Isn't spending bitcoins a tax event, meaning you must account for the fiat value of any gains regardless (i.e. fiat value of the goods or services you purchase minus fiat value of the bitcoins when you acquired them)? The tax ruling was not just about converting BTC to fiat.
They even consider trading bitcoins for bitcoins to be a taxable event.
It is absurd.
I commend the op and anybody with the balls to refuse their outrageous demands.
Taxing bitcoins is like taxing maplestory mesos or any in-game currency, it's silly.