I INTRODUCTION TO THE LEGAL AND REGULATORY FRAMEWORK
Although most activity related to cryptocurrency is provided for in some way by Russian legislation, the draft Law on Digital Financial Assets, which will specifically regulate actions related to cryptocurrency in Russia, is at its third reading and has not yet been passed. Its enactment, which is expected in 2019, has been further slowed by the need for the legislation to comply with Financial Action Task Force (FATF) recommendations. It is expected that any activities not expressly authorised in the law will be unlawful and subject to penalties.
It is also expected that Russian citizens will be prohibited from owning Bitcoin unless it is purchased at foreign exchange and sale points, under foreign law. Trading Bitcoin in Russia will not be permitted. In its current form, the draft law contains no statutory definitions of 'token', 'cryptocurrency' and other terms that featured in previous versions.
II BANKING AND MONEY TRANSMISSION
Russia's Central Bank is opposed to the introduction of cryptocurrency in the country.2 However, it is contemplating introducing a state cryptocurrency.
Prompt legislative action was prevented by a poor understanding of the very essence of blockchain tools. The policy of the Central Bank is ambiguous and in some places even contradictory. At first, the Central Bank opposed 'money substitutes' and was against introducing digital coins into the monetary system; however, it has since acknowledged the possibility of launching an official cryptocurrency. Business interest in virtual money is explained by the fact that using it helps to reduce transaction costs. The Central Bank intends to study a proposal to create a cryptocurrency linked to the price of gold, which could be used for mutual settlements with other countries.
The Central Bank will regulate all operations related to cryptocurrencies. In March 2019, it sent a draft instruction to the State Duma for discussion in which it proposes to limit the annual amount of cryptocurrency assets available for purchase to unqualified investors.
It is assumed that transactions will be limited to:
- the amount of money transferred as payment;
- the total value of digital assets that are exchanged; and
- the cost of digital operational characters transferred in exchange, including cryptocurrencies (this is only about cryptocurrencies that can be issued in Russia within the framework of a future law).
When exchanging digital assets, the transaction amount will be calculated on the basis of their nominal value.
The specific threshold of the Central Bank will be determined separately, but it will probably correspond to the maximum annual amount determined for unqualified investors by the Crowdfunding Bill (600,000 roubles).
Professional securities market participants will not act as intermediaries, but exchange operators (banks, stock exchanges and depositories) will have to track all transactions with the Central Federal Depositary and keep records of their total value.
Banks have begun to pay close attention to income derived from cryptocurrency activities. In May 2019, Sberbank requested this information from one of its clients. The bank sent a letter in which it asked its client to confirm the sources of income from cryptocurrencies and send the address of the cryptographic wallet, the user name, the documents for mining equipment and payment for electricity, an extract from the history of operations of the user of the crypto exchange, and income statements for 2018. It transpired that the recipient of the letter had transferred money received from the exchange of cryptocurrencies to his account at Sberbank and told the bank about it. Representatives of Sberbank confirmed the authenticity of the letter. They clarified that they operate within the framework of the law on combating money laundering and terrorist financing.
III ANTI-MONEY LAUNDERING
FATF measures have been introduced recommending cryptocurrency service providers to follow the same money laundering and terrorist financing procedures that traditional financial services firms are required to. The first FATF check will be carried out in June 2020.
The State Duma has prepared proposals for the regulation of cryptocurrencies, drawn up in accordance with the FATF requirements. The problem is not the cryptocurrencies themselves, but the unlawful purposes for which they are used because digital money is unregulatedreak.
Meanwhile, the Supreme Court3 introduced the concept of cryptocurrency to the 2015 ruling on money laundering in connection with the FATF recommendations. It clarified that Articles of the Criminal Code4 on the legalisation of criminal proceeds should be extended to cryptocurrency. The subject of crimes may include 'funds converted from virtual assets (cryptocurrency) acquired as a result of the commission of a crime'.5
The Federal Financial Monitoring Service (Rosfinmonitoring)6 reported that the absence of legislative regulation and state supervision over the issue and circulation of virtual currencies is considered to be among the main vulnerabilities of the Russian economy. In recent years, it has been noted that cryptocurrency has been used for the sale of narcotic drugs and the subsequent laundering of criminal proceeds. According to Rosfinmonitoring (in connection with the commission of crimes), despite the uncertainty of their legal status in Russia, cryptocurrencies are equal to property (in accordance with the purposes of their use) and are identified in monetary terms.
If money laundering occurs through the use of cryptocurrency, then these actions will be covered by Article 174.1 of the Criminal Code. Moreover, law enforcement agencies are already applying this Article in cases where cryptocurrency has been used to launder criminal proceeds.
