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DB | Remains in shadow without regulation

30 May 2018

BDO Law lawyers Justine Tomsone and Valts Sturmanis speak about cryptocurrency legal and tax regulative problems in the interview for daily business newspaper Dienas Bizness.

While Latvia is taking the first step in regulating the business of cryptocurrency, Malta's ambition is to become an active virtual metropolis, with a clear regulation of attracting companies from around the world. Due to the lack of regulation and legitimate expectations, virtual entrepreneurs in Latvia are forced to remain in the shadow economy, which is a loss both for tax revenue and a hindrance to innovative business growth, the situation is described by the leading expert organisation specialising in financial management in the SME sector BDO in Latvia. Our office has participated in the process of preparing the SRS reference, which in Latvia changes the status of the current cryptocurrency from the product as a capital asset which is considered positive in the sector. This is a breakthrough in the legal alignment of this area in Latvia. Currently, the SRS believes that the proceeds from the sale of cryptocurrency are tantamount to the income from capital gains to which the 20% IRR rate applies. "It was not so easy. But it was the SRS that showed a good understanding about the process of how the cryptocurrency transactions are closed," says Valts Stūrmanis, BDO Senior Tax Consultant and BDO Law Lawyer. "Together with the Ministry of Finance, the SRS, by analogy, equated income from such transactions to capital assets. This is a big step forward, indicating the openness and innovative approach of our civil servants because the laws have not been changed - they are simply being read differently."

Just the first step

The SRS reference answers only a part of the questions, as the problem of cryptocurrency is wide. These deals involve a variety of business and income types.  One is the creation of cryptocurrency with computer power - mining. SRS reference does not apply to this activity and the question about what the income remains open. "Technically, it could be an economic activity, because of the need for specific equipment, their operation must be systematically monitored, and the process involves a fairly high cost. Also, the goal is one - to get profit from it," says V. Stūrmanis.

It has been heard even for Latvian students who are engaged in cryptocurrency digging in their free time. Questions such as – what is it that my child is doing – are asked by parents, says BDO associate Justīne Tomsone. "Basically, cryptocurrency miners are natural persons and tax subjects as well, but the lack of regulation does not make it clear how to tax that income."

The BDO's initiative for adjusting the regulation is related to the office's own experience, beginning to accept settlements in bitcoins at the end of 2017. "When this news appeared in the press, customers began to get interested, but the path with bitcoins was not smooth," V. Stūrmanis remembers. "For a long time, we are confronted with a situation in which we can theoretically accept bitcoins as a payment for services rendered, but the Latvian banks are very cautious and skeptical, which is contrary to the banking policy on the prevention of money laundering (AML). I believe that another reason is the potential of the cryptocurrency as a form of settlement to compete with the banking business itself. "BDO's own experience suggests that many people in Latvia have problems with these issues. ”We conducted a small survey and found that financially, this problem is not so small, and the state, with no effective taxation, sums up quite significant amounts," says J. Tomsone. Mostly, customers are interested in digging, but there are also those who are looking to earn money by speculating with fluctuations in the price of the cryptocurrency. The third topical issue is the initial coin offering (ICO), with which companies do not publicly invest in cryptocurrencies. "This is a way for a company to raise capital without involving banks, stock exchanges or venture capital. Latvia in the ICO area is lagging behind Lithuania and Estonia, which are much more active in this field. Taking into account the attracted ICO capital amount, Lithuania and Estonia Currently stand with countries such as the United States and Switzerland" says Ms. Tomsone.

