i INTRODUCTION TO THE LEGAL AND REGULATORY FRAMEWORK
Blockchain in general and Bitcoin in particular have been discussed in Russia since 2008. The reaction of the Ministry of Finance initially was to prohibit cryptocurrency trade and to impose fines, as well as to equate Bitcoin with money substitutes, the use of which is contrary to the Constitution of the Russian Federation, which declares that the rouble is the only legal means of payment in the territory of Russia. However, as cryptocurrencies and particularly Bitcoin have gained popularity around the globe, the Russian authorities have altered their strategy.
Russia is now moving forward in dealing with cryptocurrencies and their legalisation. The development of legislation related to cryptocurrencies is dealt with by the Ministry of Finance, the Central Bank2 and an interdepartmental group at the State Duma3 that was specially created to draft bills on cryptocurrencies.
In March 2017, Prime Minister Dmitry Medvedev instructed the Ministry of Communications and the Ministry of Economic Development to consider the use of technology in the areas of public administration and Russia's economy in preparation for the Digital Economy programme,4 which forms part of the government's action plan for 2017 to 2025. Medvedev noted that blockchain is already used by a number of large banks and corporations, and by some states. The priority of the government, the expert community, businesses and public organisations is to analyse the prospect of using blockchain in public administration and the economy.
The Ministry of Economic Development prepared a bill that would permit trade in cryptocurrencies through digital exchanges that meet certain conditions, and that would also cover initial coin offerings (ICOs). Doing this, the Ministry of Economic Development says, will reduce the risk of fraud and make it possible to tax cryptocurrency transactions to support the state budget, although the use of cryptocurrencies in the Russian territory as a means of payment is not being suggested.
Cryptocurrencies will not be deemed as property rights, but rather as a whole new category of digital property rights. As the Prime Minister notes: 'Everything is changing very quickly and we need to have flexible legislation that sets some basic terms without interfering with the development of the digital space. Finding this balance is probably the most difficult task.'
There are still have many unsettled questions and disagreements between Russian institutions. The major problems of the blockchain sector in Russia are:
- the lack of a legal framework of an appropriate level;
- establishing standards and solutions for organising cross-border transactions;
- management infrastructure;
- security issues; and
- consensus protocols.
Legislative and regulatory initiatives have recently been adopted to solve these and other problems.
ii SECURITIES AND INVESTMENTS LAWS
The Ministry of Finance published a letter in October 2017 entitled On the Regulation of the Issue and Turnover of Cryptocurrency, in which cryptocurrencies are considered to be money surrogates, and are banned from release and introduction into the Russian territory in accordance with the Law on the Central Bank of the Russian Federation. The Ministry also noted that the legal definition of cryptocurrencies and their essence are not defined in the Russian legislation. The letter indicates that at the moment, the federal executive bodies and the Central Bank must monitor the circulation of money surrogates and assess the risks of their use for criminal purposes.
The qualification used by the Ministry of Finance makes the circulation of cryptocurrencies in Russia impossible, in principle, without adjusting the prohibition on monetary surrogates.
Russia plans to stop the participation of an unlimited number of individuals trading in cryptocurrencies, and giving such currencies the status of derivative financial instruments. This will lead to cryptocurrencies being legally circulated only among qualified investors in accordance with the legislation on the securities market. Obviously, this proposal has a narrow focus and will not cover all types of ICO projects. At the same time, it will negatively affect the structuring of ICO projects in Russia, since they use smart contract technology that involves the use of cryptocurrencies.
The government has highlighted that the rouble shall be the only legal payment means in the country. It has, however, agreed that transactions with digital currencies will be present. To lower the chances of abuse and to prevent transfers to uncontrolled spaces, the authorities have drafted regulations to develop a basis for digital currency taxation.
The President has instructed that changes be introduced in the legislation that will legalise the use of blockchain technology and smart contracts, and the mining and circulation of tokens, as well as to determine the taxation and other requirements of participants in relation to these. However, there are no recommendations or starting points for the instructions, and the government and the Central Bank will have to independently develop a consolidated position, which may be fraught with difficulties.5
In May 2018, the State Duma adopted in the first reading several draft laws that could become the basis for regulating the digital (virtual) economy: the draft law 'On digital financial assets' (DFA), the draft law on crowdfunding6 and the draft law 'On amending the Civil Code of the Russian Federation'. The draft law on mining7 has also been submitted to the State Duma. (For a discussion of the draft law on mining, see Section VI.)
i Key project provisions
The draft law 'On digital financial assets' introduces a list of key concepts for cryptoeconomics, including cryptocurrencies and tokens, combining them under the general name of digital financial assets.