Digital money is more likely to be used for the unauthorised transfer of funds abroad and to individuals who are engaged in business that is wholly or partly illegal. For these people, in the short term, there are opportunities for cash conversion of cryptocurrency or the use of international exchanges and the shadow internet.
Cryptocurrencies are a relatively unattractive prospect for investment because they do not perform any of the functions of money and are characterised by volatility (according to Rosfinmonitoring's calculations, Bitcoin volatility is 92 per cent). Digital currency cannot maintain its value over time, does not have collateral in the form of a real asset and does not have a guarantee of its relevance and value in the future.
IV REGULATION OF EXCHANGES
The activities of cryptocurrency exchanges that exchange Bitcoin and other popular cryptocurrencies are currently not regulated, except for categorical prohibitions by regulators. Recently, cryptocurrencies have become widespread all over the world and are used for a variety of purposes, from accumulating money and settlements to initial coin offerings (ICOs).
Financial market regulators (the Central Bank and Rosfinmonitoring) repeatedly warned citizens that all operations that use a cryptocurrency are speculative in nature and carry a high risk of losing value.
Draft federal legislation, the Law on Digital Financial Assets and the Law on Attracting Investment through Investment Platforms, requires the establishment of representative offices or subsidiaries in Russian territory for foreign entities to carry out crypto trading, creating legal uncertainty for foreign cryptocurrency exchanges. The largest foreign crypto exchanges have, however, set up representative offices in Russia. Nevertheless the lack of any regulation for accreditation of cryptobirth may be problematic.
V REGULATION OF MINERS
In judicial practice, a stable legal position has been formed that the mining process is an entrepreneurial activity. Accordingly, miners purchasing technical equipment for their activities do not have consumer status in relations with sellers, and from the point of view of the customs authorities, these goods are regarded as not intended for personal use. This circumstance significantly affects the amount of customs payments. Generally, the courts do not agree that a buyer of mining equipment is an ordinary consumer, as the very specifics of the goods purchased by him or her and the purposes for which he or she uses that equipment indicate otherwise.
The courts have taken the view that it is well known and does not need to be proved that cryptocurrencies are used in the financial market, have their own independent trading price and are convertible. Cryptocurrencies can be exchanged for currencies such as the US dollar, euro, rouble and other fiat currencies; they are also used as a settlement and payment instrument in accordance with Part 1, Article 61 of the Civil Procedure Code.
Thus, the buyer purposefully extracts (mines) cryptocurrency through the use of computer equipment acquired from the seller to systematically extract profit in the form of convertible and solvent (liquid) cryptocurrency.
In Russian market conditions, energy suppliers have to make concerted efforts to detect miners of cryptocurrency, because many civilians are adept at concealing this activity.
The State Duma plans to introduce administrative responsibility for any actions related to a cryptocurrency that are not provided for by Russian law. According to the Chairman of the State Duma Committee on Financial Markets, Anatoly Aksakov, all actions using cryptocurrency will be considered illegitimate, including mining, organising and issuing, circulation and opening exchange points. It is still possible to own a cryptocurrency, but only if it 'was acquired under foreign law at foreign points of sale and exchange, but not in Russia'.
The penalty for miners and all those who are somehow connected with cryptocurrency will be a fine, the size of which was not established at the time of writing. Russians will still be allowed to own Bitcoins, but only as an exception – there will be no penalty for them only if crypto tokens were acquired under foreign law at foreign exchange and sale points. A similar action carried out in the territory of Russia will inevitably entail administrative responsibility.
VI CRIMINAL AND CIVIL FRAUD AND ENFORCEMENT
Cryptocurrencies have a number of characteristics that have not yet been explored or addressed in legislation, which means that wrongdoers still have unprecedented opportunities to commit crimes. The three main factors that aid wrongdoers are the following: the ability to be anonymous when using cryptocurrencies; the decentralised nature of cryptocurrencies; and the lack of a legal regime for regulating cryptocurrency turnover.7
Cryptocurrencies have become an instrument for the implementation of cross-border money laundering. However, there are other crimes that are made possible by the use of a cryptocurrency. For example, acts aimed at preventing the enforced collection of arrears, tax evasion or legalisation of criminal proceeds, uncontrolled movement of capital and the lack of guarantees of consumer rights. In general, the factor that connects these crimes is the absence of legal regulation of the use of cryptocurrencies.
In addition, the weak security of cryptocurrency service providers (primarily cryptocurrency exchanges and wallet services) means that they are frequently attacked by hackers and customer funds are lost.
