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Where Does Bitcoin Mining Take Place?

Author: David J. Shakow, Professor Emeritus, University of Pennsylvania School of Law.1

The discussion in this document reflect legal principles as of January 20, 2020.

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If someone is engaged in mining bitcoins, for example, where does that activity take place? The answer  to that question has serious ramifications. It will affect whether the activity is deemed to be engaged  within the United States, and therefore subject to US taxation if it generates income for a foreigner. And if it is engaged within the United States, it is important to know the location of the activity for purposes  of state tax jurisdiction, even if the taxpayer is a United States taxpayer.  

Determining the location of an electronic-based activity is a focus of substantial analysis within the  international tax community. No matter what test is proposed, the ease of moving electronic-based  activity from one place to another makes it extremely difficult to impose tax on such activities. The issue  is sufficiently serious that many nations, including the U.S., have been working for the past few years,  under the auspices of the Organization for Economic Cooperation and Development (OECD), in an  attempt to solve this problem (the “BEPS” project).  

There is as yet no guidance from the IRS that would resolve this issue. What factors might be taken into account to determine the location of a mining activity? The IRS could look to the location of the  computers that are running the programs for the miners. It could look to the location of the persons  who are running the mining operation. It could look to the location of the persons who have committed  their computing resources to the mining operation, which is not necessarily the same location as where  the computers themselves are located.  

The IRS’s choices may be slightly more limited in the context of a cryptocurrency that operates under a  proof of stake protocol. In that structure, there is only one person actively engaged in confirming  transactions, and so only one person’s computers could be looked to.  

The IRS has only recently begun to suggest what direction it might follow in resolving issues such as  these. In proposed regulations relating to the characterization of cloud computing activities, the IRS  concluded that where software is sold by download, the preferred factor in determining where the sale  takes place is to identify the location where the software was downloaded. If that cannot be identified,  the address of the purchaser could be used. It should be appreciated how simplifying this result is: once  the program is downloaded, there is no reason to think that it will be used in that location. In addition,  the buyer may have substantial discretion in deciding where to download the program.  

It is not easy to extract a clear direction that the IRS might be taking from this small bit of evidence. One  can speculate that the IRS is looking for the clearest possible answer to questions in this area. Thus, when it comes to cloud computing, the IRS did not suggest that the income should be attributed to the  location of the computers involved in the activity, since, in the cloud computing context, the computers  used can vary from one moment to the next.  

However, in the blockchain context, no standard is particularly easy to apply. Someone selling through  the cloud will want to identify its buyer for billing purposes. However, in the mining context on a  blockchain, the actual identity of the parties involved may well be hidden. If we are looking for a simple  test in order to identify the location of a mining operation, we might well look to the location of the  person operating the mining operation. While this information might be made available to the  participants in the operation, confirming the information is not easy. In the somewhat informal manner  in which these arrangements are sometimes conducted, this lack of assurance may be normative,  although it also makes it easier for fraud to occur.  

There is no assurance that the IRS will follow the approach suggested above in determining the location  of a mining operation. Note that, in the situation to which the IRS’s proposed regulation dealing with  cloud transactions applies, the seller wants to identify the location of its buyer to be sure it is paid. Here  it is the participants who are trying to identify the location of the person running the activity, and they  are doing so only for tax purposes.  

As mentioned above, national governments are working with the OECD to reach a consensus on how to  locate income generated in cyberspace. It is certainly possible that a broader solution will be developed  that will result in clarifying how to deal with issues such as the location of mining activities. Until the  solution is forthcoming, practitioners will have to satisfy themselves that they have used due diligence  to determine a reasonable answer to the question of where the activity is located for tax purposes. 

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1 The statements in this paper represent the views of the author only and should not  be attributed to the University of Pennsylvania School of Law. Further, this document should not be treated as  legal advice to any reader or to Lukka. 

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