A digital financial asset is understood to be property in electronic form created using encryption means, the ownership of which is certified by making digital entries in the register of digital transactions. It is separately stated that a DFA is not a legal means of payment in Russia.
The distinction between a cryptocurrency and a token is made according to three criteria:
- the method of accounting: a cryptocurrency can be taken into account only in the distributed registry. In the case of tokens, the registry properties are not specified;
- the issuer: a token is issued by a legal entity or individual entrepreneur, while a cryptocurrency is created by an undefined set of network members who support the work of the distributed registry; and
- the objectives of creating an asset: tokens are issued to attract financing. The purpose of creating a cryptocurrency is not specified.8
While the bill pays much more attention to tokens than cryptocurrencies, it does not directly answer the question of whether a token is a security, and if so, which one.
It can be noted that this project looks conceptually undeveloped. Its main drawback is that it does not correlate with the current legislation (civil and tax legislation, securities market legislation and legislation regarding organised trades). The initiative to protect investors seems sound, but the proposed provisions are inflexible (restrictions on the amount of investments for unqualified investors, an obligation to perform operations through an exchange operator) and ignore the level of technology development (they assume the transfer of a private key from a digital wallet to a third party). Such restrictions can harm the market, making it impossible to implement many projects. In addition, many projects that are already functioning will either have to significantly change their business model (e.g., obtaining the status of an exchange operator of a DFA) or withdraw from the jurisdiction.
The bill on crowdfunding actually fixes at the legislative level the already established practice of attracting financing to commercial projects. It is proposed that:
- operators of investment platforms are to be included in the specialised register of the Bank of Russia; and
- requirements be established for them regarding the size of their own funds (at least 5 million roubles), as well as regarding, inter alia, their management bodies and beneficiaries, the disclosure of information, the availability of a reliable register of contracts concluded on a platform, and the location of main and reserve data centres (both main and reserve data centres shall be located only on the territory of Russia).
To protect investors, there are requirements for operators of investment platforms regarding identification, and restrictions on the amount of investments during one calendar year: no more than 50,000 roubles for one investor in one investment project, and not more than 500,000 roubles for all investment projects. In turn, a person can attract no more than 200 million roubles of investment within a calendar year. Compliance with these restrictions is the responsibility of the operators of investment platforms.
The bill provides that crowdfunding may be organised in traditional ways, in particular by providing loans, by acquiring securities or a stake in a company's capital, through entering business partnerships or partnerships, or by purchasing investment project tokens.
An investment project token is a record in the database of an investment platform that can certify the claim rights under various contracts. In particular, the bill provides for a model for the acquisition of investment project tokens that provide investors with the right to receive securities (either directly or through a brokerage model in which the agent is an investment platform operator).
Investment in crowdfunding projects can only be carried out by investing non-cash funds, which are credited to the nominal account opened to the operator of the investment platform. In the same way, payments are made in favour of investors by the persons attracting investments (except for transfers of income and payments on securities). We believe that in this way, projects eliminate the risks of operators of investment platforms related to the qualification of such activities as banking activities.
The draft law on crowdfunding also proposes amendments to other legislative acts related, inter alia, to advertising. The advertising of investment platforms the participants of which can only be qualified investors as well as the advertising of conditions for investing in investment projects is not allowed. In addition, advertisements of the services of operators must contain a warning that the proposed contracts 'are high-risk and may lead to the loss of the money in full'.
The projects under consideration have been prepared and published by various entities. The subject of regulation and the scope of these projects overlap to a significant extent and, in the case of the draft law 'On digital financial assets' and the draft law on mining, do not correspond to the projects stated in the texts themselves: these circumstances clearly indicate the inconsistency of the texts and a lack of coordination on the part of the entities that prepared them.9
Among the fundamental imperfections of the draft laws, three especially can be noted:
- The amendments have no independent meaning, since they refer entirely to special legislation. The bills create only rules for the circulation of digital rights and money in the case of their emergence by virtue of the provisions of that special legislation. Russia's current regulations provide a framework in the absence of special laws in this regard having been implemented.
- Controversial from a conceptual point of view is the introduction of new legal entities, although from the very concept of digital rights it follows that this is not a matter of fundamentally new objects of civil rights, but only a charging method for such rights. What certifies these rights (records), according to the idea of the authors of the bill, is recognised as a right, can change the rightholder, and be subject to orders, encumbrances and restrictions. In this regard, the draft laws on digital financial assets look more convincing, since they recognise fundamentally new objects of rights (or do not confer any rights).