In Russia, the number of crimes committed using information and communication technologies is steadily increasing, from 11,000 in 2013 to 120,000 in 2019. Supervisors take restrictive measures. The activity of exchanging fiat currencies for cryptocurrencies in Russia is viewed as being indicative of illegal entrepreneurship. The most common crimes involving cryptocurrencies are:
- the use of malicious computer programs to generate cryptocurrency;
- distributed denial-of-service attacks (when attackers send artificially generated traffic to the server to disrupt normal traffic);
- legalisation (laundering) of proceeds of crime;
- illicit trafficking in narcotic drugs, weapons and other items prohibited or limited in circulation;
- sex work and trade, and child pornography; and
- cyber fraud.
Prior to regulation expressly addressing the relevant concepts, law enforcement agencies and the courts defined cryptocurrencies differently. Thus, in court decisions, Bitcoin is defined as a peer-to-peer payment system that uses: the same unit of account;8 an international settlement system with the means for maintaining settlement accounts in the network9 and the cryptocurrency itself – the money substitute;10 electronic money;11 virtual cash;12 and a virtual means of payment and accumulation (a text sequence consisting of letters of the Latin alphabet and numbers).13
The illegal status of cryptocurrency, the absence of exchange rules and the impossibility of accounting are pushing entrepreneurs into foreign jurisdictions. Citizens wishing to generate cryptocurrency turnover are forced to use the services of foreign exchanges, many of which do not work with accounts opened in Russian banks. The withdrawal of fiat funds will require the participation of a foreign bank located in a jurisdiction supported by the exchange.
As mentioned, the lack of regulation means that violations occur frequently. According to the Russian Association of Cryptocurrency and Blockchain, the average size of losses from investments through semi-legal crypto funds is 300,000 roubles; from investments in non-existing mining projects, 2 million roubles; and from fake services as part of ICO campaigns, 500,000 roubles.14
In March 2018, the Ministry of Finance agreed on a draft law on criminal responsibility for the production and circulation of cryptocurrencies, which provides for up to four years' imprisonment. This is to ensure compliance with the requirements of the legislation on anti-money laundering and counter-terrorist financing (AML/CFT). According to the Ministry of Finance, the main risks of money laundering may arise primarily at the stage of withdrawal of cryptoactive assets in fiat money.15
With regard to taxation of transactions related to the circulation of cryptocurrencies, the regulatory authorities are not ready to give official explanations prior to the adoption of relevant legislation defining the concepts of mining, cryptocurrency and the legal status of persons conducting operations with cryptocurrency. The only exception is the taxation of personal income. Legal uncertainty can lead to abuse by both the taxpayer and the tax authority. However, by virtue of the law, all ineradicable doubts, contradictions and ambiguities arising from legislation on taxes and fees are interpreted in favour of the taxpayer. The amendments adopted in March 2019 in the first, second and third parts of the Civil Code brought some clarity with regard to which direction the regulation of cryptocurrency operations would go, but the draft laws on digital financial assets and on crowdfunding did not resolve important issues.
The lack of regulation does not mean that transactions involving cryptocurrency do not entail tax consequences. A person is still criminally liable for tax evasion and the general principles of taxation can still be used as a guide. Irrespective of how the legal status of a cryptocurrency is determined in the future, it has always been and will remain virtual. From the point of view of legal regulation, only what happens to the cryptocurrency in the real world matters. It is appropriate to apply the following concept: virtual relationships are only subject to the law when their participants foresaw or should have foreseen that they will have consequences in the real world. Based on a law that has been adopted (but not yet enacted), cryptocurrency, as an object of civil rights, can be categorised as a property right. Tax legislation is based on the fact that taxes and fees must have an economic basis. When establishing taxes, the taxpayer's actual ability to pay tax is taken into account. Clause 1 of Article 54.116 of the Tax Code prohibits a taxpayer from reducing the tax base or the amount of tax payable (or both) as a result of distortion of information about the facts of economic life, taxable items to be reflected in tax, or accounting or tax taxpayer reporting. The object of taxation17 is the sale of goods (work, services), property, profit, income, expenses or another circumstance that has a monetary, quantitative or physical characteristic. Both existing tax legislation and law enforcement practice are based on the assessment of economic activity and its value, and how it is expressed, in the real world. Therefore, as with mining, and the sale and purchase of cryptocurrency, it is the exchange for fiat money or other property (property rights) from the real world that determines its valuation.
