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September 30, 2022


What ETH-Merge and taxes have to do with each other

The ETH-Merge was successful and the foreseeable hard fork has taken place. Can a tax chaos still be averted?

What ETH-Merge and taxes have to do with each other...

What is the Merge?

The merge has been successfully completed and Ethereum 2.0 is knocking on the door. But what does that mean exactly now? The merge refers to the merging of the Ethereum-Blockchain with the Proof-of-Stake-based (POS) Beacon Chain. This has meant a departure from the previously used and heavily criticized, energy-intensive Proof-of-Work to the consensus Proof-of-Stake. In times of energy crises and climate change, this sounds perfectly acceptable in principle, but it is not universally accepted.

From a technical point of view, the ETH coins do change, of course; however, the user himself does not notice anything and this is also not relevant from a tax point of view since the exchanged "new" ETH coins are 1:1 the same as the "old" ones and basically behave in the same way. The Hodler does not even notice anything concerning his ETH coins. We are talking about a soft fork here.

The Hard Fork and its possible implications... However, there were a not insignificant number of dissatisfied people with the new POS concept among the now former ETH miners who obtained the Proof-of-Work (POW) concept, causing a split from the now POS-based Ethereum blockchain back to a POW-based concept; the so-called hard fork.

And that, in turn, could become a big problem for holders of ETH. Because in the hard fork, all coins on the blockchain were copied which, thus, also affects holders of already existing coins (namely ETH). As a result of the hard fork, they now also received so-called ETHW from the new fork in addition to their regular ETH; virtually like an airdrop. For such a scenario, the currently poor set up regulations are even more unprepared; it could be considered something like "compulsory acquisition" in Germany or "donation" in Switzerland, regardless of the intention of the holders to want this. The problem: taxes would be due for this. By the way, this does not only affect ETH, but any token based on the ERC20 token standard.

As it stands today, on 29.09.2022, ETHW is already trading at around USD 12.

How could this be processed for tax purposes?

In most jurisdictions, the assets of the "new" fork could be considered "acquired free of charge" (a so-called zero-cost basis), which in itself does not trigger any immediate tax obligations for the time being, as no real gain is yet realized. However, a later disposal after a certain period of time could mean a potential taxable gain.

In Germany, for example, the acquisition costs could be split between ETHW and ETH. At best, ETHW has a market value of EUR 0 at the time of hardfork. New assets could inherit the acquisition date of the fork origin asset. This means that if the asset was acquired e. g. one year ago, both assets would be immediately tax-free. In Austria, ETHW tokens would have an acquisition price of EUR 0. Anyway, the subsequent sale of these coins could trigger a 27.5 % capital gains tax on the proceeds. Things look bitter in the US; because here, hard forks are generally and rigorously taxable. So if there is already a market value for ETHW tokens, there is also a tax liability - even if the holder takes no action.

In order to get the whole thing under control, at least from a tax perspective, the Hodler now has a few options (these could also be relevant for other forks on other blockchains, by the way); one could determine the exact time of the fork of an asset or coin and determine the starting rates as well as the rates of the main currency. From the relation of the two rates, a notional acquisition for the new coin of the fork would have to be determined for each acquisition transaction.

Of course, the smart Hodler knows that according to current tax regulations, ETHW tokens can be sold tax-free after one year, i. e. the expiration of the speculation period or holding period, but it could well be that dramatic price increases are recorded in the meantime. In this case, the temptation to sell the new Coins is very great.

If it is a manageable amount with a few transactions, this can certainly still be done. However, if several thousand or more transactions have been completed, the skilled trader now has an almost impossible problem, which is already difficult to handle.

The solution is BLUE!

The fact that crypto profits might be a problem in terms of tax law is no new information. Even for companies that often have to declare several thousand transactions, dealing with them from a tax perspective is not easy. This is because obtaining the correct data, such as historical price data for a transaction or similar, often requires considerable effort and is inevitably not necessarily accurate. In addition, there is a significant potential for error in the management of transactions, often in the form of Excel spreadsheets. With the challenges described above due to the spin-off or a hard fork, this becomes considerably more complex, diffuse and overall, of course, more error-prone.

With DAT BLUE, however, we can help our customers manage this complex task and accurately prepare much of the transaction data. The system automatically delivers the price data at a given point in time and prepares it for relevant reporting or transfers it directly to accounting programs such as Abacus or Run My Accounts. In this case, the data ends up directly where it is best kept: With the responsible accountant.