- The bills do not correlate with other initiatives that are likely to form the basis of the special legislation to which the bills refer: their developers did not introduce the general concept of a digital asset. Instead of tokens and cryptocurrencies, digital rights and digital money are spoken about; instead of the register of digital transactions, the bills speak about the 'information system' (a definition of which is not disclosed at all, and the explanatory note just refers to future amendments to the Law on information technologies and protection of information10).11
Direct instructions in the law for cryptocurrencies should be beneficial for businesses, which are currently experiencing great difficulties due to a lack of clear explanation in this regard by the regulators and the existing judicial practice: operations with cryptocurrencies are periodically associated with the release and turnover of money surrogates and the commission of transactions that are banned by the law on combating the laundering of money obtained by criminal means. In general, this approach is balanced by the more pragmatic view of the Federal Tax Service of Russia, which already provides (in general form) explanations on the taxation of operations with cryptocurrencies for both individuals and legal entities.
Meanwhile, it is already clear that the proposed regulation of many issues does not correspond to business practice, and therefore its application will be either impossible or ineffective.
In conclusion, none of the bills that have been proposed as a basis for regulating cryptocurrencies in Russia addresses the issues of accounting and tax accounting of digital assets, or considers details of foreclosure on digital assets in the framework of enforcement proceedings, or the features related to their issue and turnover. The current version of the proposed regulations is unlikely to cover the basic practical issues facing investors and internet projects, thereby casting doubt on the attractiveness of the Russian market.
iii BANKING AND MONEY TRANSMISSION
Cryptocurrencies in Russia are in a legal vacuum. Operations using them are not regulated, and the regulators and state bodies still cannot decide whether to allow operations with them or to prohibit them. Therefore, it is still difficult to transfer an amount from a cryptocurrency to a fiat currency in a bank account.
Since Russia does not yet have a single law on cryptocurrencies and their status, banks make decisions based on the Law on Currency Regulation and Currency Control, and on letters of the Central Bank, the Tax Service and the Ministry of Finance. Crucially:
- the current legislation does not prohibit the use of cryptocurrencies;
- the use of cryptocurrencies is a ground to check whether such use involves money laundering and the financing of terrorism;
- the Bank of Russia warns against the exchange of cryptocurrencies for goods, services or fiat currency;12
- the regulator does not prohibit citizens from investing in cryptocurrencies, but points out that it is a big risk and, in the event of any problems, that it will not be able to help;13
- the Federal Tax Service considers the purchase and sale of cryptocurrencies to be currency transactions that must be carried out through residents' accounts opened with authorised banks;14 and
- the Federal Tax Service may request information from the Federal Financial Monitoring Service (Rosfinmonitoring)15 about the purchase and sale of cryptocurrencies, although the procedure for monitoring transactions is not prescribed in law.
Banks do not like payments where the source of funds is a cryptocurrency. Focusing on the position of the Central Bank and the Law On Money Laundering and the Financing of Terrorism, they can suspend any such operations. Such transactions are automatically considered potentially suspicious, especially if the source of the money is received from abroad.16
If a bank is unsure whether a source of money is legal, it can block an account, and freeze or cancel a specific transaction without warning, and the restrictions will remain in force until the account holder documents the source of the funds.17
A bank will inform Rosfinmonitoring about such blocking, and the money in question will be transferred into a transit account. Money will only be sent back or transferred to a main account from such transit account following an investigation. Rosfinmonitoring may require clarification about such matter, and money is often frozen for 30 days while proceedings are under way.18
It cannot be known in advance whether a bank will block a payment. Each bank has a financial monitoring service that controls turnover of accounts and prevents the legalisation of illegal money. Banks cannot transfer amounts over 15,000 roubles without customer identification, and they are required to check each transfer of over 600,000 roubles. In addition, each bank has its own limits on transfers from card to card (usually no more than 50,000 to 100,000 roubles per day).
This leads to a vicious circle: if a person transfers money without specifying the payment, a bank will suspect that account holder of money laundering and terrorist financing. If the account holder honestly points out that the money was received from the sale of a cryptocurrency, the bank can still see this as an attempt to launder money, and can block the account and transfer the case to Rosfinmonitoring. Cashing is the main thing that banks and Rosfinmonitoring pay attention to, and it is impossible to predict in advance what amount will raise a bank's suspicion. Suing banks for illegal blocking because of the use of a cryptocurrency is difficult due to an absence of regulatory mechanisms.
iv ANTI-MONEY LAUNDERING
According to information on the use of cryptocurrencies issued by Rosfinmonitoring, the processes of the issuance and circulation of cryptocurrencies are completely decentralised, and there is no possibility of their regulation. The key features of using cryptocurrencies are the anonymity of users, and that there is no maintenance of special reporting documentation.
