The year 2017 was marked by the exponential growth of virtual currencies – which includes cryptocurrencies such as Bitcoins – market in Brazil. In this period the number of Brazilian investors in Bitcoins surpassed the number of individual registrations in the Stock market and the total investors active in the Brazilian Direct Treasury.
When filling the personal income tax return, individuals that traded Bitcoins and other virtual currencies in 2017 must pay attention to do not make mistakes in calculating their tax owed and do not provide inaccurate information in their tax return form.
Complying with the Brazilian tax rules that are currently in force could be tricky for virtual currency investors, mostly for individuals. This is because they must calculate and collect the tax owed on their own and there are hazy questions regarding taxation of capital gains earned for individuals in transactions with virtual coins. The delay from the Federal Government in regulating this market also contributes to increase the legal uncertainty of these transactions.
Financial institutions, for instance, as they are subjected to tight tax and regulatory rules, are obliged to calculate, withhold, and collect the income tax owed by their investors and provide annual earnings statements to its investors individuals with all information required to file the personal income tax return properly. Brazilian virtual currency exchanges, on the other hand, for not being subject to any specific tax and regulatory rules, are not obliged to withhold the personal income tax nor provide statements for its investors with information regarding their virtual currencies transactions.
These are the reasons why individuals must pay attention in reporting the virtual currency transactions in their income tax return and calculating the income tax arising out of these transactions.
A common mistake regarding this subject is the limit of the personal income tax exemption on capital gains obtained from disposal of goods and rights of small value. It is exempted of the income tax capital gains obtained by individuals on disposal of goods and rights which the sum of sales transactions, practiced within the same month, does not exceed R$ 35,000.00 (for transactions in the counter market, the limit is R$ 20,000.00). If the sales price sum exceeds that limit, the capital gain obtained is taxable even when the capital gain is much lower than R$ 35,000.00.
The most concerning questions on virtual currency taxation, however, are related with the its calculation basis and tax rate.
The Brazilian IRS has not issued any guidance of virtual currency taxation besides a mention in its 2017 annual Q&A that the general rules on taxation of capital gains obtained from individuals are applicable to tax capital gains arising out of virtual currency transactions. These rules, however, are generic and do not consider important features of virtual currency.
To calculate the acquisition cost according to these general rules, for instance, individuals taxpayers must have a detailed track record of their virtual currency acquisitions, with values, dates, units and codes, to determine precisely which units (or portions of it) are being sold in every single sale transaction. In situations of dozens of purchase and sale transactions practiced in a short period of time, it is obvious that these general rules are impracticable.
For this reason, there are legal grounds to support the calculation of virtual currency acquisition cost based on weighted average cost method, applying by analogy the method set forth to calculate the acquisition cost of shares held by individuals.
Besides that, there are doubts about how the personal income tax progressive rates on capital gains shall apply on taxation of capital gains arising out of virtual currency transactions.
The regular rate on taxation of capital gains earned by individuals is still the same, 15%. From January 1st, 2017, however, the portion of the capital gain that exceeds R$ 5 million is subjected to progressive rates of 17.5% (gains from R$ 5 million to R$ 10 million), 20% (gains from R$ 10 million to R$ 30 million), and 22.5% (gains over than R$ 30 million).
In this scenario, questions could be raised on whether the progressive rates shall apply: only when, by a single transaction of virtual currency, the capital gain earned exceeds R$ 5 million; or, as same as in sale of shares held by an individual, capital gains earned in transactions of virtual currency practiced in certain period of time (until the end of the next year from the first transaction, in case of shares) shall be summed to apply the progressive rates? There are arguments (and consequences) to defend both hypothesis.
Considering the logic of capital gain taxation for individuals, which gain is taxed regardless other earnings and expenses, combined with the fact that virtual currency transactions are not necessarily linked to each other, it should prevail the understanding that the progressive rates are only applicable when the capital gain obtained in one transaction exceeds R$ 5 million.
On the other hand, considering the fungible nature of virtual currencies, there are grounds to support that the progressive rates are applicable on the sum of capital gains earned on transactions of virtual currencies practiced in a certain period. To support this understanding, can be argued that the income taxation must pursue actual earnings to apply progressive rates, which in case of transactions with fungible goods (as currencies in general) is the sum of net result of these transactions (practice in a certain period).
This second line of thought implies in admitting the offset of losses in virtual currency transactions with gains obtained in the same transactions to determine the taxable capital gain. Although there is no legal provision in this way, there are legal grounds to claim the permission to offset losses in Court. The Brazilian IRS has already admitted in its Annual Q&A that virtual currency shall be deemed as a financial asset.
Once calculated the amount due, the personal income tax on capital gain shall be collected in the form DARF, with code number 4600, until the last business day of the month after that the capital gain was earned. After maturity date, the tax payment shall include interest calculated by Selic rate and late fine of 0.33% of tax due per day (limited up to 20% of tax owed). Late fines may be challenged in Court.
In the personal income tax return, the information regarding purchase and sale transactions of virtual currencies must be reported in capital gain folder, as well as income tax paid in connection with these transactions. This information must be filled in the proper capital gain software (available to download at Brazilian IRS’ website) and the file created by this software shall be uploaded in the personal income tax return.
In the goods and rights folder, it must be informed only the the individual’s patrimony on December 31st of each year. The amount of each type of virtual currency, if exceeds R$ 1,000.00, must be informed by its the acquisition cost (and not by the market value on Dec 31st) under code 99 (other assets and rights). It is also recommendable that the item description reports the type of virtual currency, quantity, and if possible, the acquisition dates.
In the light of the notable complexity that surrounds the taxation of virtual currencies, it is recommendable that individuals look for specialized assistance to help them with IRS obligations, specially individuals that made many transactions of purchase and sale of virtual currencies such as Bitcoins and other cryptocurrencies in 2017.