Cryptocurrencies are poised to become the currencies of the future. Distributed Ledger Technologies ("DLT") have the potential to disrupt every fabric of the society and yet, globally, regulation on cryptocurrencies and DLTs is still on its infancy. In this article, we will analyse the legal and tax considerations of cryptocurrencies under Cyprus law.
What is a cryptocurrency?
A cryptocurrency is a digital or virtual currency, designed as decentralized networks based on blockchain technology—a distributed ledger enforced by a disparate network of computers. Cryptocurrencies are secured by cryptography, making them virtually impossible to be counterfeited or to be double-spend.
A distinctive feature of cryptocurrencies, especially Bitcoin, is that they are generally not issued by any central authority, such as a Central Bank, and therefore they operate almost independent of any government interference or manipulation.
Cyprus regulatory developments and Cryptocurrency regulation
Cyprus has been closely monitoring the development of cryptocurrencies regulation globally and as a result, the Cyprus government has formed an ad hoc working group to develop and implement blockchain technology in Cyprus via a Council of Ministers' decision N. 85.629 dated 30 August 2018. The priority for its national strategy is the enactment of a legal framework in order to regulate blockchain and cryptocurrencies.
Currently, there is no legal or regulatory framework in force in Cyprus regarding cryptocurrencies, either directly for cryptocurrencies or making specific references to cryptocurrencies. There is however regulation of activities regarding companies who offer services related to cryptocurrencies and blockchain.
In Cyprus, the Prevention and Suppression of Money Laundering and Terrorist Financing Law, L188(I)/2007 (the "AML Law") was amended earlier this year through L13(I)/2021 (the "Amending Law"), in order to harmonize domestic legislation with the provisions of the 4thand 5thAML Directives (Directives (EU) 2015/849 and 2018/843).
The 5thAML Directive made several amendments to the 4thAML Directive (together the "AML Directives") effectively extending AML / CTF controls to:
- Providers of exchange services between virtual currencies and fiat currencies ("Exchange Providers"); and
- Providers of custody services for virtual currencies ("Custody Providers").
As a result of amendments introduced by the 5thAML Directive, EU Member States are required to ensure that Exchange Providers and Custody Providers are registered and that persons who hold management functions or are beneficial owners of Providers are fit and proper.
The Cyprus Stock and Exchange Commission ("CySec") has been designated as the competent supervisory authority overseeing and supervising compliance of Crypto-Asset Services Providers with AML Law.
It should be noted that the EU Markets in Crypto-Assets Regulation ("MiCA") is expected to come into force by 2024. MiCA will be directly applicable across all EU Member States and will potentially cover a lot of the same subject matter as the provisions that are discussed in this article.
Legal Definitions of Virtual Currencies and Crypto-Assets
The 5thAML Directive adopted following definition for "Virtual Currencies":
"a digital representation of value that is not issued or guaranteed by a central bank or a public authority, is not necessarily attached to a legally established currency and does not possess a legal status of currency or money, but is accepted by natural or legal persons as a means of exchange and which can be transferred, stored and traded electronically".1
In Cyprus, the Amending Law introduced a definition for "Crypto-Assets" as per below2:
"a digital representation of value that is not issued or guaranteed by a central bank or a public authority, is not necessarily attached to a legally established currency and does not possess a legal status of currency or money, but is accepted by natural or legal persons as a means of exchange and which can be transferred, stored and traded electronically and is not:
a) fiat currency; or
b) electronic money; or
c) a financial instrument as defined in Part III of the First Appendix of [L144(I)/2017]3.
Crypto-Assets as Financial Instruments or Electronic Money
The European Securities and Markets Authority's ("ESMA") Advice on Initial Coin Offerings4and the European Banking Authority's ("EBA") Report on Crypto-Assets5discussed how Crypto-Assets are legally qualified under EU financial services laws. Both papers provide summary of the consultations made with EU National Competent Authorities ("NCAs") as to how Crypto-Assets are legally qualified across the different EU Member States. Several NCAs, although not explicitly mentioned in the aforementioned papers, considered that in certain circumstances, Crypto-Assets can qualify as both financial instruments and/or electronic money.
In Cyprus, CySec and the Central Bank of Cyprus have yet to publish any guidance or directive as to when, in their view, a Crypto-Asset might constitute a financial instrument or electronic money for the purposes of the Investment Services Law or the national law implementing the Electronic Money Directive (Directive 2009/110/EC). As a result, we cannot for the time being consider how Crypto-Assets will be legally qualified in Cyprus in the near future.