The above circumstances, and primarily the anonymity of payments, may lead to the active use of cryptocurrencies in the trading of drugs, weapons and counterfeit documents, and in other criminal activities. These facts, as well as the possibility of uncontrolled cross-border transfers of funds and their subsequent cashing, present a high risk of potential involvement of cryptocurrencies in schemes aimed at the laundering of proceeds from crime and the financing of terrorism.19
It should be noted that the absence of a controlling centre for systems of cryptocurrencies means it is impossible to appeal against or cancel an unauthorised transaction, while the fact that cryptocurrencies fall outside the legal field does not provide an opportunity to implement legal mechanisms to ensure the fulfilment of obligations by the parties to a transaction. For example, if a payment is made, but the service or the goods that have been paid for are not received, then there is no guarantee of the return of such payment. By undertaking an analysis of the possible interest of the criminal world in unsecured assets with a large range of volatility, it can be noted that the legalisation of digital money and of transactions using them will help to reduce the risk of unreasonable attention on the part of the competent state bodies for bona fide economic entities.
Despite the absence of a ban on conducting transactions with cryptocurrencies, one should be prepared for the attention of Rosfinmonitoring, the tax authorities and law enforcement agencies, as the mechanism of interaction between the state and subjects of digital transactions remains unresolved.
Transparent accounting could be the most logical way to deal with government agencies. Order of the Ministry of Finance of 10 December 2002 No. 126n 'On Approval of the Accounting Regulation' allows cryptocurrencies to be accepted for accounting under existing paragraphs.20
The most important part of the legalisation on cryptocurrencies is the preservation of the attractiveness of cryptocurrencies as assets, which is threatened by possible integration into the system of fiat money, dependence on the discount rate and the actions of the regulator.
Regarding the benefits of legalisation, it is possible to highlight the provision of judicial protection by consolidating the status of cryptocurrencies in the Civil Code of the Russian Federation: this should be considered as a general large-scale reduction in the risk of the loss of assets.
v REGULATION OF EXCHANGES
According to the media, the first Russian crypto exchange will possibly be established at the end of 2018, and will be located in a special economic zone. Initially it will be operated by one state-owned bank, but subsequently the number of partners may increase.21 The crypto exchange will pay all necessary taxes according to the law. Authorisation could be made through the Public Service Portal,22 and only citizens of Russia will have access. There will be a limit on the input–output of funds for individuals and legal entities of no more than 600,000 roubles and 10 million roubles a month, respectively.
The only currencies that will be traded to begin with are Bitcoin, Ethereum and (possibly) a cryptorouble. The operator of the exchange will become a large state-owned bank that conducts anti-money laundering and know your customer procedures.
There are not many state-owned banks in Russia that could operate the national crypto exchange. It is known that Sberbank23 launched a research blockhouse laboratory at the beginning of the year, and that it is also going to introduce the Ethereum platform into the real business sector.
The government's idea is to create a crypto exchange for Russian miners on which they could convert extracted assets into a traditional currency. The draft law 'On digital financial assets' already provides for the possibility of carrying out such operations with cryptocurrencies at organised auctions.
According to the Deputy Head of the Ministry of Finance: 'Our approach is that transactions with cryptocurrencies should be as much as possible inscribed in the current regulation. Now there is a licence of the auction organiser, which is given by the Bank of Russia – they are at the Moscow stock exchange, the stock exchange of St. Petersburg – and there are no specialised exchanges or special regimes for trading cryptocurrencies.' However, he does not exclude the possibility of creating a separate exchange site for miners: 'We offer the possibility of buying and selling currency against each other and to the currencies of any exchange, either specially created, or any other.'
The adoption of bills on the regulation of the crypto industry has been delayed owing to the lack of consensus on this issue among government agencies and working groups. One open topic is control of the activities of crypto exchanges, which has so far been confined to unified standards. This issue is important, as the draft law 'On digital financial assets' states that unqualified investors will be able to exchange virtual currencies only through a special account of an exchange operator.
The Russian Association of Cryptocurrency and Blockchain (RACIB)24 has already started monitoring the Russian market, identifying fraudulent projects and creating a register of reliable companies. The list includes not only projects directly working with a cryptocurrency, but also organisations that help in the preparation and promotion of primary placements and provide advice in this area. To enter the white list, a company must agree to check financial indicators and the existence of tax debts; have the necessary permits, experience and reputation; and confirm the absence of legal proceedings. To date, only 52 organisations have been included in the register. Perhaps, with the help of such initiatives, the government plans to further regulate the crypto industry.
