The Government put before the State Duma a draft law on the taxation of digital rights

Pepeliaev Group advises that on 14 April 2022 the Government put before the State Duma a draft law (the “Draft Law”) on the taxation of digital rights (transactions with digital financial assets).

The Explanatory Note indicates that the establishment of a procedure for taxing these items is necessary for the effective functioning of the digital economy, for the robust implementation of digital projects and for the development of a competitive market of digital rights in Russia.

The Draft Law contains provisions about digital financial assets (“DFAs”) and digital rights which include both DFAs and utilitarian digital rights (digital assets).

We remind you that Federal Law No. 129-FZ [1], which regulates relationships connected with transactions with DFAs, stipulates the specific aspects of how an operator of an information system and a DFA exchange operator should work, as well as relationships connected with the circulation of digital currencies in Russia. According to this law, the category of DFAs comprises digital rights which include:

• monetary claims,
• a possibility to exercise rights under issuable securities,
• rights to participate in the capital of a non-public joint stock company, and
• a right to claim a transfer of issuable securities which are provided for by a resolution to issue DFAs.

At the same time, the law contains a definition of a digital currency which is separate from DFAs. Therefore, the Draft Law does not contain any provisions which regulate any issues of the taxation of digital currencies (cryptocurrencies).

For owners and issuers of DFAs

1. VAT

The Draft Law provides that the sale of DFAs will not be subject to VAT (article 149(2)(38) of the Russian Tax Code[2] (the “Tax Code”)). At the same time, separate regulation is provided for of transactions for the sale of digital assets (including both DFAs and utilitarian digital rights). The sale of them is subject to VAT and the tax base is determined as the difference between the sale price and the purchase price of such digital right taking into account the amount of tax (article 155(6) of the Tax Code).

2. Personal income tax

The Draft Law assumes that income from transactions with DFAs will be subject to personal income tax[3].

The specific aspects of how the tax base should be determined for transactions with securities are set out in new article 241.11 of the Tax Code. When the tax base is determined, income from the settlement and disposal of DFAs is taken into account, as are payments which are not connected with the settlement (including dividends and similar distributions).

The expenses include:

• the cost of purchasing the DFAs from the issuing party or under a sale and purchase agreement (as well as any expenses of the testator (grantor) if the DFAs were received in this way),
• fees for operators’ services (commissions, storage and so on), amounts on which tax was assessed and paid when the digital asset was purchased (received),
• other expenses directly connected with the purchase, storage, disposal and settlement of digital financial assets.

The tax base for transactions with digital financial assets will be the positive financial result.

DFAs received free of charge or for partial payment will be treated as income received in kind.

A negative financial result of transactions with DFAs will generate a loss. The carrying forward of losses received from transactions with digital financial assets is prohibited.

The procedure for paying personal income tax

The amount of tax on income received from transactions with DFAs will be determined and withheld by the tax agent (the operator of the information system or the exchange operator of the digital financial assets, who pays to the taxpayer income from transactions with DFAs, another source of the corresponding income (a Russian company or individual entrepreneur who is not an operator), or a nominal holder of the DFAs). It is proposed to regulate their activities connected with DFAs in article 226.2 of the Tax Code.

3. Profit tax

Amendments to article 271 of the Tax Code regulate the procedure and the period when profit can be acknowledged in the form of:

• monetary funds received by the party having issued the digital rights from the first owner of such digital rights;
• monetary funds received by the owner of the digital rights from the party having issued these digital rights when these digital rights are bought out;
• Profit received by the owner of digital rights which is not connected with the buying out of them;
• the amount of VAT deducted by the latest owner of the digital rights which include both digital financial assets and utilitarian digital rights.

The application of profit tax to profit from transactions with DFAs is similar to the taxation of profit from transactions with securities. Therefore, the basic approach is the taxation of profit when the financial result is received (the date when obligations discontinue under digital rights; the 10-year anniversary of the date of issue if the buyout period is not set or exceeds 10 years, and the date when the asset is paid for if no buyout is intended).

