Tue, Aug 14, 2018 - Page 10 News List

Hedge funds face tax problem over bitcoin investing

Bloomberg

Dozens of hedge funds investing billions of US dollars in cryptocurrencies do not know if they are calculating their taxes correctly, which might be a problem now that US authorities have said they are going to be scrutinizing virtual currencies.

Just like individual taxpayers, institutional investors that have plunged into bitcoin, Ether and other digital currencies are finding there are few guidelines governing their holdings, and those that exist are murky.

As a result, many funds have tried to minimize their liabilities without really knowing what the rules are.

That could all come to a head later this year, following an announcement by the US Internal Revenue Service (IRS) last month that virtual currencies would be a focus of audits for its large business and international division.

The new batch of cryptofunds could face bigger tax bills, or even penalties.

UNCERTAINTY

“There is still a lot of uncertainty about how the IRS will come down on virtual currency,” said Clay Littlefield, a tax attorney for Alston & Bird in Charlotte, North Carolina. “There are some good arguments for why this analogy or that analogy should apply, but there’s not a lot there.”

Part of the problem stems from how slow regulators have been to define their views of virtual currencies. The IRS considers them to be property rather than currency.

The Commodity Futures Trading Commission (CFTC) says they are commodities, which could open up some tax advantages if the IRS agrees.

When the IRS added virtual currencies to its list of “compliance campaigns” last month, it said taxpayers with unreported transactions should correct their returns, but that it was not contemplating a voluntary disclosure program, which lets taxpayers limit their criminal and civil liabilities for breaking the rules.

In 2014, the IRS said virtual currencies would generally be treated as property for tax purposes.

Investors who traded bitcoin would need to report gains and losses the same way they would other property, as would cryptocurrency “miners” and others who got paid with it.

At that time, most bitcoin trading was done by small investors. In the past two years, more hedge funds have started trading cryptocurrencies, creating a new set of issues that the IRS has still left unaddressed.

Even after plunging 55 percent this year, bitcoin has a market capitalization of US$111.5 billion. Morgan Stanley estimated that investment firms launched 84 cryptocurrency hedge funds last year, which hold about US$2 billion in virtual currencies.

The burgeoning interest is leading some tax firms to devote increasing resources to sorting out the tax issues created when a hedge fund buys virtual currencies.

Seward & Kissel, a New York law firm that focuses on hedge funds, started a cryptocurrency practice last year and now advises more than two dozen cryptofunds, said Brett Cotler, one of the firm’s tax attorneys.

Many hedge funds hope that the CFTC’s view that many virtual currencies are commodities prevails. Some federal judges have also reinforced that the currencies should be treated as commodities over the past couple of years.

Funds often set up offshore vehicles in the Cayman Islands or other low-tax jurisdictions for investors who do not live in the US.

If the fund is operated correctly, income from trading commodities, stocks or other securities will not trigger the need for a US tax return or for foreign investors to pay US taxes.

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