In accordance with the Tax Code,18 the transfer of property rights is subject to value added tax (VAT). The tax base will be defined as the value of these property rights. The moment of determining the tax base will be the date of the exchange of cryptocurrency for fiat money. In most cases, the cryptocurrency can be sold for foreign currency. When determining the tax base, the taxpayer's revenue in foreign currency is recalculated into roubles at the exchange rate of the Central Bank as at the date when the tax base is determined when realising property rights.19 At the same time, both miners and traders can use the right to a tax deduction on VAT20 according to which the tax requested from the taxpayer upon the acquisition of property rights is deductible from the budget. This concerns, for example, VAT paid by energy supply organisations or VAT paid when buying cryptocurrency from a VAT-paying resident of Russia. This approach is justified by the nature of the VAT. It is also favoured by the Presidium of the Supreme Court, which noted that, as a general rule, a taxpayer who uses purchased goods (work, services) to conduct VAT-taxable activities is guaranteed the right to deduct the 'input' tax imposed by counterparties, and the exceptions to the rule should be prescribed by law. In this case, the law clearly indicates that this deduction is possible.21
When calculating the income tax, the law explicitly states that the taxpayer has the right to reduce its income from the sale of property in the amount of the purchase price of the property and the amount of expenses related to their acquisition and sale.22 Entrepreneurs and legal entities that are subject to special tax regimes and use simplified accounting systems should bear in mind that their income is also determined by the date of sale of cryptocurrency for fiat money. But those traders who apply the 'income minus expenses' method will not be able to include the cost of buying cryptocurrency in their expenses,23 as the Tax Code only provides this possibility for goods. With regard to paying taxes to individuals, the Ministry of Finance takes a clearer position and determines the tax base from cryptocurrency purchase and sale operations as the excess of the total income received by the taxpayer in the tax period from the sale of the corresponding cryptocurrency over the total amount of documented expenses for its acquisition. The property deduction of 250,000 roubles, provided for by Subparagraph 1, Paragraph 2, Article 220 of the Tax Code, cannot be applied.
The Ministry of Finance believes that operations with cryptocurrencies should be subject to personal income tax.24 Accordingly, individuals should independently calculate and pay tax, receiving remuneration from individuals on the basis of civil law contracts. In other words, if one individual sells Bitcoins to another individual, then he or she must independently determine the tax base, report on the income received, and calculate and pay the tax. However, the Ministry of Finance also relies on the provisions of Article 41 of the Tax Code on determining income.
The general consensus is, therefore, that cryptocurrency should be taxed, but it is not yet clear how income in the form of cryptocurrency or from mining cryptocurrency will be tracked.
VIII LOOKING AHEAD
The lack of dialogue between the government and businesses reduces the possibilities for adopting prudent regulation of new markets. Also, the insufficient use by public authorities of 'soft' tools, such as guidelines on the compliance of new market participants and new technologies with legislation, creates additional risks of inadvertent violation by businesses of existing laws (e.g., not knowing what taxes are applied to mining). This, in turn, leads to an outflow of capital and reduces the competitiveness of the Russian economy.
The general barriers to the development of the digital economy and to business, including the development of blockchain technology and ITO campaigns, should be removed for Russia's digital economy to thrive. It is also necessary to formulate an approach to reduce the risks of the state regarding the violation of tax and business law by businesses, to eliminate the possibility of using virtual currencies to launder money obtained by criminal means and to hide other crimes.
With regard to the regulation of cryptoeconomics, the consolidation of concepts such as 'token' and 'cryptocurrency' in Russia's civil legislation is unlikely and, if it occurred, might adversely affect the formation of a new market owing to the inability to initially envisage all the qualitative characteristics of these objects. In the next few years, as part of the development of the industry, this approach will be developed by the participants together with government authorities. For example, in relation to the definition of the term 'token', the position is being taken that it is a property right within the meaning of Article 128 of the Civil Code and therefore no further changes to the legislation are required. It seems that the concept of 'cryptocurrency' will include other property (within the meaning of Article 128).
Russia should develop approaches to reduce the risk of AML/CFT and diluting the tax base. It seems that it could stimulate the development of the market by directly extending AML/CFT legislation to new market participants without subjecting them to the Federal Law on Banks and Banking Activities and the Federal Law on the National Payment System. It is necessary to develop a guideline that will clarify the procedure for taxation of transactions with cryptocurrency and income from them.
The development of cryptocurrency market regulation and tokens should begin with soft measures aimed at raising market awareness among the participants and the regulators themselves.
Legislative work is under way to legalise cryptocurrency, but until the adoption of amendments to the current legislation, those who use cryptocurrencies do so at their own risk and do not have the right to expect legal protection if their rights are infringed. In particular, they will not be able to recover the money spent on the purchase of cryptocurrency or to bring any property claims against the traders who manage their cryptocurrency assets. The courts often repeat the argument that, as cryptocurrencies are not regulated, all cryptocurrency transactions carried out by the participants in civil transactions are done so at their own risk.