Despite the fact that classical methods of regulation are not always applicable to the sphere of virtual currencies, the text of the existing draft laws states that the operator of the exchange will be a legal entity that has received a licence in accordance with the requirements of the Federal Law 'On Organised Tenders' and works within the norms of the securities market. However, the experience of other countries shows that with this issue, it is necessary to be flexible and to create special requirements to take into account the specifics of the crypto sector.
vi REGULATION OF MINERS
Another draft law in the sphere of the regulation of cryptocurrency assets is the draft law 'On the system of distributed national mining', which has been submitted to the Parliament. This document attempts to regulate the use of computing power for mining, but not of any cryptocurrency, but rather a national digital asset, the cryptorouble, which will be given the status of a legal means of payment throughout the country. The cryptorouble is a digital financial asset that has circulation and is a legal means of payment in the territory of the Russian Federation.
An authorised bank will participate in the structuring of mining regulations. Its powers will include operations for transferring funds to nominal and ordinary accounts on behalf of the participants in the process on the basis of entries in the distributed register. Under the main goal of the adoption of this bill, it is necessary to countercheck illegal activities and the sponsorship of terrorism.
However, this bill does not solve the problem of the mining of all other cryptocurrencies, which are in great abundance on the domestic market regardless of whether the public authorities recognise them or not: that is, the bill only deals with regulating a single cryptocurrency under the control of the state. Meanwhile, it is also not entirely clear how the state will monitor the activities of a large number of miners for which the cryptorouble shall become a legal payment means, and if it is entirely possible to reach a compromise by legalising their turnover as assets that can be the object of various civil transactions.25
Many Russian companies are forced to go under the jurisdiction of other states to deal with cryptocurrencies. For example, Sberbank, owing to the lack of legal regulation, began trading in cryptocurrencies through its subsidiaries in Switzerland, where it creates special financial instruments. In this regard, the Ministry of Communications has prepared legislative acts under which it plans to allow the mining of crypto-loans to companies and individuals. The Ministry of Communications suggests creating a special system for detecting miners to correlate the capacity of their mining equipment with the amount of a cryptocurrency that the user declares on the Russian crypto exchange. Miners will be identified by monitoring electricity consumption and internet traffic. Undoubtedly miners are entrepreneurs, since they produce cryptocurrencies truly on an industrial scale, using a huge amount of energy resources and computing power. In the absence of legal regulation, courts in the resolution of individual disputes also qualify mining as an entrepreneurial activity, since it is impossible to attribute it to an occupation related to personal needs.26
The Agreement between the governments of the Russian Federation, the Republic of Belarus and the Republic of Kazakhstan dated 18 June 2010 'On the procedure for the movement by individuals of goods for personal use across the customs border and the commission of customs operations associated with their release' fixes the criteria for determining the purpose of using the goods being moved.
Violators can be held accountable for their failure to fulfil the obligation to declare goods for mining (video cards, power supplies, and other technical equipment with a large capacity designed to execute software codes, store information, and serve users and databases (mining farms)), and for paying the customs fees and other payments due.
Part 1 of Article 16.2 of the Russian Administrative Code provides for administrative liability in the form of a fine for non-declaration in accordance with the established form of goods subject to customs declaration, except in cases of non-declaration or inaccurate declaration of money and monetary instruments. Between one-half and two times the value of goods will be the subject of such administrative offence (with or without the goods' confiscation or the confiscation of objects of an administrative offence), and a fine of between 10,000 and 20,000 roubles may be imposed on officials.
The widespread popularity of mining has led to a variety of proposals regarding the matter from, inter alia, entrepreneurs who make money on the sale of video cards and special mining equipment, and owners of commercial real estate leasing large areas for the organisation of farms for the production of cryptocurrencies.
There are, inevitably, miners who are scammers that connect to other people's computers and smartphones without authorisation in order to use their potential. Owners of such equipment should be especially vigilant, and install special antiviruses to suppress such threats.
Massive electricity bills have forced the owners of mining farms to find alternative ways of extracting cryptocurrencies: there have been cases of placing such farms in the trunks of electric cars, which can be charged for free at some petrol stations.
