LEGITIMATIZATION of Virtual/crypto-currencies (VCCs) is set to gather pace with G20 lauding their benefits while seeking regulations to prevent their misuse.

Tax authorities in developed countries and emerging economies including India have legitimized VCCs by taxing VCC-based transactions. They look for new opportunities to widen the tax net on VCCs. Their anonymous ownership makes them easy option for tax evasion.

As put by the US Internal Revenue Service (IRS) in a reminder dated 23 March 2018 to taxpayers, "Virtual currency (VC), as generally defined, is a "digital representation of value that functions in the same manner as a country's traditional currency. There are currently more than 1,500 known virtual currencies. Because transactions in virtual currencies can be difficult to trace and have an inherently pseudo-anonymous aspect, some taxpayers may be tempted to hide taxable income from the IRS".

International Monetary Fund (IMF) has also pointed out that VCs have a high potential as a means for tax evasion. It notes: "This is particularly the case with crypto currencies, where participants need not disclose their identity, and transactions are peer-to-peer and can take place across borders. Given that tax evasion is already illegal in most jurisdictions, the key problems in this area relate to developing effective means of enforcement".

Monetary authorities, on the other hand, have not formally recognized VCCs as legal means for commercial transactions in most countries. Many have, however, allowed them to mushroom and flourish. Some such as the ones in Indonesia, Iran and India have frowned upon them.

Central Banks know decentralized VCCs might pose a challenge to sovereign currencies in the long run.Some of them are thus themselves considering launching their own digital currencies.

The tone for guarded promotion of VCCs has been set by G20 Meeting of Finance Ministers and Central Bank Governors (FMs-CBGs), who met in Buenos Aires for two-day conference ending 22th July 2018.

In their communique, FMs-CGBs observed: "Technological innovations, including those underlying crypto-assets, can deliver significant benefits to the financial system and the broader economy".

They stated: "Crypto-assets do, however, raise issues with respect to consumer and investor protection, market integrity, tax evasion, money laundering and terrorist financing. Crypto-assets lack the key attributes of sovereign currencies. While crypto-assets do not at this point pose a global financial stability risk, we remain vigilant".

G20 depends on Financial Action Task Force (FATF), IMF, Financial Stability Board (FSB), International Organization of Securities Commissions (IOSCO) & other global agencies to take a stand on diverse economic issues including VCCs.

FATF's work on VCCs is important from the standpoint of preventing rampant use of VCCs as avenues for tax evasion and money laundering.

In its report G20 FMs-CGBs, FATF cautioned: "The global regulatory environment for virtual currencies/crypto-assets is changing rapidly. This may make it challenging to ensure a consistent global approach, which could increase risks. Given the highly mobile nature of virtual currencies/crypto-assets, there is a risk of regulatory arbitrage or flight to unregulated safe havens".

FATF would put VCCs under special regulatory gaze under the Presidency of the United States. It assumed the annual presidency of Financial Action Task Force (FATF) with effect from 1 July 2018.

According to FATF's New President Marshall Billingslea, the US Presidency will clarify how the FATF standards apply to virtual currency providers and related businesses. FATF will also embark on a new project that focuses on investigative best practices on virtual currency to support law enforcement.

As put by Mr. Billingslea, "Virtual currencies are increasingly being used to launder the proceeds of crime, but are not explicitly acknowledged in the FATF recommendations".

He points out that most countries, including the majority of the FATF members, still do not regulate and supervise virtual currency providers for anti-money laundering/counter-financing of terrorism (AML/CFT).

Among the G20 countries, only China, India, Indonesia have prohibited issue and use of VCCs. Seven G20 countries – USA, Japan, Australia, France, Germany, Italy and Switzerland - regulate VCC intermediaries/exchanges.

Argentina and South Africa apply only suspicious transaction reporting norms to VCCs. Remaining G20 countries are preparing laws or regulations to prevent abuse of VCs.

Instead of preparing regulatory framework for VCCs, the stakeholders of global financial stability should first address basic issues. Why the trumpeted benefits of VCCs such as financial inclusion and faster payments can't be performed by the existing financial system? Are electronic payments including net banking not good enough?

Why should the world become theatre for cat (regulations) & mouse (VCCs) game? Would digital technology-driven VCCs not always remain a few steps ahead of finest regulatory framework?

If share of VCCs in global GDP rises from an estimated 1% at present to 5-10 percent, would it increase money supply? Would this, in turn, fuel inflation? Would VCCs become an asset bubble, if existing volatility in prices of some crypto currencies such as Bitcoin is any indication?

Fundamental issues should thus be addressed up front by G20 and not deferred till VCCs virus spreads too deep and too far to rock the global financial stability.

It is here pertinent to quote US Federal Reserve (Fed) Governor Lael Brainard. In April this year, he said: "One area that the Federal Reserve is monitoring is the extreme volatility evidenced by some crypto currencies. For instance, Bitcoin rose over 1,000 percent in 2017 and has fallen sharply in recent months".

Fed has so far adopted accommodative stance towards VCCs.

During June 2018, Federal Reserve Bank of St. Louis, one of the 12 regional reserve banks forming a part of Fed, launched indices for four crypto-currencies -Bitcoin, Bitcoin Cash, Ethereum and Litecoin.The indices are based on data obtained from Coinbase, a crypto-currency exchange company.

Fed's positive approach towards VCCs is also reflected in a comprehensive speech on crypto-currencies delivered by Lael Brainard, Member, Fed Board of Governors, during May this year.

Ms Brainardstated: "It is an exciting time for the financial sector as digital innovations are challenging conventional thinking about currency, money, and payments. Crypto currencies are strikingly innovative but also pose challenges associated with speculative dynamics, investor and consumer protections, and money-laundering risks".