  1. Stūrmanis assesses, for example, that Lithuania's success is related to certain transactions. An example is the ICO executed by Banker's blockchain banking services company, which attracted around EUR 150 million this year. "The Lithuanian regulator already has technical problems, because the money came in amounts that nobody had expected. It also points to the potential of this field, "says V. Stūrmanis.”The Lithuanian regulator is much more responsive to this type of project than our Financial and Capital Market Commission," says J. Tomsone. In the assessment of BDO lawyers, in a small country, many processes are significantly altered by individual people, such as heads of institutions, especially if there is a joint vision as well as commitment and courage across institutions. V. Stūrmanis envisages that the openness of Vilnius and Tallinn to the blockchain technology business will mean the attraction of this business also from Latvia; therefore us losing it. As an Estonian feature, he mentions the attraction of Russian entrepreneurs in this area, as St. Petersburg is near and the Russians happily choose Tallinn which has an open mind toward cryptocurrency in the EU’s jurisdiction for the establishment of their enterprises. The FCMC's attitude is based on the EU's legal position that cryptocurrency is a contractual, not a legal tender. "This means that, with the agreement of the parties, mutual settlements can take place in the form of barter or apples, but this does not make it a legal means of payment in the country; therefore the FCMC is also distant from it," commented J. Tomsone. "In the context of the cryptocurrency, we cannot even legally say “invest" because according to the law it is not an investment," she says. "Any person who wants to acquire a cryptocurrency or a token is subjected to risk because some kind of investment is in fact actually carried out, but the current legislation does not protect the rights of this person.”

At the moment, most of those who want their company to raise capital with ICO, try not to mention the word "investment," as well as they, try to ensure that the value statements issued by the investor do not recall any financial instrument. Otherwise, the matter falls within the competence of the FCMC, which suggests, as one of the potential solutions, the establishment of an investment management company. Unfortunately, such a practice often turns out to be ineffective because the investment management company is a licensed institute with a minimum equity of 125 thousand euros. A start-up company, whose development requires additional capital, cannot afford anything like that. As a consequence, it slows down the business as well as the development of start-ups.

Maltese Leadership

In the legal framework and the national policy regarding the field of cryptocurrency Malta is taking the lead. There are three laws in the process of adoption: the Virtual Financial Assets Act, the Law on Digital Innovation, the Law on Technology Innovation and Services, as well as the establishment of a control body that will control and license this business. Malta will be the first in Europe to have a clear set of rules on which and at what point to take and which body responds. This is the result of close private-public sectors cooperation. Binance has already announced that it will transfer part of its operations to Malta, the largest exchange trading company in the world. This is a huge business, and in the first three months of this year, Binance's profit amounted to 200 million euros, while Germany's largest bank, Deutsche Bank, totaled 146 million euros over the past year. The Prime Minister of Malta is actively promoting national policies - come with us because there is a clear regulatory framework here.

This is obviously happening - other big swap trades also report partial or full relocation of their operations. The primary benefit for the business is the clear amount of obligations and rights to the state, the clear costs; also the daily work is not bothered by the often unpredictable risks. In other places, these risks cannot be identified because there is no regulation.

In the transnational level of the EU, the cryptocurrency figure is combined with counter-terrorism measures in the Fifth Directive of the AML. Ms. Tomsone commented that this is understandable, since cryptocurrency, due to its anonymity, can also be used successfully for the purchase of prohibited goods. "But this is a matter of regulation, which does not exist. Malta is, therefore, a positive example. I think that Latvia should learn from it because it is a new and fast-growing sector with potential benefits for the country. We have had some customers who are interested in the possibility of building ICO projects, but in the end, most of them choose Malta as their jurisdiction, which is now gradually becoming the ICO's citadel. “

The AML's risks in her assessment do exist, however, "any self-respecting and self-investing ICO project already prepares a package of documents for this process, which is quite similar to those packages needed to license a financial and capital market regulator under the supervision of an entity. AML policy is now the ICO standard for any pledge. If Malta adopts legislation that sets clear requirements, Malta will have a fantastic opportunity to attract these projects. If it is possible to attract up to 150 million euros in one ICO project, as it happened in Lithuania with Banker, then it is a signal that the state should have an interest in it. The typical ICO is not always as big; nonetheless, it is big money. “

In the meantime, eight ICO projects have been successfully concluded in Latvia. "If the start-up invests these funds in good faith in development, then these funds are also future taxes to the state. Now, as a result of financial attraction, entire start-ups are being transferred to Malta, as the state machinery is expected. The hardest part is to work in conditions if you do not know what will be the situation tomorrow due to lack of legitimate expectations,” both lawyers estimate.

