Virtual currencies are considered an “asset” for tax purposes, and their sale therefore constitutes a taxable event. In addition to the tax liability itself, holders of virtual currencies face practical difficulties in depositing proceeds from their sale with Israeli banks, which may also impede their ability to pay the tax due to the Israel Tax Authority.
Against this backdrop, the Israel Tax Authority submitted to the District Court a draft temporary procedure intended to regulate the collection of taxes arising from individuals’ activities involving virtual currencies. Subject to certain conditions, the procedure is expected to allow tax payments to be transferred directly from a foreign bank account to the Israel Tax Authority’s bank account, where it has been demonstrated that an Israeli bank has refused to accept the funds. The procedure requires full disclosure of the relevant activity and the submission of information and supporting documentation. However, it does not resolve potential criminal exposure arising from failure to report income and does not replace a voluntary disclosure procedure.
A virtual currency is considered an “asset” for tax purposes (in accordance with the position published by the tax authorities several years ago), and therefore the sale of virtual currencies constitutes a taxable event for the seller. In most cases, income from the sale of virtual currency will be classified as capital income and will accordingly be subject to capital gains tax. However, where activity involving virtual currencies amounts to a “business” (based on the tests adopted under Israeli tax law), income from the sale of virtual currencies will be classified as ordinary income and taxed accordingly (at marginal income tax rates or corporate tax rates, as applicable).
For VAT purposes, income from the sale of virtual currencies by an investor whose activity does not have business characteristics will not be subject to VAT. However, a person whose activity involving virtual currencies has business characteristics will be classified and registered as a “financial institution” for VAT purposes and taxed accordingly.
Following the publication of its general interpretative position on the taxation of virtual currencies, the Israel Tax Authority has in recent years also published its position on a number of related issues, including the sale of NFTs, the issuance of digital tokens to the public, and the manner in which receipts for services paid for in digital currencies should be recorded.
However, the publication of the Israel Tax Authority’s position regarding tax liabilities arising from virtual currency activities has not resolved the various practical difficulties faced by holders of virtual currencies with respect to holding such currencies and depositing the resulting proceeds. These difficulties primarily stem from the banking system and its challenges in managing the associated risks.
As a general rule, Israeli commercial banks frequently impose restrictions on the receipt of funds originating from virtual currencies due to difficulties in tracing the source of the funds and concerns that they may be connected to money laundering or terrorist financing. The inability to deposit the proceeds from the sale of virtual currencies into the seller’s bank account may, of course, also make it difficult or impossible for the seller to pay the resulting tax liability, as tax payments are generally required to be made from an Israeli bank account.
This practical difficulty has led to several court proceedings addressing these issues. Among other matters, these proceedings have raised the difficulty of paying Israeli income tax on profits from virtual currencies held abroad when the sale proceeds cannot be transferred to Israel.
In one such proceeding, the Israel Tax Authority recently submitted to the District Court a draft “Temporary Procedure for the Receipt of Tax Payments in Respect of Profits from the Realisation of Decentralised Means of Payment” (virtual currencies). It should be noted that the procedure has not yet been formally published by the Israel Tax Authority and is initially expected to apply for a six-month period beginning on 1 January 2024.
The purpose of the procedure is to regulate the process and examinations required to enable the receipt and collection of taxes arising from individuals’ activities involving virtual currencies directly into the Israel Tax Authority’s bank account. The procedure applies where it has been demonstrated to the Israel Tax Authority that the Israeli commercial banking system (at least one bank) has refused to open an account or accept funds originating from virtual currencies.
The procedure includes various technical and substantive provisions. In brief, the taxpayer is required to approach the assessing officer responsible for their tax file and provide full disclosure regarding their virtual currency activities, taxable income and tax due. The assessing officer will then determine the tax liability applicable to that income, whether by agreement or otherwise.
As part of the assessment process, the seller is also required to provide various details and waive confidentiality, enabling the Israel Tax Authority to disclose the seller’s information to the Israel Money Laundering and Terror Financing Prohibition Authority, the Israel Police and the Bank of Israel. The seller must also provide declarations and various supporting documents, including information regarding the source of the funds used to purchase the virtual currencies, transactions involving the virtual currencies, and confirmation of the account from which the tax payment will be made.
It is important to emphasise that the new procedure does not resolve potential criminal exposure arising from failure to report income. In other words, it does not replace the need to implement a voluntary disclosure procedure in respect of an individual’s income.
Implementation of the procedure will allow sellers of virtual currencies to pay their tax liability by transferring funds from a foreign bank account, including an account of a crypto exchange, investment house or other financial services provider maintained with a foreign bank, provided that it is regulated abroad and is not located in a high-risk jurisdiction, directly to the Israel Tax Authority’s bank account. The transfer must be made in Israeli shekels. This will effectively enable the payment to bypass the Israeli banking system.
