The popularity of cryptocurrency has skyrocketed in recent years and by 2021 Bitcoin has reached an all-time high of over $60,000. Due to the volatility of the crypto market, it is attractive for many to try day trading to take advantage of any price rises or falls. We see more and more that a trading bot is used for this, because what is more convenient than a bot that takes all the work off your hands and makes you rich while sleeping?
However, the use of a trading bot can have very negative consequences for the way in which the realized returns are taxed. In this blog I will explain the elements that play a role in the assessment of whether the activities in box 1 or box 3 are taxed. The following topics are discussed:
- The distinction between box 1 and box 3 (general)
- Speculative transactions
- Trade using a trading bot
- Risk analysis
Box 1 vs. Box 3 (general)
In my previous blog I explained how cryptocurrencies are taxed. The warning was that when using a trading bot, the Tax and Customs Administration can take the position that there is taxable income in box 1, because this (in short) exceeds the level of the ‘normal investor’. To clarify the difference in tax burden between the two boxes, first a short example:
The value of your crypto holdings is $200,000 and the return is $80,000
In box 1, the (active) income is taxed progressively, which means the higher the income, the heavier the tax burden. In box 3, the active income is not taxed, but tax is levied on the value of the assets (the investment). Since 1 January 2017, a writing system also applies to box 3, whereby the capital is taxed more heavily according to its height, but the total tax burden is considerably lower compared to box 1. Moveco.io has enough information. With assets up to two million euros, the tax burden on total assets is below 1.6 percent. It is therefore much more advantageous to fall into box 3 than box 1, but on what basis does the distinction take place?
Box 1: ‘a source of income’
If the conditions for having a ‘source of income’ are met, the realized benefits are taxed in box 1. Within box 1, there are two flavors: profit from business (‘WUO’) or results from other activities (‘ROW’). ‘). If the source conditions are met, it must be determined whether WUO or ROW is involved. The source conditions are as follows:
Participation in economic traffic
If the taxpayer publicizes his activities, for example by offering them or by trading with third parties, this constitutes participation in economic transactions. It should therefore concern activities that take place outside the private sphere or as a hobby.
The purpose of benefit (profit-making)
If the activities are developed with the aim of gaining an advantage, there is soon a profit motive. Incidentally, the lack of profit motive does not prevent a source of income from being available. The decisive factor is then whether the third condition is met.
The benefit can reasonably be expected
The requirement of the objective benefit expectation means that it must reasonably be expected that the benefit will be obtained from the activities. It is precisely this requirement that plays an important role in whether the use of a trading bot leads to a source of income (see further, § 3).
Distinguish WUO and ROW
The difference between WUO and ROW is that the aim is to realize the advantage with the help of a ‘sustainable organization of capital and labour’ (the corporate tax criterion). In view of the sustainability criterion, an incidental benefit cannot lead to WUO, but to ROW. Furthermore, capital must be available to be able to develop the business activities and labor must be performed to put products or services on the market.
Box 3: ‘normal active asset management’
Taxation takes place in box 3 if the activities qualify as ‘normal active asset management’. The word ‘active’ sounds strange because it is often assumed that investing is passive, but it refers to activities that are inherent to asset management. Think of the real estate investor who has contact with tenants, collects rent and draws up rental agreements (late). If the activities are inseparable from the nature of the operation of the assets does not result into load capacity in box 1.
In the case where an investor strives for the highest possible return and performs work, uses specific (inside) knowledge and/or expertise to achieve that goal, the level of the normal investor can be transcended. Examples include the real estate investor who carries out maintenance and renovations himself, or who regularly buys and sells with a quick profit (pounding out properties) or the stock trader who has price-sensitive information (inside information). In these cases, work is performed or knowledge or expertise is used with the aim of achieving a higher return than can be expected with normal active asset management, resulting in ‘more’ than normal active asset management. The level of the normal active investor is then exceeded, with the result that the returns are taxed in box 1.
The criterion of ‘more than usual active asset management’ is in line with the above source conditions. After all, if the nature and scope of the activities comprise more than with normal active asset management (‘labour-plus test’) and the aim is to achieve benefits that exceed the return arising from normal active asset management (‘return-plus test’), test’) and the return can reasonably be expected as a result, a source of income will be deemed to exist. Folm.io has enough information. In those cases, the outcome (the benefit) is the result of the taxpayer’s efforts. In other words: the result can be influenced by the efforts of the taxpayer.
The element of speculation
The assessment of whether the activities in box 1 or box 3 are taxed is generally based on the above frameworks. Earlier I noted that in cryptocurrency trading, the third source condition plays a major role, namely whether the benefit can be objectively reasonably expected. With regard to trading in cryptocurrencies, which in nature is comparable to stock exchange and securities trading, the transactions are speculative in nature. There is speculation if the result cannot be influenced by the efforts of the taxpayer. In those cases, the outcome of the transaction (the benefit) is not reasonably foreseeable and the third source condition is not met.
Due to the speculative nature of the transactions, the intention to purchase cryptocurrencies and to have a return on investment or to bet on price rises or falls by means of day trading on price rises or falls does not lead – for the normal active investor – to tax in box 1 due to the speculative nature of the transactions. This is of course different if insider trading is used or if the taxpayer in some other way has an advantage over the normally active investor and can therefore achieve a higher return. If that lead position is not present, the (speculative) nature of the transactions continues to dominate.
Trade using a trading bot
When trading with the help of a trading bot, it therefore comes down to the question of whether the result is foreseeable (objectively reasonably to be expected). This is the case if the trading bot can be regarded as a means by which the user gains an edge position over the normal active investor and uses that position to earn extra returns.
To answer the question of whether a leading position is present, it will be necessary to look at the functioning of the trading bot and in particular the algorithm. After all, the quality of a trade is determined by how ‘smart’ the algorithm is. In addition to the algorithm, the following aspects will also be considered:
- What is the trading bot’s strategy?
- Is the trading bot built/developed by itself?
- What other activities are performed by the user?
- What is the size and frequency of the transactions?
- What is the average success rate of the trades?
- Does the success rate depend on a bear or bull market?
- Is the trading bot sold or otherwise offered/made available to third parties?
- Is the trading bot being promoted?
Unfortunately, it is not possible to say in a general sense when the use of a trading bot leads to taxable income in box 1. The Tax and Customs Administration assumes an assessment of the facts and circumstances of the specific case. To determine whether there is a risk that the use of a trading bot will lead to taxability in box 1, it is advisable to subject the functioning of the trading bot and the other aspects to a risk analysis.