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Bitcoin is a peer-to-peer payment system and digital currency. It is a crypto currency, as it uses cryptography to control the transfer of money.

Bitcoins are created by a process called ‘mining’, in which users verify and record payments into a public ledger in exchange for transaction fees and Bitcoins. Bitcoins can be obtained by ‘mining’ or in exchange of products, services, or other currencies.

Globally the use of Bitcoins by speculators has grown, causing the price also to rise enormously. Bitcoins as a form of payment for products and services is becoming more and more popular for both traders as well as merchants, for whom it is a more cost efficient method as transaction fees are lower than the 2–3% imposed by credit card providers.

As regards to the legal status of the crypto currency Bitcoin, it is currently evolving rapidly around the world with some countries such as Thailand, Lebanon, India and Taiwan excluding Bitcoins, some countries such as Germany, Canada, Belgium, Denmark, Norway, Poland, Russia, Singapore and Switzerland stating Bitcoins are entirely legal, and other countries such as China limiting some uses of Bitcoins while stating others are legal.

There has been an increasing interest lately in Cyprus, in making payments with Bitcoins. Nevertheless the Ministry of Finance, Energy, Commerce, Industry & Tourism as well as the Central Bank of Cyprus warned of the dangers associated with buying, owning and trading with virtual currencies such as Bitcoins.

As an unregulated digital product, it can be used only for the exchange of goods within a limited network of merchants. The following risks connected with Bitcoins have been pointed out:

• The money may be lost, if the online trading platform collapses;
• Hackers may steal Bitcoins from any digital wallet;
• The value of Bitcoins fluctuates considerably;
• Virtual currencies may be used for criminal activities.
• The rapid growth of the use of Bitcoins has further raised concerns about the lack of transparency and the use for tax evasion and money laundry.

What is the tax treatment of Bitcoins?

There are two possible ways of how Bitcoins should be treated for tax purposes, either as (1) an intangible asset, or (2) a foreign currency. The problem with defining it as a currency is that it is not issued by a government, as traditional currencies are.

Canadian and Swedish tax authorities are treating Bitcoins as an asset. Also, the German Finance Ministry does not classify Bitcoins as e-money or a foreign currency, but rather as a financial instrument under German banking rules. Unless the Congress enacts legislation to treat Bitcoins as a foreign currency, they will further be treated as an asset by the Internal Revenue Service.

At this stage, in the UK there is 20% VAT on the purchase of Bitcoins providing for threats from UK-based traders wanting to move abroad as such a high VAT rate makes their businesses unprofitable. The HMRC is now considering alternative VAT solutions, such as excising VAT only on commissions charged by the crypto currencies’ trading exchanges.

In terms of the tax treatment of Bitcoins, income or gains arising from crypto currency transactions will be calculated for the tax payable. For Bitcoin investors, the sterling equivalent of gains made in any tax year, where exceeding the annual capital gains tax allowance of £10,900 (2013/14) will be charged 18% - 28%.

Bitcoin miners and online traders accepting Bitcoins for products and services will be taxed upon their profits.

Internet gamblers using Bitcoins should be exempt from UK taxation because HMRC doesn’t regard gambling and betting as trades. However, internet gamblers maintaining crypto currency stockpiles will be chargeable to UK capital gains tax on the sterling equivalent of gains in their stockpiles.

For UK tax residents the current tax rules provide a reasonably clear framework for Bitcoin transactions in contrast to individuals not UK domiciled, for which the situation is less clear due to legal uncertainties on where Bitcoins are actually situated and/or traded.

Once the VAT position of Bitcoins is resolved, the UK could be one of the first countries to maintain a consistent tax framework for Bitcoin transactions. The HMRC will then be expected to circulate guidance informing those using crypto currencies to declare their tax liabilities. A point of consideration for the HMRC might be the secrecy of the internet being a real problem for tax evasion.

Similar to the UK, the Japanese government indicated that Bitcoin transactions will be taxable when used to make purchases or when bought on an exchange, fulfilling requisitions on income tax, corporate tax and consumption tax laws.

Japan's cabinet stated that Bitcoins will not be treated as a currency and will not be under the country's Financial Services Agency, they will rather be treated as a commodity.

Tax authorities around the world seek to capture revenues from Bitcoins and minimise risks of tax avoidance and evasion. The value of the world’s stock of Bitcoin has currently risen from $150 million to $10 billion over the past year, adding urgency to regulators’ efforts to finally clarify its status.