She believes that the financial sector will find valuable ways to employ crypto's core component - distributed ledger technology in the area of payments, clearing, and settlement in coming years.

According to Financial Stability Board (FSB),"crypto-assets do not pose a material risk to global financial stability at this time, but supported vigilant monitoring in light of the speed of developments and data gaps".

In its report on crypto-assets submitted to G20 on 16th July, FSB has pointed out the limitation of public data on VCCs. It says: "the quality of the underlying data can vary, and might not always be satisfactory. Furthermore, market-related figures, such as metrics on prices, trading volumes, and volatility may be manipulated by generally prohibited practices such as ‘wash trading,'‘spoofing,' and ‘pump and dump,' the existence of which cannot be ruled out at this stage".

In an earlier report released during March 2018, FSB explained why VCCs don't pose risks to global financial stability at present. It stated: "This is in part because they are small relative to the financial system. Even at their recent peak, their combined global market value was less than 1% of global GDP".

The Report continued: "In comparison, just prior to the global financial crisis, the notional value of credit default swaps was 100% of global GDP. Their small size, and the fact that they are not substitutes for currency and with very limited use for real economy and financial transactions, has meant the linkages to the rest of the financial system are limited".

International Organization of Securities Commissions (IOSCO)has observed that many regulators are responding to VCCs to protect investors and maintain market integrity.

The capital market regulators have to address issues like whether a traded crypto-asset is a security, commodity, or some other financial product. They also have to decide whether crypto-exchanges are compliant with relevant laws.

Unlike monetary and capital market regulators, anti-money laundering authorities are relatively more alert to risks posed by VCCs.

The US Department of the Treasury's Financial Crimes Enforcement Network (FinCEN), for instance, is regulating VC exchanges & users with hawkish eye. More than 100 of such exchanges are registered with FinCEN.

In 2013, Fin CEN extended certain banking regulations to them. In July 2017, it imposed a $110 million fine on BTC-e, an Internet-based, foreign-located money transmitter, for violating US anti-money laundering law.

FATF, in a report on Professional Money Laundering (PML) released on 26th July 2018, has raised a stink about misuse of VCCs for criminal activities.

FATF points out that PMLs offer a variety of services including the use of VCs in an attempt to anonymise those committing crimes and their illicit transactions. The use of complex, computer-based fraud schemes has led cyber criminals to create large-scale mechanisms to move the proceeds earned from these schemes.

More specifically, virtual currency exchangers have been used as unlicensed or unregistered Money Value Transfer Services (MVTS) providers to exchange criminal proceeds in the form of VCs to fiat currency.

As put by the report, "PMLs also arrange schemes that allow criminals to cash out proceeds generated in virtual currency via online illicit markets (e.g. Dark Web drug-trafficking marketplaces). In many cases, payments for illicit drugs purchased online are transferred to e-wallets held in fiat currency or in virtual currency (e.g. Bitcoin)".

As for direct and indirect taxation, the global norms and standard practices for VCCs domain are yet to be put in place.

International Monetary Fund (IMF) aptly raised issues relating to taxation in its first Staff Discussion Note (SDN) on VCs issued during January 2016.

According to SDN, VCs have tax implications to the extent they perform an economic function. The function may be VC serving as store of value or a medium of exchange.

SDN says: "A key issue in the tax treatment of VCs is whether they should be treated as a form of(non-monetary) property, or as a form of currency. Where the former position is adopted, use of a VC to purchase goods or services or for investment purposes would result in the recognition of gains or losses".

It adds: "The character of the gain or loss would depend on the applicable rules in the relevant jurisdiction, for example whether the property is defined to be a capital asset, the length of holding period, or the classification of a transaction as speculation. In the second case-when VCs are treated as a currency-most jurisdictions would require the recognition of foreign exchange gains or losses".

IRS treats VCCs as property. It thus applies general tax principles relating to property transactions to VCCs-based transactions.

Similarly, Inland Revenue Authority of Singapore (IRAS) taxes businesses that buy and sell VCs in the ordinary course of their business. It taxes profit derived from trading in VCs. It also subjects to tax profits derived by businesses which mine and trade VCs in exchange for money.

IRAS says: "Businesses that buy virtual currencies for long-term investment purposes may enjoy a capital gain from the disposal of these virtual currencies. However, as there are no capital gains taxes in Singapore, such gains are not subject to tax".

According to Indian Income Tax Department (ITD), the gains arising from the transfer of crypto-currencies is liable to tax depending upon the nature of holding of the same.

It had issued notices to nine crypto exchanges in five cities durng December 2017 following surveys under section 133/A of the Income tax Act, 1961.

For its field staff, ITD has prepared a manual titled ‘Introduction to Crypto-currencies and Forensic Examination of Bitcoin Transaction (Guide for Investigation Directorates)'.

As regards indirect taxes, IRAS says: "Virtual currencies (e.g. Bitcoins) are not considered as 'money', 'currency' or 'goods' for GST purposes. Instead, the supply of virtual currency is treated as a supply of services, which does not qualify for GST exemption".

It adds: "When you use virtual currencies to pay for goods or services, the transaction will be considered as a barter trade. There are two supplies made - one by the supplier who supplies the goods and services, and another by you who use virtual currencies to pay the supplier.GST will need to be charged on each supply if the respective supplier is GST-registered".

By reviewing taxation approaches in different jurisdictions including European Union, the G20 or OECD should prepare comprehensive guidelines for taxation of business conducted under VCCs, assuming that they would not be banned or discouraged across the world.