Does the exchange of cryptocurrencies into traditional (FIAT) currencies affect the right to deduct VAT?

Cryptocurrencies are becoming increasingly popular in everyday business transactions, including as a means of payment in commercial relationships. While the tech community approaches this development with enthusiasm, tax authorities still appear to lack a full understanding of the nature of cryptocurrencies and their practical application in business. A ruling issued by the Director of the National Revenue Information Service on 11 September 2024 (ref. 0112-KDIL1-3.4012.298.2024.2.MR) highlights the significant gap between the perspective of the technology sector and the interpretation of tax regulations by the authorities.

A controversial position by the tax authority

The ruling concerned an IT company providing software development services to a foreign client, with remuneration for these services to be paid in cryptocurrencies. The company believed that the exchange (sale) of received cryptocurrencies was not subject to VAT. It also argued that even if such an exchange were considered a taxable activity, it should benefit from a VAT exemption and be treated as an ancillary transaction within the meaning of Article 90(6) of the VAT Act, which would mean it would not affect the taxpayer’s right to deduct VAT.

The Director of the National Revenue Information Service disagreed with the taxpayer’s position. According to the tax authority, the exchange of virtual currencies constitutes a taxable provision of services, which, although indeed exempt from VAT under Article 43(1)(7) of the VAT Act, cannot be regarded as an ancillary transaction.

The authority held that the sale of cryptocurrencies is closely linked to the company’s core business, i.e., the provision of software development services. The authority reasoned that, since the company anticipates the possibility of receiving payments in cryptocurrencies and plans to exchange them into traditional currency, with the value of these assets potentially being significant, such transactions cannot be considered incidental (ancillary).

Should the exchange of cryptocurrencies into traditional currency really be considered a service?

Let us start with the basics – the VAT treatment of transactions involving cryptocurrencies is fundamentally influenced by the judgment of the Court of Justice of the European Union (CJEU) of 22 October 2015 in the case of Hedqvist (C-264/14). The Court held that the exchange of traditional (fiduciary) currencies for Bitcoin and vice versa constitutes the provision of services, rather than the supply of goods – which is hardly surprising, given that Bitcoin is not a tangible asset.

Importantly, the Court emphasised that such services are subject to VAT only when performed for consideration. In the case at hand, the remuneration of the currency exchange platform was the margin included in the exchange rate. Notably, such a remuneration model is quite common among currency exchange offices and trading platforms. The Court also indicated that a VAT exemption could apply to financial services involving virtual currency exchange transactions, recognising that Bitcoin serves as a means of payment when contractually accepted by the parties as an alternative to traditional currencies.

However, it is important to distinguish between entities that professionally provide currency exchange services (e.g., exchange offices or trading platforms), for which they receive remuneration and those that merely use the services of such exchange offices/platforms to exchange cryptocurrencies themselves.

To illustrate this distinction, consider a simple example: suppose an exchange office converts PLN into EUR and charges a margin for this operation – in this case, we are indeed dealing with the provision of a VATable service (which is simultaneously VAT-exempt), with the exchange office being the service provider. However, the entity exchanging PLN into EUR at the exchange office is merely the service recipient, who does not provide a service and receives no remuneration.

Let us recall that Article 43(1)(7) of the VAT Act exempts from VAT “transactions, including intermediation, concerning currencies, banknotes and coins used as legal tender, excluding banknotes and coins that are collectors’ items, i.e., gold, silver or other metal coins and banknotes not normally used as legal tender or having numismatic value.”

Therefore, if tax authorities treat cryptocurrencies as a means of payment (and since they indicate that such services are covered by the exemption provided in the above provision of the VAT Act, it must be assumed that this is indeed the case), then classifying their exchange into traditional (FIAT) currencies as a “provision of services” is inconsistent. Under normal circumstances (i.e., in the case of exchanging two fiduciary currencies), the authorities do not claim that the service recipient exchanging currency at an exchange office is providing a service by selling that currency.

This controversial and somewhat surprising treatment of cryptocurrencies is not new – tax authorities apply similarly inconsistent reasoning in cases involving payments made in cryptocurrencies.

What Is the significance of recognising a transaction as ancillary?

Although one may disagree with the tax authorities’ approach to cryptocurrency exchange, it cannot be ignored, as it may have serious consequences for VAT settlements.

In cases of so-called mixed activity (comprising both VATable and VAT-exempt sales), a taxpayer wishing to deduct input VAT must first directly allocate a given expense to a specific type of activity: taxable – which entitles the taxpayer to deduct VAT, or exempt – which does not. Only expenses exclusively related to taxable activities entitle the taxpayer to full VAT deduction. If such direct allocation is not possible — i.e., the expense relates to both types of activities — the taxpayer must apply the so-called VAT pro-rata. To prevent occasional VAT-exempt transactions from distorting this ratio, the VAT Act provides for their exclusion from this calculation.

Whether a transaction may be regarded as ancillary (or incidental – following the terminology of the VAT Directive), although not expressly defined in the Act, is assessed in the context of the taxpayer’s overall activity. Key factors include whether the transaction:

• does not constitute a direct, permanent, and necessary complement to the core business,
• involves only marginal use of resources for which VAT deduction is available,
• is not a typical feature of the taxpayer’s business profile.

In light of the above, the sale of cryptocurrencies may be treated as an ancillary transaction if this is justified by the scale, frequency, and extent to which such sales are integrated into the taxpayer’s core business. The more regularly cryptocurrency transactions become a source of revenue or a feature of the business model, the harder it is to treat them as incidental.

In the cited ruling, however, the company was not operating a currency exchange business, was not engaged in trading, the sale of crypto did not involve significant use of its resources, and its sole purpose was to “convert” received remuneration. Therefore, it is difficult to agree with the authority’s conclusion that such transactions cannot be treated as ancillary.

The risk of a reduced VAT deduction ratio

For taxpayers receiving remuneration in cryptocurrencies, the tax ruling in question poses a serious risk. Challenging the ancillary nature of cryptocurrency exchanges may limit the right to deduct VAT on purchases.

Treating cryptocurrencies as a means of payment, while at the same time classifying their exchange as a taxable financial service, exemplifies a lack of consistency in interpretation, which leads to unpredictable and disproportionate tax consequences. Coupled with an incomplete understanding of the concept of “ancillarity,” this results in a ruling that does not align with market realities.

If your company is in any way involved in settlements in cryptocurrencies, it is worth analysing the potential need to apply the VAT pro-rata. It is also advisable to monitor interpretative trends and current case law, both domestic and EU-wide, to better assess the tax implications of your activities.

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