Meanwhile, disputes over the use of these tools periodically arise, which means the courts are forced to adapt existing legislation to protect the interests of bona fide participants in civil transactions.
The draft law of the Ministry of Finance on digital financial assets25 proposes to consider cryptocurrency as 'a type of digital financial asset created and accounted for in a distributed digital transaction registry by participants of this registry in accordance with the rules for maintaining a digital transaction registry'. From this definition, it is impossible to identify the constitutive signs of a new economic and legal phenomenon (cryptocurrency), which is necessary to regulate cryptocurrency trading in the financial market. It is unclear what purpose the legislators of this bill are pursuing by adopting a technocratic approach to cryptocurrencies. Technologies used to create cryptocurrencies can change significantly owing to the rapid development of science and technology. The use of cryptocurrency as private non-fiat digital money in the global financial market represents a challenge to the global financial system.
Digital assets such as tokens and cryptocurrencies cannot be limited to national legal frameworks.26 Therefore, it is necessary in the legal sphere to use the terminology that is used globally. In this regard, it seems inappropriate to use 'digital financial asset' as a concept to unite tokens and cryptocurrencies.
There are proposals to make information an object of civil rights. But the concept of information is not the same as the concept of a digital asset used by businesses. Reference to information without an explanation and without defining the limitations of its scope and purpose is too broad for the purposes of applying civil law.
1 Maxim Pervunin is the managing partner and Tatiana Sangadzhieva is a lawyer at TFH Russia LLC.
3 The Supreme Court of the Russian Federation is the supreme judicial body in civil, criminal and administrative cases, in cases regarding the resolution of economic disputes and other cases falling under the jurisdiction of courts, established in accordance with Federal Constitutional Law on the Judicial System.
4 The Criminal Code of the Russian Federation is the main source of criminal law in Russia. New laws providing for criminal liability are subject to inclusion in this Code.
6 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.
7 FATF/GAFI. Virtual currencies – Key Definitions and Potential AML/CFT Risks. https://www.fatf-gafi.org/media/fatf/documents/reports/Virtual-currency-key-definitions-and-potential-aml-cft-risks.pdf
8 Decision of the Court of Intellectual Property Rights of 7 September 2016 in Case No. SIP-368/2016 // SPS Consultant Plus.
9 The definition of the Moscow AU on 14 September 2017 in Case No. A40-138925 / 16-95-126; Determination of the Moscow Region AC on 7 September 2017 in Case No. A41-94274 / 15 // SPS Consultant Plus.
10 Decision of the Primorsky District Court of 7 June 2017 in Case No. 2-7811 / 2017 // SPS Consultant Plus.
11 The verdict of the Trans-Baikal Regional Court of 21 February 2017 in Case No. 22-500 / 2017 // ATP 'Consultant Plus'.
12 The verdict of the Bratsk City Court of 3 March 2017 in Case No. 1-50 / 2017 // SPS ConsultantPlus.
13 The decision of the Anapa City Court of 25 February 2016 in Case No. 2-869 / 2016 // SPS ConsultantPlus.
14 Gladysheva T. In Russia, a 'white list' of companies in the field of cryptocurrency and ICO appeared // Izvestia, 13 July 2018.
15 Pertseva E. Ministry of Internal Affairs took up Bitcoin // Izvestia, 23 August 2018.
16 Limits on the Exercise of Rights Relating to the Calculation of the Tax Base and (or) the Amount of a Tax, a Levy or Insurance Contributions.
18 Subsection 1, Clause 1, Article 146.
19 Clause 3, Article 153 of the Tax Code.
20 Clause 3, Article 153 of the Tax Code.
21 Clause 2, Article 171 of the Tax Code.
22 Subparagraph 2.1, Paragraph 1, Article 268 of the Tax Code.
23 Article 346.16 of the Tax Code.
24 Letter dated 13 October 2017, N 03-04-05 / 66994.
25 Draft federal law on digital financial assets // https://www.minfin.ru/en/document/?id_4=121810&page_id=2104&popup=Y&area_id=4
26 Broy, Sh. U., Zaytz T. G. Legislative regulation of the prevention of terrorism and organised crime in the process of using cryptocurrencies and their impact on the economy and society // Legal Impact on the Economy: Methods, Results, and Prospects: Monograph / Rep. ed., V. A. Vaipan, M. A. Yegorova. M: Yustitsinform, 2018.