Libra cryptocurrency users face taxing problem

Facebook and its partners hope that consumers and businesses across the world will spend money in a new cryptocurrency – Libra.  However, users of Libra seem likely to face a potential tax charge and additional tax compliance, which could be both costly and inconvenient.  It is not clear how Facebook intend to solve this problem.

The basket of currencies behind it means currency gains will be taxable.

What’s the problem?

The Libra White Paper says that Libra will be fully backed by a reserve comprising bank deposits and short-term government securities in a range of traditional fiat currencies. Because the reserve will be effectively backed by a basket of fiat currencies, the exchange rate of Libra against any particular fiat currency (e.g. the Libra/GBP rate) will inevitably fluctuate as those underlying fiat currencies fluctuate.

This creates a novel problem for users of Libra: each time they transact using Libra, they’ll be making a currency gain or loss in their local fiat currency.  In most countries those currency gains will be taxable.  Those users will need to pay any tax due and may need to file a detailed tax return showing all their transactions and the exchange rate at the time.  Unless this problem is somehow solved, this seems to us to be a significant barrier to wide adoption of Libra.

Why is this different to other cryptocurrencies?

Gains and losses on cryptocurrencies are taxable in almost all countries.  However, whether early adopters of Bitcoin (and other decentralised cryptocurrencies) have actually paid the tax due is a different question.  While some cryptocurrency exchanges are now reporting account-holders to tax authorities, many still are not.

Libra is very different.  Instead of adopting the decentralised model of Bitcoin and other cryptocurrencies, the Libra Blockchain will be governed by the “Libra Association”, a not-for-profit organisation made up of a range of businesses including Facebook, MasterCard, Visa, Stripe and PayPal among others.  This means that unlike Bitcoin (and others), for Libra there will be a ‘central authority’ with oversight over users’ transactions.  Our strong expectation is that tax authorities will require the Libra Association to report on its users’ transactions, either under existing tax reporting laws or under new legislation.

For this reason, users probably won’t be able to ignore the tax treatment of Libra.

Users won’t be able to ignore the tax treatment of Libra.

How will the tax work?

If Libra rises in value (relative to the user’s home fiat currency) between the time a user acquires Libra and the time they spend it, then they will have made a gain which most countries will tax.  On the other hand, if Libra falls in value, the user will have made a loss which they may be able to set against any Libra gains made in that tax year.  This will generally be the case regardless of whether the user is actually making a gain or loss in economic terms.

Users will therefore have to track the point that they acquire Libra, the point at which they spend it, and the exchange rate relative to their home fiat currency each time.  If the overall result across a tax year is positive, tax will have to be paid.

For a typical UK consumer, the compliance will often be more painful than the actual tax (given the UK’s generous £12,000 annual allowance for tax-free capital gains).  For consumers in other countries, actual tax liabilities are much more likely (as France, Germany and others have much more limited, or zero, annual allowances).

This seems to us a big problem for Libra to solve.  How many users will be willing to deal with all this complexity and the risk of a tax charge?

What are the potential answers?

1. a) A political solution: Libra could lobby governments and tax authorities to create a special exemption from tax on Libra gains and losses. This seems to be Facebook’s intention. However, given the political and regulatory difficulties Facebook are already facing in relation to Libra, and the fact this would seem to open the door to tax-free gains on other cryptocurrencies (which tax authorities will doubtless resist), the chances of this seem remote.
2. b) A tech solution:Automatic tax calculation and reporting systems could be integrated into Libra wallets to make the process as straightforward as possible for users and tax authorities. But the prospect of an unexpected tax bill at the end of the year will still be off-putting to many consumers.  And this would highlight to users the relative advantage of transacting in local fiat currency instead of Libra.
3. c) A market solution: Don’t operate Libra in countries where the tax treatment for consumers is awkward (or, alternatively, operate it, but don’t expect large scale take-up). This seems contrary to Libra’s stated goals.
4. d) A more fundamental solution: Change Libra so that, instead of being a new currency, it is essentially an e-wallet system. A UK consumer spends £50 to buy £50 of Libra, and spends pounds in UK stores; a French consumer spends €50 to buy €50 of Libra, and spends euros in Eurozone stores; and so on. The tax complexities would largely disappear, but this would be a significant reversal from what has been announced.

Finding a solution which meets both Libra’s apparent aspirations and the needs of its intended users does not appear to be straightforward. If Libra is to launch in 2020 as expected, the Libra Association will need to move quickly to solve these issues in order to ensure that it delivers the seamless experience users have come to expect from Facebook and its other founding members.

By Rob Sharpe, senior associate, Clifford Chance