One of the most common crimes in the field of computer technology is the launch of malicious programs to hack into other people's computers, mobile devices and other gadgets to gain access to personal authorisation data, which makes it possible to mine cryptocurrencies. Article 273 of the Criminal Code of the Russian Federation provides for criminal liability for the creation, distribution or use of computer programs or other computer information designed for the unauthorised destruction, blocking, modification or copying of computer information, or for neutralising computer information protection facilities. This Article covers the illegal actions of miners who extract cryptocurrencies at another party's expense.
vii REGULATION OF ISSUERS AND SPONSORS
The situation regarding ICOs in Russia is rather complicated. One of the most worrying of the RACIB's statistics is that around half of the ICO funds in the country that were raised in 2017 – amounting to US$300 million – have gone into pyramid schemes.
Economic and political uncertainty, together with numerous corruption scandals, have severely dented investor appetite for virtual currency projects in Russia. Such investing is seen very much as a high-risk, high reward-based game, and, when combined with the volatile nature of virtual currencies, this perception is unlikely to change any time soon.
In May 2018, Moscow hosted one of the largest cryptocurrency summits of 2018, with over 200 speakers and over 3,000 participants taking part in the event. The decisions that will be made by the government need to be made in the spirit of blockchain development and with the aim to further technological, as well as economic, advancements, as opposed to being a means to destabilise the US dollar.
Many working groups have been established in Russia to draft bills on ICOs and cryptocurrency regulation. Their opinions differ from 'all is forbidden' to 'everything is resolved'.
Despite the fact that there are already examples of successful ICO companies that build real businesses and pay taxes (such as LavkaLavka (a farmers' cooperative), a zirconium plant) in Russia, there is no legal connection between these companies and their ICOs, as no company can conduct an official ICO in Russia. In addition, if a company gains some money related to a cryptocurrency in its account, a bank can monitor this, and this money will be the last payment that is accepted by that company in that bank. If the focus of the bank is repeated, this will be the last settlement account that the company will be able to open in the territory of Russia.
The law should be permissive in order to create conditions under which cryptoeconomics can peacefully and legitimately exist in Russia, and so that companies can register here, open accounts, pay taxes and use Russian infrastructure. If the law continues to be prohibitive, nothing will change: companies will simply register in other jurisdictions. Today's situation offers Russia zero advantage.
The establishment of clear regulation will seriously improve the market. Once the legal field for ICOs is established, professional investors will start to come to the market more actively, and the number of frankly weak or fraudulent projects will decrease in time.
Owing to the growing number of ICOs, investors will continue to seek a third point of view in the form of an external audit, which function is today filled by market rating agencies: independently tracking all projects in order to not miss potentially beneficial ICOs is hardly possible. At the same time, we note that most companies that conduct ICOs can count on gaining not tens of millions of dollars, but considerably less: an understanding has already been formed that a company does not need US$50 million or US$150 million to develop and output a quality product to the market.
The question of taxes on cryptocurrencies in Russia so far remains unanswered. Individuals who have received income in some form must pay personal income tax. A Ministry of Finance letter of 13 October 2017 states that there is no special taxation procedure for cryptocurrencies, and that income tax must be paid according to general rules.
The Ministry of Finance confirms the absence in the Tax Code of the Russian Federation of a special procedure for taxing income when performing transactions with Bitcoins. At the same time, the Ministry indicates that, according to Article 41 of the Tax Code, income is recognised as an economic benefit in cash or in kind that is taken into account when it is possible to assess it and to the extent that such benefit can be assessed. However, the Ministry does not comment on the possibility of accounting for any expenses by taxpayers when determining the taxable base for income from operations with Bitcoins.27 The issue of accounting for expenditures (e.g., the cost of purchasing cryptocurrencies and commissions paid to trade organisers) for such transactions is not unambiguous. In the absence of a special taxation procedure and uncertainty of cryptocurrencies' legal nature, consideration of any expenses can be challenged by the tax authorities. In practice, when submitting a declaration of income from the sale of a cryptocurrency, misunderstandings of employees, bureaucracy and potentially legal problems may be encountered.
As the Ministry of Finance notes, the provisions of the Tax Code apply to taxation of all income received by a taxpayer in the conduct of profit-making activities. Thus, when receiving a cryptocurrency as a counterpart in a sale of goods (works, services), the taxpayer recognises income on an accrual basis in the same manner as it would for other transactions for consideraation. Despite the fact that cryptocurrencies are not qualified as an object of civil rights, the Ministry of Finance has indicated that operations with cryptocurrencies lead to the formation of income in cash or in kind, which actually equates cryptocurrencies with the already existing objects of taxation.
After the adoption of the law on cryptocurrency, it is likely that some clarifications will be required regarding the tax legislation: to date, nothing precise has been determined.