Confidence in private hands

One thing is untapped taxes, but more importantly for the economic growth is the fact that, due to the lack of regulation, part of the Latvian start-up companies pass on the opportunity of the capital that can be attracted through ICO. “It is sad because there are Latvia has many start-up companies with great ideas, but, as statistics show, they have much less chance of attracting bank capital than large companies, also the interest rates are high," says J. Tomsone. "Therefore, ICO is not a bad opportunity, and regulation would be a sure bet for investors as well, that it is not a fraudulent scheme of some sort.” Unfortunately, in the absence of a monitoring institution and clear documentation requirements, the element that currently promotes confidence in investors for specific ICO projects is not government monitoring, but the personalities involved in those projects - people who have shown themselves, to be honest, successful in the ICO environment projects, rather than fraudulent schemes. A similar guarantee for investors is the attraction of large auditing companies and law firms. There is a lot of money in the virtual assets environment, and people would be willing to invest it further, rather than turn it into currency through the bank and spend it.

To identify the situation in Latvia, BDO has established the Virtual Currency Association. “It is not just about blockchain technology and virtual currencies, but it is about virtual assets in general. They can be different, not only for contractual payments and securities equated with value certificates. They can also be virtual gaming assets that have a high monetary value," says V. Stūrmanis. "These assets are capable of generating high income. The association aims to create a debate that will result in clear policies for doing so with such incomes. "

He is convinced that there are people in Latvia who have income from virtual assets. "There is a need for regulation to be stimulated to get out of the underground. That would be a benefit for everyone. Because people with such incomes are currently deciding to remain in the shadow economy. "In turn, Tomsone points out that the BDO survey did not want to disclose information. "No one does not comment on himself, because it is unclear what legal consequences can be of what you are doing. At the same time, if it is a business that is not used for criminal purposes, its legalization is in everyone's interest.“

He is convinced that there are people in Latvia who have income from virtual assets. "There is a need for regulation for them to be stimulated to get out of the underground. That would be a benefit for everyone. Because people with such incomes are currently deciding to remain in the shadow economy.” In turn, J. Tomsone points out that in the BDO survey people did not want to disclose information. "No one comments about himself, because it is unclear what legal consequences can be of what you are doing. At the same time, if it is a business that is not used for criminal purposes, its legalization is in everyone's interest.”

The contribution of the association will be the legal and tax aspects of this problem. Such associations in Latvia already exist, for example, the Latvian Blockchain Association. "They are definitely strong regarding technical issues. But our contribution will be in the legal, tax and future regulatory issues, "says J. Tomsone. Meanwhile, in the assessment of both lawyers, part of the economically active population of Latvia lives in a "ghost world" - they seem to be here, and yet they are not. "Currently, the only way to identify these people is through the bank's denied payments when they try to convert a virtual currency into a bank. But even then it is impossible to tell how much money do they have,” says V. Stūrmanis. "These people currently do not have a normal life in Latvia because they can not use their assets. The risk and lack of legal certainty forces them to remain in the shadows.“ The associate points out that these problems can be bypassed by renting a property instead of buying it. "There is no problem to pay rent and utility bills with cryptocurrency because there are a number of companies providing such services in the world. An example is also airBaltic, where a ticket for bitcoins can be bought for almost four years now. If a person knows where and how to do it, then technically you can calmly continue to live in this parallel economy. Of course, now there is an even bigger reason to move to Malta, where you will soon be able to earn a virtual asset and fully live in the official economy."

In Latvian: here