The FBI's raid on the online marketplace Silk Road may mark the start of the US authorities' attack on digital currencies such as Bitcoin as a tax evasion tool.

The raid resulted in the seizure of some 26,000 Bitcoins, the most popular of the several digital currencies in circulation. Bitcoin also features prominently in the indictment of Silk Road's owner Ross Ulbricht for money laundering and other offences, as it was a standard means for users of the site to buy goods ‒ allegedly including illegal drugs ‒ from one another.

However, Bitcoin is also of considerable interest to global tax authorities as a means of avoiding both direct and indirect taxes. Because it is an anonymous electronic token that can be exchanged directly between two parties in any countries, it does not need to pass through any financial intermediaries. So Bitcoin transactions, like cash transfers, cannot be traced by third parties and are effectively invisible to the tax authorities ‒ although US federal government regulators have issued guidance regarding its use. Moreover, there is no jurisdiction in which they operate so they are not subject to taxation at source. Tax information exchange agreements are irrelevant, since there is no jurisdiction to exchange information with.

One tax law expert, Omri Marian of the University of Florida, considers that so-called cryptocurrencies like Bitcoin could replace tax havens as the tool of choice for tax evaders. This process could be speeded up by the recent emergence of much tougher government action against offshore tax avoidance, for example by the US Foreign Account Tax Compliance Act. Marian believes there will be much more regulation of digital currencies once the authorities recognise their potential for tax evasion. A whole industry has already grown up around Bitcoin, including 'miners', 'brokers', currency exchanges, investment funds and even licensed banks. There about 12 million of the digital coins in circulation. In Germany it is even recognised as legal tender.

'Earnings [paid in Bitcoins] are not subject to taxation, and taxpayers' anonymity is maintained,' he comments in a recent paper on the topic. 'Cryptocurrencies have the potential of defeating the recent successes of governments in battling offshore tax evasion. To the extent that cryptocurrencies continue to gain momentum, we could reasonably expect tax-evaders ‒ who traditionally executed their tax-evasion techniques through the use of offshore bank accounts in tax-haven jurisdictions ‒ to opt out of traditional tax havens in favour of cryptocurrencies.'

Governments have paid some attention to this issue, but so far have failed to identify the acuteness of the potential problem, he says.

However this is now changing. The US authorities have already attacked one of Bitcoin's rival currencies, Liberty Reserve, this year, accusing its operators of money laundering and running an unlicensed money-transmitting business. With the shutting-down of Silk Road, Bitcoin itself has come under attack. Though the technology behind the currency is considered to be safe from law enforcement, its reputation is not ‒ and its reputation determines the Bitcoin's exchange rate against the US dollar, since the value of a Bitcoin fluctuates with its popularity. The FBI's Silk Road raid caused a sharp dip in its value last week, but by Friday it was back up to about USD140. Further regulatory action is undoubtedly being planned to undermine its stability.

Sources