For the purposes of personal income tax, the full amount will be subject to taxation:28 that is, the received rouble amount will be included in the tax base. It would be logical to always consider such revenue as revenue from sources outside Russia. Thus, it would be taxed only for Russian tax residents, and would be taxed externally only for tax residents of foreign countries.
If a natural person receives Bitcoins free of charge from other persons, then there is an income in kind, which for tax purposes should be valued at market prices.29 However, in certain cases such income is not subject to taxation on the basis of the Tax Code. If a legal entity receives Bitcoins free of charge, then taxation should occur by analogy with cases of gratuitous receipt of property that is not depreciable. The income is the determined by the market value of the received property.30 It will not be included in the tax base if it falls under the conditions specified in Sub-clause 11 Paragraph 1 of Article 251 of the Tax Code, inter alia, if the property is received from a participant with a stake of more than 50 per cent and it is not transferred to third parties within a year of receipt. Theoretically possible by using Sub-clause 3.7 Paragraph 1 of Article 251 of the Tax Code, it is unlikely that anyone will want to contribute to the property of an economic company by using Bitcoins.
Changes in the Bitcoin rate should not be taxed, since this is not directly stipulated by the Tax Code. Foreign currency that is available to an organisation is revalued at the end of a month and on the date of the transaction, and there are exchange differences that are recorded for tax purposes.31 The determination of exchange rate differences speaks directly about currency values expressed in a foreign currency, but says nothing about assets such as cryptocurrencies. Therefore, there is no reason to take into account changes in their rate in the tax base, especially since there is no official state stance on the matter, and it is difficult to determine the market rate by a specific value (since cryptocurrencies have no single physical location, there is no source for its determination). For example, a revaluation of fixed assets is also not taken into account for tax purposes.
Regarding VAT, this will need to be assessed only if a sale falls under the definition of an object of taxation, and that corresponding definition is tied to the place of sale.32 A cryptocurrency cannot have a physical location, so these norms do not apply to it. If Bitcoins are used as a payment means for goods (works, services), then have they been implemented? The definition of implementation is based on signs of the transfer of ownership.33 When exchanging a cryptocurrency for goods (work, services), ownership of it as property passes to the counterparty, so if the cryptocurrency is treated as property, then there will be an exchange (or barter) and this is the realisation of its implementation.
As such, everything goes to the fact that operations with cryptocurrencies should be taxed. However, it is still unclear how the receipt of revenue in the form of a cryptocurrency or cryptocurrency mining are supposed to be tracked. It would be logical to include sales of cryptocurrencies or their use as a means of payment in the number of transactions that are not subject to taxation. The implementation of transactions related to the circulation of Russian or foreign currencies is not recognised as an object of VAT taxation,34 so applying a similar approach to cryptocurrencies would make sense.
ix LOOKING AHEAD
The appearance of cryptocurrencies and their circulation are subjects of interest to state financial control bodies, and an effective mechanism for their legal regulation needs to be created in Russia.
Cryptocurrencies are unreliable means of payment not guaranteed by the Bank of Russia: operations with cryptocurrencies are made outside the legal field, and the Bank warns participants in the financial market about the increased risks inherent in the use of virtual currencies, declaring that 'the premature admission of cryptocurrencies, as well as any financial instruments nominated or associated with cryptocurrencies, into circulation and use at organised trades and in settlement and clearing infrastructure in the territory Russian Federation' is problematic.35
The risks inherent in the circulation of cryptocurrencies include:
- the issuance of cryptocurrencies is carried out by a large number of anonymous subjects;
- according to Federal Service for Financial Monitoring information, due to the decentralised release of cryptocurrencies, there is no entity that will ensure their solvency; and
- there are risks in the performance of exchange transactions regarding securing rights to virtual currencies, which can lead to financial losses for individuals and legal entities and, most importantly, an inability to protect and restore violated rights.
However, not recognising or even banning virtual currencies also has risks that are perhaps even more serious. In Russia, one of the main goals of economic development is to strengthen the share of the business sector and increase the economic activities of the population. Under the conditions of the non-use of cryptocurrencies, business in this area is doomed either to operate 'in the shadows' or cease operations.
The increasing penetration of cryptocurrencies into Russian life is difficult to halt, and abandoning them could prove a backward economic step. It would be much more appropriate to begin adopting legislation to cryptocurrency use: only by giving cryptocurrencies official legal status will it be possible to limit and control their turnover.
To create an effective mechanism for legal regulation of cryptocurrencies in Russia, it is necessary to take into account the experience of foreign countries and apply their technologies, but with adaptations to Russia's economic and legal realities.
