act, the transfer of which triggers income tax on capital gains. Securities, on the other hand, are, and gains made on the transfer of crypto assets that are considered to be security tokens would therefore be taxable.

This having been said, in view of Malta’s remittance basis of taxation, if the transferor is resident but not domiciled in Malta like our case study volunteer, only security tokens that are deemed sited in Malta would be taxable (subject to a step-up option). Unfortunately, the Revenue did not extend its written guidance on the situs of crypto assets. Suffice it to say, however, that if the private keys of such security tokens exist solely on a wallet or other form of cold storage situated in Malta, then such assets would likely be deemed sited in Malta. If, on the other hand, coins or tokens are held on a foreign-based centralised exchange, it is likely that the situs thereof would be determined by the location of the exchange.

The remittance basis of taxation in Malta

Persons who are both domiciled and resident in Malta are taxed on a worldwide basis. However, persons who become ordinarily resident in Malta without acquiring a domicile of choice in Malta are taxed on a source and remittance basis only: that is, on income arising in Malta and on income (excluding capital gains) arising outside of Malta that is remitted to Malta. Capital gains arising outside Malta in the hands of such persons would not be subject to tax in Malta even if remitted to Malta. If this sounds familiar to British lawyers, it’s because the system comes down from the first Income Tax Act back in colonial times.

The concept of domicile is not indigenously defined in Maltese law but is applied reference to British law from where it derives. As in the UK, every individual has a domicile of origin that is acquired at birth but can be changed by choosing a permanent home in another country or tax jurisdiction (domicile of choice). An individual’s domicile of origin is automatically revived if a domicile of choice is lost. Unlike in the UK, however, there are no deemed domicile rules and the acquisition of a domicile of choice is very much a facts and circumstances test.

The concept of residence in Maltese tax law is based on a combination of physical presence in Malta coupled with the intent to reside in Malta, as evidenced by facts and circumstances. An individual intending to establish his residence on the island would be considered ordinarily resident regardless of the duration of his stay in any particular year. The Income Tax Act considers an individual resident in Malta if present in Malta except for such temporary absences as to the Commissioner may seem reasonable and not inconsistent with the claim of such individual to be resident in Malta. Temporary residents, on the other hand, are those who are in Malta for some temporary purpose only and not with any intent to establish residence therein and who do not actually reside in Malta at one or more times for a period equal in the whole to six months in a year. If an individual is absent from Malta, he may continue to be considered ordinarily resident in Malta if personal, social and economic ties with Malta are retained.

A person who is ordinarily resident in Malta but is domiciled elsewhere is liable to a minimum taxation of €5,000 per annum if he or she generates income outside of Malta of at least €35,000 that is not remitted to Malta. A higher minimum tax may apply in case of residence in Malta under special tax programs aimed at high net worth individuals seeking to reside in Malta and who may remit larger amounts of foreign-sourced income into Malta at a reduced flat tax rate. The Residence Programme and Global Residence Programme, in particular, are aimed at EU and EEA nationals or third country nationals respectively, granting tax residence status in Malta, including a beneficial tax status of 15% on non-Malta sourced income that is remitted to Malta (with a €15,000 minimum tax per annum). It is important to consider here that a number of requirements would apply in this case, in particularly property rental or ownership, passing a fitness and properness test, demonstration of economic self-sufficiency and health insurance requirements.

What’s in it for Mr X?

Having established his place of residence and centre of vital interests in Malta, Mr X can set out to plan and restructure his wealth with a certain degree of certainty and peace of mind. As a result of Malta’s tax system, the possession of coins, utility tokens or other crypto-assets would not attract any capital, wealth or inheritance taxes in Malta, given that there is no such thing. Most importantly for Mr X, the transfer of his coin and most of his tokens would not be subject to any capital gains tax in Malta. Any gains made on any security tokens in his portfolio would also not be subject to income tax of such assets if assurance is made that such assets are sited outside Malta.

Some early adopters have actively sought to profit from crypto’s wild swings while others, like Mr X, have casually purchased their crypto with a long-term hold strategy in mind. Should Mr X rather change his strategy and actively trade his crypto, then it must be said that any income derived from such trading activity would be subject to income tax in Malta. In that case, Mr X would be well advised to adopt a corporate strategy to benefit from Malta’s tax refund system. But this could be the topic of another discussion.

It is true that people in their twenties hardly think about their demise. Suffice it to say that, should Mr X consider staying in Malta for a longer term – perhaps starting a family there – his advisers would be comforted to know that no inheritance taxes would apply in Malta in the unfortunate event of his passing. Maltese succession law is based on continental principles and does contain forced heirship rules. This having been said, Maltese succession law would only apply to the estate of a deceased that is domiciled in Malta and to immovable property situated in Malta. In terms of the EU Succession Regulation (Regulation (EU) 650/2012, a testator may also choose the law of this nationality to apply to his estate.

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