Denmark is proposing a new tax model that taxes unrealized gains on cryptocurrencies at 42%, bringing digital assets in line with existing rules for certain financial contracts.
This approach means that gains and losses are calculated annually based on the change in the value of the taxpayer’s assets, regardless of whether the assets have been sold. Taxable income would reflect the difference between the value at the beginning and end of the year.
Under this inventory-based tax system, profits would be included as capital income, while losses could be deducted from profits in the same category in the same year. Unused losses can be carried forward to offset future profits. This method aims to provide a consistent framework for taxing financial instruments, including cryptocurrencies.
The traditional tax on financial instruments in Denmark
Denmark processes a number of traditional financial contracts according to the rules laid down in the Kursgevinstloven (Capital Gains Tax Act), in particular Articles 29 to 33. However, only certain types of investments and accounts are subject to tax on unrealized gains .
- Inventory-based taxation (Bearing principle):
Gains and losses on financial contracts are taxed annually based on their value at the beginning and end of the financial year, regardless of whether the contract is sold (realized). This system guarantees taxation even on unrealized profits. - Separation principle (Separation principle):
Financial contracts are taxed separately from the underlying asset. This means that the changes in the value of the financial contract are important for tax purposes, and not necessarily the movements of the underlying assets. - Restrictions on tax deductions (Fradragsbegrænsning):
Although companies can generally deduct losses on financial contracts, there are exceptions. For example, losses on specific share-related contracts, such as contracts linked to subsidiaries or group shares, are limited. These losses can only be deducted from profits on other financial contracts. - For individuals:
For individual taxpayers, losses on financial contracts can only be deducted from profits within the same category (i.e. financial contracts). Losses can be carried forward and used in future tax years, but are subject to limitations.
Some exchange-traded funds (ETFs) in Denmark are taxed annually on unrealized gains. These are typically ETFs that accumulate and reinvest dividends and are taxed each year at rates of 27% or 42% on unrealized gains.
Aktiesparekonto (share savings account) allows individuals to invest in listed shares and share-based investment funds with a tax rate of 17% on returns. Taxation is based on unrealized profits at the end of the year, according to the ‘bearing principle’ (stock principle).
These investments are exceptions to the general rule, where traditional financial contracts such as stocks and bonds are typically taxed on realized gains. The ‘bearing principle’ is applied to these specific investment types to encourage long-term investment strategies by taxing annual capital gains rather than waiting until the investment is sold.
Impact on crypto trading via new system
The new system can be considered less burdensome for low-frequency traders as they have fewer assets to value annually, reducing administrative workload. Frequent traders can benefit from improved accuracy of reported income without the need to closely monitor individual trades. Instead, they would focus on the overall change in the value of their property during the tax year.
However, taxing unrealized profits leads to liquidity problems. Taxpayers may owe taxes on gains made without selling assets to generate cash for payment. The recommendation recognizes this challenge and includes possible measures to alleviate liquidity constraints, such as carryback rules or provisions to mitigate the effects of sudden price drops after the end of the tax year. These measures are intended to alleviate the financial pressure resulting from taxing profits that exist only on paper.
Implementing an inventory-based tax model could have a significant impact on crypto investors in Denmark. Taxing unrealized gains can impact investment strategies because investors may need to consider potential tax liabilities even if they hold assets long-term. This could influence trading behavior, allowing investors to strategically realize gains or losses to manage their tax liabilities. The requirement to pay taxes on paper profits could also impact the attractiveness of crypto investments compared to other asset classes.
Liquidity issues are especially notable in the crypto market, where asset values can fluctuate dramatically over short periods of time. Taxing profits that exist only on paper could strain investors’ resources, especially if the market experiences a downturn shortly after the tax bill. Even with measures to alleviate liquidity constraints, investors may face difficulty meeting their tax obligations without liquidating assets, which poses additional risks and uncertainties.
Increased scrutiny of crypto taxes in Europe
This step by Denmark is in line with increasing global supervision of cryptocurrencies. As reported by CryptoSlateresearchers from the Federal Reserve Bank of Minneapolis and economists from the European Central Bank (ECB) recently discussed ways to tackle the challenges of cryptocurrencies like Bitcoin. Some have even proposed measures to “eliminate” Bitcoin, highlighting growing concerns among regulators about the impact of digital assets on traditional financial systems.
ECB economist Jürgen Schaaf expressed concern that Bitcoin’s rising price disproportionately benefits early adopters, potentially leading to significant economic disadvantages for latecomers or non-holders. He argued that Bitcoin does not increase the productive capacity of the economy and that capital gains for early investors come at the expense of others. Schaaf suggested that policies should be implemented to curb or possibly eliminate Bitcoin’s expansion, warning that pro-Bitcoin policies could further skew wealth distribution and threaten societal stability.
However, the Satoshi Action Fund has produced a solid rebuttal to the ECB documentwhere the shortcomings in the arguments are succinctly highlighted.
Some observers see Denmark’s proposed tax model as part of this broader effort, which may aim to curb cryptocurrency use by imposing stricter tax obligations. By aligning the crypto tax with certain financial contracts and taxing unrealized profits, the government could aim for stricter regulation of the crypto market, potentially discouraging speculative investments.
Why does Denmark want to tax unrealized crypto profits?
The proposed model is in line with the existing Danish taxation of financial contracts, promoting consistency between different financial instruments. By treating crypto similarly, authorities aim to streamline the tax system and reduce the complexity of crypto taxation. This reflects an attempt to integrate cryptocurrencies into the established financial regulatory framework.
However, implementing such a tax system requires careful consideration of its impact on investors and the broader crypto ecosystem. It is critical to balance the need for effective taxation with the potential burden on taxpayers to avoid unintended consequences. These could include taking crypto activities underground, pushing investors to jurisdictions with more favorable tax regimes, or reducing the competitiveness of the Danish financial sector.
The government’s recommendation signals an important development in crypto taxation, highlighting the desire to adapt tax law to emerging financial technologies. How this proposal will impact the Danish crypto market remains to be seen, but it highlights the continued evolution of regulatory approaches to digital assets.