At a glance:
- In a landmark decision, the German Fiscal Court (Bundesfinanzhof – BFH) confirmed that capital gains from the sale of cryptocurrencies are subject to income tax.
- The BFH considers cryptocurrencies to be ‘other assets’ (andere Wirtschaftsgüter) within the meaning of Section 23 (1) sentence 1 no. 2 of the German Income Tax Act (Einkommensteuergesetz – EStG).
- Capital gains from cryptocurrencies held as private assets are taxable as ‘other income’ (sonstige Einkünfte) pursuant to Section 22 no. 2 of the EStG if the capital gain was realized within one year of the purchase of the asset(s).
- The BFH also ruled that exchanging one cryptocurrency for another cryptocurrency qualifies as a ‘purchase and sale’ of those cryptocurrencies.
- This tax treatment does not conflict with the German constitution, since there is no tax enforcement deficit in the taxation of capital gains from sales of currency tokens (kein normatives Vollzugsdefizit).
Background of the court decision
The German Fiscal Court (Bundesfinanzhof – BFH) is the highest appeal court for disputes between taxpayers and the government represented by the German fiscal administration.
The current decision1 relates to the acquisition, exchange and sale of various cryptocurrencies by the plaintiff (a German taxpayer) in 2017. The transactions involved bitcoins (BTC), ethereum (ETH) and monero (XMR) and were undertaken by the plaintiff as a ‘private person’. The taxpayer generated a total capital gain of €3.4 million from the transactions with these cryptocurrencies. The tax authority (Finanzamt) assessed the income tax as part of its consideration of these capital gains. A dispute arose with the tax authority as to whether the capital gains from the cryptocurrencies transactions were subject to income tax. The taxpayer submitted an action to the competent fiscal court which was rejected in large parts. The taxpayer subsequently sought BFH’s review of the decision of the fiscal court to reject the action.
In its ruling, the BFH made a number of fundamental decisions regarding the tax treatment of cryptocurrencies. These can be summarized as follows:
Cryptocurrencies as ‘other assets’ within the meaning of Section 23 (1) sentence 1 no. 2 EStG
According to the BFH, cryptocurrencies (also known as virtual currencies, currency tokens or payment tokens)2 qualify as ‘other assets’ (andere Wirtschaftsgüter) within the meaning of Section 23 (1) sentence 1 no. 2 of the EStG. The BFH concludes that the term ‘asset’ (Wirtschaftsgut) must be interpreted broadly. In addition to tangible objects and rights, ‘asset’ also comprises ‘actual conditions as well as specific possibilities and advantages’, if the acquisition of these ‘actual conditions, specific possibilities or advantages’ usually involves costs for a taxpayer and such ‘actual conditions, specific possibilities or advantages’ are deemed by market participants to carry a market value.
The BFH ruled this to be the case for cryptocurrencies and that bitcoins, ethereum and monero are to be regarded as a means of payment from an economic point of view. They are traded on trading platforms and exchanges, have a market value and can be used for payment transactions to be settled directly between participants. In BFH’s view, the technical details of cryptocurrencies are not relevant to determine their status as economic goods / assets. As a consequence, if such cryptocurrencies are acquired and sold within one year of their purchase, the resulting gains or losses are subject to taxation as other income (sonstige Einkünfte) within the meaning of Section 22 no. 2 of the EStG.
Exchange of cryptocurrencies against other cryptocurrencies qualifies as a ‘purchase and sale’
The BFH also clarified that exchanging one cryptocurrency against another cryptocurrency or against fiat money is to be treated as a purchase or sale of the cryptocurrency, for the following reasons:
The terms ‘purchase’ (Anschaffung) and ‘sale’ (Veräußerung) within Section 23 (1) sentence 1 no. 2 EStG derive from the provisions of Section 6 of the EStG, Section 255 (1) of the German Commercial Code (Handelsgesetzbuch – HGB) and Sections 135, 136 of the German Civil Code (Bürgerliches Gesetzbuch – BGB). Accordingly, the purchase or sale is defined as the acquisition against payment and the transfer of other assets against payment to another person. Exchange transactions are treated in the same way as purchase and sale against payment. The acquisition and disposal transactions by which taxpayers acquire, exchange or sell the respective units of a cryptocurrency result in a change of legal subject (in this case: an individual person) owning the units of the cryptocurrency. The BFH assumes that such a change of ownership requires the transfer of the right of disposal from the holder of the ‘private key’ to the acquirer.
As a further argument, the BFH continues that the acquirer and seller effect the transfer of the respective tokens ‘from wallet to wallet’, by transferring the acquired or exchanged tokens to a private digital address via an intermediate digital address on the trading platform or by transferring the sold tokens to the acquirer with the help of a specially generated ‘private key’, based on transaction agreements sui generis. In each individual case, this leads to the transfer of the (factual) entitlement or right to dispose of an economic good / asset to another legal subject. Due to the same reasoning, it must be assumed that the holding periods under this provision restart on each such exchange.
No conflict with the German constitution
The BFH does not see that declaring the capital gains from cryptocurrency transactions taxable conflicts with the German constitution. There is no so-called structural enforcement deficit such that the tax collection or tax assessment of profits and losses from transactions in or with cryptocurrencies would not be practical. The fact that, in individual cases, taxpayers may manage to evade taxation when trading in cryptocurrencies despite all investigative measures by the tax authorities (e.g. in the form of collective information requests) cannot justify a structural enforcement deficit.
In this context we note the EU legislative proposal of DAC83 which is intended to introduce provisions on reporting and exchange of information on cryptoassets.
Consequences of this decision
The decision of the BFH is a landmark decision. The BFH’s ruling on the treatment of capital gains effectively confirmed the rules that the German Federal Ministry of Finance (Bundesministerium der Finanzen – BMF) adopted and published as a circular dated 10 May 2022 (the BMF Circular)4. The BMF Circular states that capital gains from the sale of cryptocurrency held as private assets are taxable as income from private sales of ‘other assets’ within the meaning Section 23 (1) sentence 1 no. 2 of the EStG and that the holding periods under this provision restart on each exchange.
The BFH ruling and BMF circular confirm that these specific types of tokens (cryptocurrency) and transactions fit within the existing framework for tax treatment in Germany.
However, it may not automatically apply to other categories of cryptoassets (e.g. ‘digital tokens’). In its February 2023 ruling, from a tax perspective, the BFH categorizes bitcoins, ethereum and monero as means of payment and uses terms such as ‘currency tokens’ or ‘payment token’ to describe them. This does not necessarily mean that such fiscal categorization would be the same from a regulatory law perspective (please see footnote 2).
The BFH decision does not mean that all questions relating to the tax treatment for cryptoassets have been answered. There are a lot of open questions, for example, how the BMF Circular views other tokens, different profit-generating transactions (e.g. from staking or DeFi lending transactions) and other individual issues. This BFH decision only covers a small portion of the diverse cryptoassets that are available. Issuers and service providers, as well as users and investors in cryptoassets, should therefore keep an eye on the dynamic tax developments.