Digital Financial Assets: Russian approach

Иван Ермохин Иван Ермохин Expert of Center Russia-OECD published
Digital Financial Assets: Russian approach

1. What is cryptocurrency?

In July 2020, Duma adopted the Law on digital financial assets (come into force on January 1, 2021). According to the Law's definition, digital currency is recognized as a means of payment and can be an investment. Financial Action Task Force on Money Laundering — FATF qualifies virtual currency as a means of expressing value, which is digitally tradable and functions as an exchange means; and/or (2) the monetary unit of account; and/or (3) a means of value's store but does not have legal tender status in any jurisdiction.

Thus, following the definition, virtual currencies are not legal tender but can be used as a unit of account by agreement. Therefore, today countries (the USA, EU countries, Switzerland) recognize and accept cryptocurrencies as a contractual means of payment.

However, under Art. 14, Russian legal entities and individuals are not entitled to receive digital currency as a counter-provision for goods, services transferred, or as payment in any other way. It contradicts the recognition of cryptocurrency as a means of payment and significantly limits its use in Russia and reduces the economic feasibility of owning a cryptocurrency.

Besides, any claims for digital currency can be subject to judicial protection only if they are informed of possession of digital currency and transactions with it. It is worth noting that the Law does not establish a specific procedure for notifying whether such information can be carried out within a tax return framework or in another way.

2. What is a token?

Today Russian legislator does not use the term “token” to regulate relations in the crypto economy sector. The adopted amendments to Civil Code, Law on Investment Platforms, and Law on Digital Financial Assets use the generic notion – digital law (which is a token). Moreover, depending on a type of the granted rights for such digital assets, they can be divided into utility digital rights and digital financial assets (there are two types of tokens depending on granted rights).

Under the Russian legislation, utility digital rights – product tokens – are issued only on investment platforms (crowdfunding platforms) and can provide legal claims on services and goods and intellectual property transfer. However, digital financial assets provide right on a pecuniary demand, exercise rights to equity securities, the right to participate in the capital of a non-public joint-stock company, and the right to demand equity securities transfer.

As for issuing digital financial assets within the ICO, Russia has a unique path of development. On the one hand, there is an issuance of digital financial assets, representing monetary claims and other rights. On the other hand, digital financial assets issued in the form of security are regulated by legislation on the securities market. Therefore, on the one hand, the scheme is similar to the approach in France, where there is a regulation of the ICO procedure for product tokens, while the concept of product tokens is quite broad: a token may not only give the right to receive a product or service but may also have some signs of securities.

At the same time, tokens that are entirely similar in terms of securities or financial instruments are issued, taking into account the legislation on securities. At another point, concerning the regulation of the digital financial assets in the form of securities, the legislator followed the scheme of the United States, Switzerland, and some EU countries, where the legislation on the securities market and derivative financial instruments applies to tokens similar in their characteristics to securities. That means that it is possible to legally issue product tokens under the law.

3. ICO realization.

The bill establishes the requirements applicable in other countries to the ICO procedure (Switzerland, France, USA). For example, the law defines detailed requirements for a white paper (a decision on the release of digital financial assets), requirements for communicating information about an ICO to investors (requirements for the publication of a decision on the issue), etc. The law sets requirements for an information system in which digital financial assets. The information system should be included in the register of the Central Bank.

It allows the ICO not to spend extra money on creating its token issuance system. Also, it limits the ability to use its own systems, which will have to be registered. However, the information system’s obligations are burdensome only in terms of requirements for participants (business reputation and qualifications), the need to create internal rules and security systems, etc. In contrast, the criteria concerning capital are absent. The information system is also responsible for access to assets, the continuity, and continuity of operation, the integrity and reliability of the information on maintaining the register of users of the information system, which forces the system to take appropriate organizational and security measures.

4. Stock and money exchange

The Law on Digital Financial Assets introduces a new entity in the Russian crypto market - digital financial asset exchange operators. Such operators are crypto exchanges, but only for exchanging tokens recognized as digital rights under Russian law. Under Art. 141.1 of the Russian Federation's Civil Code, these include digital rights recognized by a special law. Today, such special rules are the Federal Law on Investment Platforms and the Federal Law on the Digital Financial Assets. Thus, exchange operators can organize the trade of utility digital rights and digital financial assets.

Thus, existing crypto exchanges trading cryptocurrencies, such as Bitcoin and Ethereum, do not fall under the definition of a new entity and remain unregulated. However, under the Law on Digital Financial Assets, there is a direct possibility of organizing a platform to exchange cryptocurrencies in Russia. Article 14 of the Law on Digital Financial Assets establishes that the organization of the issue and (or) issuance, the organization of the circulation of digital currency in the Russian Federation, are regulated according to federal laws. This approach differs from existing practices in the US, UK, and most other OECD countries.

In these countries, the legislator has extended the existing legislation on financial intermediaries and organized trading platforms to such companies. Both crypto-exchanges operating in these countries and crypto-exchanges providing services to these countries (the principle of extraterritoriality) should obey this approach.

5. Special requirements for business reputation, qualification, an internal control service

Law on Digital Financial Assets establishes the requirements of "business reputation" to the information system's executive bodies, the operator of the digital financial assets exchange. Such requirements include the absence of an unexpunged and outstanding conviction, of facts of bringing to administrative or criminal liability in connection with bankruptcy in recent years, in connection with the activities of a financial organization, information about persons' involvement in extremist movements or terrorism, etc.