The monetary funds which are due for payment by the party having issued digital rights, except for payments connected with the buyout of these digital rights, will be included in non-sales expenses.

It is proposed to set out in new article 282.2 of the Tax Code the specific aspects of how the profit tax base should be determined.

For taxation purposes, no ongoing revaluation of DFAs should be carried out.

For companies that hedge risks

The Draft Law assumes that DFAs can be issued or purchased for hedging risks, specifically for reducing (compensating for) any consequences that are adverse for the taxpayer and are caused by:

• a loss,
• profit deficiency,
• reduced revenue,
• a decrease of the market value of property,
• an increase of the taxpayer’s liabilities caused by changes in prices, the interest rate or a currency exchange rate.

In such cases, transactions with DFAs are treated as hedging transactions according to the procedure set out in articles 301 and 326 of the Tax Code (forward transactions). This approach is likely to have a favourable effect on the development of the DFAs market.

For operators of DFAs

It is proposed to provide an exemption from VAT in Russia to:

• services of operators of information systems which issue DFAs and
• services of DFA exchange operators to admit digital rights to circulation in information systems.

The exception will be advisory services and services of providing rights to use computer software; these services will not be exempt from VAT.

Operators perform the functions of tax agents when personal income tax is assessed and paid, including sending a notification that it is impossible to withhold tax.

Also, if an operator does not perform the functions of a tax agent, it is obliged to submit annually to the tax authority information about individuals disposing of assets in its information system for each individual.

For those who are interested in cryptocurrencies

We remind you that according to the information from the Russian Government, the cryptocurrencies market in Russia is valued at RUB 10 trillion. In December 2020 the Government introduced draft law No. 1065710-7 on the taxation of digital currencies. The draft law was passed in the first reading, but there have been no further developments since October 2021.

At the same time, the Russian Ministry of Finance (the “Ministry of Finance”) was considering different matters connected with profit from transactions with cryptocurrencies even before this draft law. The general position of the Ministry of Finance is that income from the sale of cryptocurrencies (less expenses) should be subject to personal income tax on the basis of the general provisions of article 23 of the Tax Code[4]. At the same time, it is apparent that without introducing the corresponding obligations for operators and stock exchanges, it is almost impossible for tax authorities to keep track of income received from cryptocurrencies.

What to think about and what to do

Despite the fact that this Draft Law has just appeared, we have grounds to believe that it will be adopted very soon[5]. This means that, as early as at the beginning of 2023, operators will need to report transactions for the disposal of DFAs which were effected in 2022.

Both companies that are considering the possibility of issuing DFAs and individuals who are owners or potential owners of DFAs should take into account the provisions of the law which have been developed.

In our opinion, it is very likely that regulation of the taxation of income from cryptocurrencies will be finalised and adopted in the nearest future.

Help from your adviser

Pepeliaev Group's experts continuously monitor amendments of legislation in the sphere of DFAs and are actively developing experience of providing comprehensive business support in issues concerning compliance with legislation, the identification and assessment of legal risks, and the development of business-oriented proposals to minimise the risks identified.

Pepeliaev Group’s services include providing advice regarding compliance with the requirements of legislation in the sphere of the circulation and taxation of DFAs and preparing documents necessary for the issuance and circulation of DFAs.

[1] Article 1(2) of Federal Law No. 259-FZ “On digital financial assets, digital currencies and on amending certain items of Russian legislation” dated 31 July 2020.

[2] References to provisions of the Tax Code are provided in accordance with the amendments proposed by the Draft Law.

[3] For the purposes of personal income tax, DFAs include digital rights which certify both digital financial assets and utilitarian digital rights (article 210(8) of the Tax Code).

[4] Letters of the Ministry of Finance No. 03-04-05/74126 dated 26 September 2019 and No. 03-04-05/9243 dated 10 February 2022.

[5] It is expected that the law will come into force 1 month after it is published and will start to apply from the next tax period for the corresponding tax.