It is planned that cryptocurrencies will be regulated in the same way as securities. The emergence of professional participants in the virtual currency market is also expected, since cryptocurrencies are not the usual paper money, or even electronic money stored in bank accounts, and the very essence thereof is difficult to understand.
The basic bills mentioned throughout this chapter certainly do not take into account all the nuances of the circulation of cryptocurrencies, but in any case the legislative work on their legalisation has been initiated, which can only be welcomed. The turnover of cryptocurrencies in Russia is taking place regardless of attitudes to this phenomenon on the part of the courts, other law enforcement agencies and the state as a whole. In this regard, the delay in their legalisation and regulation is fraught with the fact that entrepreneurs will continue to be more loyal to the jurisdiction of a cryptocurrency when structuring their transactions.
In the expert community, views have been expressed on the need to expand preferences in Russia for entrepreneurs working with cryptocurrencies, for example, by optimising taxation and other benefits; however, entrepreneurs are unlikely to count on these, because as a first stage in introducing legal regulation of digital assets, the financial regulators will actively monitor this segment, and only when the results of such supervision are known will it be possible to sum up the intermediate results and determine the prospects for further developments.
1 Maxim Pervunin is the managing partner and Tatiana Sangadzhieva is a lawyer at TFH Russia LLC.
2 The Central Bank of the Russian Federation (Bank of Russia) has a special legal status and the exclusive right to issue currency, protect the rouble and ensure its stability.
3 The State Duma is the lower house of the Federal Assembly of Russia (Parliament) which is the legislature of the Russian Federation.
4 The Digital Economy programme was approved by the government in Resolution No. 1632-r dated 28 July 2017.
5 E V Voskresenskaya, 'On the Need for Legal Regulation of Virtual Currencies'.
6 Draft law 'On Alternative Methods of Fundraising (Crowdfunding)'.
7 Draft law 'On the system of distributed national mining'.
8 Deloitte News: 'Decryption: ICO News and Cryptoeconomics'.
9 Deloitte News: Decryption: ICO News and Cryptoeconomics.
10 Federal Law on information, information technologies and protection of information N149 FZ dated 27 July 2006.
11 Deloitte News: 'Decryption: ICO News and Cryptoeconomics'.
12 Information letter of the Central Bank dated 27 January 2014 'On Use Virtual Currency, in particular, Bitcoin'.
13 Information letter of the Central Bank dated 4 September 2017 'On Use of Private Virtual Currency (Cryptocurrency).
14 Banks that may carry out foreign currency transactions subject to a Central Bank licence.
15 Rosfinmonitoring is a federal executive body responsible for combating money laundering and terrorist financing, and developing and implementing state policies and regulatory and legal frameworks in this area.
16 Roman Yankovsky, partner at Zarcin, Yankovsky and Partners: 'Banks have black lists of requisites and stop words. They may believe payment to be from a suspicious source.'
17 Ibid.: 'either there are no such documents, or banks do not accept documents from stock exchanges and exchangers'.
18 Alexander Nektorov, partner at Nektorov, Saveliev & Partners.
19 Information letter of Rosfinmonitoring 'On Use of Cryptocurrency'.
20 O Rozhkov, 'Crypto in Law'.
22 The Public Services Portal of the Russian Federation provides data exchange and technological interaction of information systems used for rendering state and municipal services in electronic form.
23 Sberbank of Russia is the largest bank in Russia, whose founder and the principal shareholder is the Central Bank.
24 The Russian Association of Cryptocurrency and Blockchain is an association of developers, blockchain technology users and products for the development of digital economy.
25 Deloitte News, 'Decryption: ICO News and Cryptoeconomics'.
26 D Bondarchuk, 'Cryptocurrency, mining and smart-contracts are legalised. How will it affect legal work?'.
27 Letter of the Ministry of Finance dated 12 July 2018 N 03-04-05/48714.
28 Paragraph 1 of Article 210 of the Tax Code.
29 Item 1 of Article 211 of the Tax Code.
30 Clause 8 of Article 250 of the Tax Code.
31 Clause 11, Article 250, Sub-clause 5, Clause 1, Article 265 of the Tax Code.
32 Subparagraph 1 of Clause 1 of Article 146 of the Tax Code.
33 Paragraph 1 of Article 39 of the Tax Code.
34 Sub-item 1 of Clause 3 of Article 39 of the Tax Code.
35 A V Kurakin, D V Karpukhin, A R Shilina, 'Problems of Legal Regulation of Use of Crypto Currency in the Russian Federation'.