Some crypto tokens have been experiencing a huge increase in prices in recent weeks and months, occasionally reaching new all-time highs. The rapid increase in the price of Bitcoin garnered particular publicity. As a result of this rally, there is an increased interest both in the direct acquisition and trading of crypto tokens as well in other crypto financial products, such as crypto futures and crypto CFDs (contracts for differences). These products enable investors to trade on price movements without purchasing the underlying tokens themselves. This allows investors to achieve the same participation in price movements but with a lower capital investment than if the tokens in question had been acquired (leverage effect). Similarly — as with conventional forward transactions (Termingeschäfte) — investors can also trade on price decreases.
However, investors must beware of tax pitfalls with this type of investment.
They must, in particular, take into account the rules newly introduced as of 1 January 2021 on the offsetting of losses incurred from forward transactions and from other capital claims (sect. 20(6) sent. 5 et seqq. German Income Tax Act – Einkommensteuergesetz or EStG). This entails specific tax risks for private investors.
I. Classification for tax purposes of CFDs and futures held as private assets
Gains from CFDs and future contracts that are not geared towards the delivery of the respective underlying assets are generally qualified as forward transactions and, as income from capital assets (sect. 20(2) sent. 1 no. 3 ITA), are subject to a flat-rate tax of 25% (plus solidarity surcharge and, where applicable, church tax).
In the view of the tax authorities (decree of Germany's Federal Ministry of Finance of 18 January 2016, Federal Tax Gazette I 2016, p. 85), all option contracts and forward contracts (Festgeschäfte, "firm transactions") whose price depends on stock-exchange and market prices or prices of securities, money-market instruments, foreign currencies, interest rates, goods or precious metals are to be classified as forward transactions.
Whether these principles are also transferable to crypto CFDs and crypto futures has not yet been confirmed by the tax authorities. While it would seem a little far-fetched if the tax authorities were to qualify such transactions as earnings from a trade or business (Einkünfte aus Gewerbebetrieb), this might, at the very least, be conceivable. Such a qualification would entail taxation at the personal income-tax rate of up to 47.5% (income tax plus solidarity surcharge and, where applicable, church tax).
In principle, however, it seems appropriate to apply the general principles to this special type of CFDs and future contracts, too, as the reference value should not be the key factor in forward transactions. Gains would thus be subject to the flat-rate tax. Unlike for the sale of crypto tokens held as private assets, a tax exemption for the sale of financial products after the expiry of the one-year period known as the "speculative period" (see sect. 23(1) sent. 1 no. 2 EStG) does not usually come into question. This would, however, need to be assessed differently — contrary to the view of the tax authorities — if there were a right to claim delivery of the respective underlying asset and if, in addition, this underlying asset were kept available by the issuer. At any rate, this is what the German Federal Fiscal Court held in the case of "Gold Bullion Securities" bearer bonds on 16 June 2020 (case no. VIII R 7/17).
Due to the large number of providers and conceivable structuring of crypto financial products, there are manifold product names, which are not binding for tax purposes. A case-by-case examination of the respective financial product is therefore indispensable.
II. New legal frameworkRegardless of the existing uncertainties in connection with crypto financial products, the tax situation for private investors has deteriorated significantly as of 1 January of this year. Losses from forward transactions may be offset against gains from forward transactions only up to a maximum amount of EUR 20,000 (sect. 20(6) sent. 5 EStG). Losses in excess of that amount, resulting from loss-making forward transactions, have no effect on taxable income in the year in which they were realized. While the losses that may not be offset in that way may be carried forward to subsequent years, they may – as discussed – only be offset against future gains from corresponding forward transactions and only up to EUR 20,000.
The new rules may lead to investors realizing an overall annual loss from forward transactions while still being subject to taxation with their profitable forward transactions of that same year. This is a major problem with crypto futures and crypto CFDs because the leverage effect described above and the high volatility in this asset class can result in faster gains and losses. If investors are not permitted to fully offset losses in a given year, there is a risk of significant excessive taxation.
Investor A realizes a large number of forward transactions in 2021. In total, profitable forward transactions resulted in realized gains of EUR 80,000.
The losses resulting from loss-making forward transactions amount to EUR 120,000.nThe total result from the forward transactions is therefore EUR −40,000.
For tax purposes, only losses of up to EUR 20,000 may be offset against the gains, which means that the taxable result is EUR 60,000. The tax charge is EUR 15,825 (flat-rate withholding tax plus solidarity surcharge and, where applicable, church tax) although, on balance, the investor has realized a significant overall economic loss – and within the very same investment class. Any losses that may not be used immediately may be carried forward and do not simply lapse. However, they can only be offset to a very limited extent against future gains (up to EUR 20,000), as set out above, provided that any such gains are generated in the first place and no further losses are incurred. Depending on the situation in subsequent years, an effective use of the losses is therefore possible to a very limited extent only (if at all).
The concept of the restrictions on the offsetting of losses was inserted into the EStG in December 2019, at that time still with an amount limit of EUR 10,000.
Since then, considerable constitutional concerns have been raised regarding the new rules, as already illustrated by the above example. Many assumed that the new rules, to be applicable as of 1 January 2021, would be repealed even before becoming effective for the first time. But that did not happen.
The increase in the permissible amount, under the restriction on the offsetting of losses, to EUR 20,000 acts like the often-quoted ›drop in the ocean‹.
The concerns under constitutional law remain.
Scope of application:
Commercial investors — including commercial partnerships and GmbHs (companies with limited liability) — are not subject to the aforementioned restriction on the offsetting of losses. As a possible alternative, it could therefore be considered to enter into forward transactions using business assets.
Although there is a similar restriction on the offsetting of losses for commercial investors (sect. 15(4) sent. 1–3 EStG), which stipulates that losses from forward transactions may only be offset against gains from such transactions,
there is no limit on the amount — unlike in the case of private investors (as set out above).
Nevertheless, the prerequisites for assets to be treated as business assets as well as the advantageousness for tax purposes must be thoroughly examined on a case-by-case basis.
III. OutlookIt is to be hoped that the existing concerns under constitutional law will lead to a change in the EStG in the near future. In addition, it would be desirable for uncertainties relating to crypto financial products to be removed by a statement from the tax authorities. Until then, investment decisions and possible investment structures must be examined carefully and on a case-by-case basis.
Owing to the concerns under constitutional law, any tax assessments in which restrictions on the offsetting of losses are applied to forward transactions should be prevented from becoming final and binding.