The last few weeks have highlighted the volatility of the cryptocurrency market.
We live in a world where a few tweets affect values which is pretty worrying for your average investors.
At the same time, keeping abreast of the tax issues associated with cryptocurrency is now as challenging as ever.
Within Australian tax legislation, there are specific rules governing the taxation of foreign currencies, but Australia (and most other countries) have categorically stated that cryptocurrency is not a foreign currency and therefore the foreign currency translation rules contained within our tax legislation do not apply to cryptocurrencies and they are taxed like any other type of asset eg. real property in Australia.
Before we even delve into the taxation of cryptocurrencies, taxpayers need to determine when a taxable event occurs.
A common misconception is that cryptocurrency is only taxable once it is exchanged for cash, but this is not the case and there may be other taxing events e.g. when one cryptocurrency is exchanged for another.
This is a simplistic example, but complications arise where there are airdrops, initial coin offerings, chain splits, mining, and more complex taxing events.
Once there is a taxing event, you then need to determine the tax implications.
The treatment will generally fall within one of three categories listed below:
Capital Gains Tax Asset
Most individuals would generally hold the cryptocurrency as a Capital Gains Tax (CGT) asset. A key characteristic is the intention to hold the cryptocurrency as an investment for the long-term. CGT assets are subject to the CGT regime.
If you held on to the cryptocurrency for more than one year, you would receive a 50% CGT discount on any subsequent gains (if any).
If you incur a loss from your investment, the loss would be considered a capital loss which can only offset current year (or future) capital gains.
There are exceptions to the rule where it can be shown that the cryptocurrency is a personal use asset – those assets costing less than $10,000 used for personal use or consumption – however, this would be a rare occurrence.
Cryptocurrency trading business
Whilst not many would fall into this category, cryptocurrency gains and losses may be assessable on revenue account as trading stock if you are in a business of trading cryptocurrency.
Carrying on a business of trading cryptocurrency is a matter of fact and there needs to be a level of sophistication to fall within this category.
As a cryptocurrency trading business, gains on the sale of the trading stock are assessable in full (and not eligible for the 50% CGT discount) and any losses may be deductible against the taxpayer’s assessable income during the year.
There is the ability for some tax planning as the trading stock can be valued at cost, market or replacement value.
For example, if the value of Bitcoin falls, the Bitcoin could be valued at market value so that the losses from the Bitcoin could be potentially offset against other gains.
If you acquire cryptocurrency with the intention of making a profit and are not a cryptocurrency trader or holding the cryptocurrency as CGT asset, the cryptocurrency is likely to be held as a revenue asset.
As a revenue asset, gains on the disposal of the cryptocurrency are assessable in full (and not eligible for the 50% CGT discount) and any loss would also be considered a revenue loss.
A key difference between trading stock and revenue assets is the ability under the trading stock provisions to value the trading stock at cost, market or replacement value.
Care should be taken by taxpayers who suffer losses and want to argue the loss is on revenue account and therefore, deductible against other assessable income.
The Australian Tax Office (ATO) do not shy away from reviewing and challenging these positions.
There is substantial case law around when an asset is held with the intention of making a profit or part of a commercial transaction, which should be carefully considered.
What’s in the pipeline?
The OECD has previously suggested that tax authorities worldwide should work towards standardising the taxation of cryptocurrency given the complications in relation to the various taxing events and different types of cryptocurrencies.
Another area to keep an eye on is the issuance of digital currencies by central banks around the world and this would certainly add some more complexity.
It could be that in a few years’ time, we may have separate rules depending on the type of cryptocurrency being held and a “one size fits all” approach would no longer be appropriate.
Time will only tell but we may land in the situation where certain cryptocurrencies are taxed as a foreign currency (especially if it is backed by a central bank) as opposed to the methods described above.
One thing is for sure, this is an evolving area of taxation, and we may be a few years away from achieving a simple way to tax cryptocurrency – if that is possible at all.
- Davide Costanzo is chairman of the Moore Australia Tax Committee.