For example, this criterion is used in Switzerland and applies to founders and executive bodies. In foreign countries, the requirements for qualifications are also established (for example, have special education or income). The bill also establishes qualification requirements: higher education and experience in managing a credit institution or non-bank financial institution or government agencies' experience.

The criterion of work experience in government agencies is not used by foreign countries, since this criterion does not confirm the availability of skills in economics, investments, and new technologies. A positive norm is a requirement for the operator of the information system in which the digital financial assets are issued and for the operator to exchange digital financial assets to have an internal control service and a risk management service. Such requirements are common in France and Switzerland as part of the ICO and dictated by international standards, such as the OECD and FATF.

Besides, the operator of digital financial assets' exchange is required to store information about transactions with digital financial assets for at least five years. The Bank of Russia has the right to establish additional requirements for the activities of information systems and exchange operators for digital financial assets, for example, requirements for operational reliability and requirements for reporting. Such demands can enhance transparency as well as safety. However, when establishing the requirements, the principle of technological neutrality must be taken into account: the ability to use any safety technologies, not only those developed or installed by the state.

6. Advertising

The Law establishes requirements for advertising of a digital asset that concerns the identification of the person issuing a digital asset, information on a digital asset, duty to warn investors that the proposed digital asset is high-risk, and their purchase may lead to the loss of the deposited funds in full. This requirement to warn investors about the possible risks of buying digital financial assets is common in many countries (France, Switzerland, USA). Moreover, under the Law, advertising should not promise to pay income on digital financial assets, except for the payment of income provided by the issuance's decision. Advertising should not contain forecasts of growth in the market value of issued digital financial assets, which is also a measure of protection against misleading investors, excessive expectations regarding investments, and ensuring the investor's reliable assessment of such investments.

7. Anti-money laundering and combating the financing of terrorism (AML/CFT).

Due to the Law on Digital Financial Assets, there will be new legal entities obliged to comply with anti-money laundering and combating the financing of terrorism regulation - operators of information systems in which digital financial assets are issued and operators of exchange of digital financial assets.

Corresponding amendments are being made to Federal Law No. 115 "On Counteracting Legalization (Laundering) of Criminally Obtained Incomes and Financing of Terrorism". Existing crypto exchanges that trade cryptocurrencies, for example, bitcoin and ethereum, do not fall within these definitions and remain outside the perspective of Federal Law No. 115. The law establishes that in the event of repeated violations by the operator of the exchange of digital financial assets of the requirements of Federal Law No. 115 "On Counteracting legalization (laundering) of proceeds of crime and financing of terrorism" and regulations of the Bank of Russia adopted in accordance with Federal Law No. 115.The Bank of Russia has the right to exclude such an operator from the register of operators to exchange digital financial assets.

The information system, the operator of the exchange of digital financial assets, are finally included in the AML/CFT regulation. Remarkably that the information system for the issue of digital financial assets and the operator of the exchange of digital financial assets have the right to entrust, based on the agreement, to the operator of another information system in which the issuance of digital financial assets is carried out, as well as to another operator of the exchange of digital financial assets, the identification of the client, the client's representative, beneficiary, the beneficial owner, if these operators belong to credit institutions or professional participants in the securities market. That means the law allows attracting third platforms, which are professional market participants, to carry out identification during transactions or the release of digital financial assets.

8. Taxation

The Law on Digital Financial Assets does not regulate issues on taxation of digital financial assets. Thus, the question of the tax implications of transactions with digital virtual currencies remains open. However, tax authorities often resolve taxation issues through an explanatory statement on the systems for paying taxes on transactions with digital assets. Thus, the turnover of crypto assets will be subject to general taxation rules, leading to several difficulties and contradictions and will work against the development of a new market.

Currently, Russia has not defined an approach to indirect taxation of crypto assets. Although foreign regulators, for example, in the EU, were primarily trying to eliminate this issue's uncertainty. Information circulars only cover specific direct taxation issues. In particular, the Ministry of Finance of Russia expressed its opinion on the taxation of cryptocurrency transactions for individuals in a Letter dated May 17, 2018 No. 03-04-07 / 33234. The Ministry of Finance noted that there is no particular procedure for taxing individuals' income when performing transactions with cryptocurrencies.

Individuals must independently calculate the tax and submit a declaration to the inspectorate. The tax base for transactions in the sale and purchase of cryptocurrencies is determined in rubles as the excess of the total amount of income from the sale of a cryptocurrency over the total amount of documented expenses its acquisition. Unless there is no legislative regulation of issues related to the circulation and taxation of cryptocurrencies, the determination of the tax base must be based on Art. 220 of the Tax Code of the Russian Federation.

Ministry of Finance of Russia published some explanations related to corporate taxation (Letters dated August 28, 2018 No. 03-03-06 / 1/61152 and dated August 16, 2018 No. 03-03-06 / 1/58171). The Ministry of Finance emphasized that according to Article 247 of the Tax Code of the Russian Federation, the object of taxation for corporate income tax is the profit received by the taxpayer. In the general case for Russian organizations, it is the difference between the income received and the expenses incurred, qualified under Chapter 25 of the Tax Code of the Russian Federation.

The logic of the provisions of Chapter 25 of the Tax Code of the Russian Federation implies taxation of all income received by the taxpayer in activities, except for those named in Art. 251 of the Tax Code of the Russian Federation. Meanwhile, there is no special procedure for taxing income when performing transactions with cryptocurrency under Chapter 25 of the Russian Federation's Tax Code.

An explanation of the Federal Tax Service on the nature of the tax consequences of transactions with cryptocurrencies, including typical transactions with cryptocurrencies, could have a more positive impact.