The current uptake in crypto funds, i.e. collective investment schemes (CIV) holding cryptocurrency, causes the need to shed some light on the tax and regulatory law implications with regard to the various avenues available for direct or indirect investment in cryptocurrencies from a German tax point of view.

In a nutshell, for a German private investor the indirect investment in cryptocurrency via CIVs is less tax beneficial than a direct holding of this asset class.

German Tax Law Implications of Crypto Investments

Direct investment in cryptocurrency

In Germany, any gain from selling cryptocurrency held directly by the investor as a Blockchain asset in a respective “Crypto-Wallet” is in general taxable income that is subject to the individual taxpayer’s progressive income tax rate. A sale for tax purposes is not only triggered by the exchange of crypto units into state currency, but also by exchanging crypto units into other crypto units or even for simply buying goods or services.

However, in the case of such “direct” investment in cryptocurrency, a holding period related tax exemption is available. The sale of cryptocurrency is tax-exempt in Germany if the private investor has held the crypto asset for more than one year.

Investment in cryptocurrency through Exchange Traded Notes (ETNs)

Exchange Traded Notes (ETNs) are unsecured debt securities that track an underlying index of securities and trade on a major exchange like a stock. ETNs are similar to bonds but do not have interest payments. Instead, the price of the ETN fluctuates with the underlying asset, in this case, Bitcoin or other cryptocurrencies.

While there is no official guidance yet on the German tax treatment of such Crypto ETNs (neither from the German tax authority nor the German tax courts), the highest German tax court (the “BFH”) has issued a decision in a comparable case: exchange-traded gold bearer bonds where the note conveys a claim to delivery of the underlying asset. In the case of such gold bearer bonds, the BFH has ruled that the gain from the sale of the note is tax exempt after holding the note for more than one year (i.e., like a direct investment in gold).

The German tax authority may draw a parallel between the above decision and the case of Crypto ETNs and treat an investment via ETNs similar to a direct investment in Bitcoin (tax exempt after a one year holding period).

Investment in cryptocurrency through a Crypto Fund

Investing in cryptocurrency through a crypto investment fund can provide investors with exposure to the cryptocurrency market while potentially mitigating some of the risk associated with direct investments. Crypto funds pool together the resources of multiple investors to invest in a diversified portfolio of cryptocurrencies. Furthermore, In addition the investment through fund vehicles – like the investment through an ETN – does not require any additional, crypto-specific hard- or software (e.g. a crypto wallet).

The investment in cryptocurrency through an investment fund may, from a German tax law perspective, lead to very different tax effects. Any income received by a German private investor from a public investment fund, like e.g. a crypto ETF, is for the purpose of German tax law qualified as “investment income” which is subject to a special uniform tax rate of 26,375 %. This fund investor level taxation applies regardless of which specific kind of income from cryptocurrency is generated on the level of the fund.

German Regulatory Law Perspective on Crypto Funds

From a regulatory perspective, Germany has introduced regulation on crypto fund units that allows fund managers to issue fund units on an electronic instead of a physical basis. This new regulation came less than a year after the Fund Location Act (“Fondsstandortgesetz”) allowed institutional investors to invest in crypto assets through special AIFs. Specifically, domestic special funds (Spezialfonds) in Germany are permitted to invest up to 20% of their portfolios into crypto assets like Bitcoin. Domestic mutual funds are allowed to hold a maximum of 10% of their portfolio in crypto assets.

Conclusion

While there is by now some official guidance on the tax treatment of crypto investments available in Germany, the fast evolving crypto market and its on-going novelties inevitably lead to legal uncertainty. While the German legislator is endeavoring to open up regulatory doors to the opportunities presented by the crypto market, Germany does not yet match the pace of the American legislator.

Original text you can find here.