Ownership of cryptocurrencies
There is no restriction or requirement under Cyprus law in relation to cryptocurrency ownership and therefore, in theory, cryptocurrencies can be owned by both natural and legal persons.
Taxation of cryptocurrencies
Cyprus law does not have any provisions as to how gains from cryptocurrencies are to be taxed, whether held by a natural person or by a legal person. There is no Capital Gains Tax ("CGT") on sales of shares or business assets except for capital gains on immovable property in Cyprus and shares in companies the assets of which consist of immovable property in Cyprus. Gains from trading and sales of shares listed on a recognized stock exchange are exempt from capital gains tax. As a result, if cryptocurrencies are to be treated as shares, and therefore titles, they could potentially fall under the same rule of sales of shares.
A potential trader interested to engage into trading of cryptocurrencies, could potentially consider the incorporation of a Cyprus Company and trade cryptocurrencies with an e-wallet opened and operated in the name of the Cyprus Company, where the corporate tax rate would be 12.5% on all income generated by the Company, without any tax applied on the dividends generated from the trading of crypto-assets.
The only other taxation that cannot be avoided in addition to the 12.5% corporate tax rate, is the General Health System taxation, that currently stands at 2.65% applicable on dividend income.
CySec, Central Bank of Cyprus and general banking industry concerns
Sale and purchase of cryptocurrencies is not without risks, and Cyprus regulators such as CySec and the Central Bank of Cyprus ("CBC") have repeatedly expressed their concerns as to the risks involved when trading cryptocurrencies.
CySec on 13 October 2017 has issued an announcement titled "Warning to investors on trading in virtual currencies" where it stated that "Trading on virtual currencies or on contract for differences ('CFDs') relating to virtual currencies is not suitable for all investors. These products are highly complex and as such investors must always make sure that are fully aware and understand the specific characteristics and risks regarding the trading on virtual currencies and/or trading on CFDs in relation to virtual currencies, including the risks of the venues on which such virtual currencies may be traded on.
Importantly there are no specific EU regulatory provisions that would protect existing and/or potential investors who trade on these products.
Trading on such products therefore comes with a high risk of losing all your invested capital. Also, the trading prices of virtual currencies and CFDs based on those values can widely fluctuate or become temporarily or permanently unavailable, therefore investors should trade carefully and only with funds that they can afford to lose."6
Similarly, the CBC on the 28 April 2021 has issued a statement according to which"As mentioned in the European Supervisory Authorities (i.e. the European Banking Authority, the European Securities and Markets Authority and the European Insurance and Occupational Pension Authority – jointly the "ESAs") announcement of February 2018, purchasers of cryptoassets are exposed to a number of risks including:
- extreme price volatility
- absence of legal protection due to lack of regulation
- lack of exit options from such transactions
- lack of price transparency
- operational disruptions exhibited in some virtual currency exchange platforms
- incomplete information made available to consumers wishing to buy virtual currencies."7
The banking sector in Cyprus, following the statements and guidelines issued from CBC has taken a cautious approach regarding proceeds generated from cryptocurrencies trading due to the fact that the sources of funds used for the acquisition of such cryptocurrencies, including the funds derived from the sale of such cryptocurrencies, is not transparent enough to meet the AML Law criteria, especially when the traders are natural persons using anonymous e-wallets. As a result, it is a common phenomenon banking institutions in Cyprus refusing to transfer funds to or accept funds from cryptocurrency exchange platforms.
On the other hand, companies enjoy a heightened level of transparency and diligence since they can engage in cryptocurrencies trading via a corporate e-wallet with funds deposited to their corporate bank account linked with such corporate e-wallet as well as a cryptocurrency exchange.
Footnotes
1 Article 3(18) of the 4thAML Directive
2 Section 2 of the AML Law
3 L144(I)/2017 (the "Investment Services Law") transposes the Second Markets in Financial Instruments Directive, Directive 2014/65/EU, ("MiFID II") into domestic law. Note that the definition of "financial instruments" in the Investment Services Law effectively adopts the definition of "financial instruments" in MiFID II.
4 https://www.esma.europa.eu/sites/default/files/library/esma50-157-1391_crypto_advice.pdf
6 https://www.cysec.gov.cy/CMSPages/GetFile.aspx?guid=4436a24d-05f5-4290-9008-e17d345b99f6
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
