When I read recently that the famous USA sales house, Fasig-Tipton, became the very first auctioneers worldwide to accept Cryptocurrency as a mode of payment for its 100th Saratoga Select yearling sales, I instinctively knew that it’s about time I wrote an industry article on this topic.
The breeding and racing industry is a “high risk, high stakes” industry where many of its players have been successful in other pursuits that, unsurprisingly, also exhibit the same risk profile.
Higher risk industries such as property developing, securities trading, professional gambling, mining, hospitality and winemaking readily spring to mind as industries that often generate serious horse industry players.
Our practice has found, especially in the past 10 years, that investing in Cryptocurrencies has become especially appealing to our clients (not just horse industry!) with a natural propensity for tolerating greater risk for higher returns. Exotic new forms of investing always creates great curiosity.
Our Cryptocurrency investors (and their network) are constantly approaching us to establish what the tax implications are for this type of investing, so maybe it’s time to “break the mould” and provide a release on the important tax issues for this emerging investment class.
- What is Cryptocurrency?
The popularity of investment in cryptocurrency has been exaggerated in recent years because of its substantial appreciation in value.
By way of background, ‘cryptocurrency’ is a form of digital currency. Whilst it is distinct from physical currency, it exhibits similar properties and may be used to buy physical goods and services. It allows for instantaneous transactions and borderless transfers and has been described as “a virtual currency essentially operating as online cash”. Cryptocurrencies use cryptography for security to regulate the generation of units of currency and verify the transfer of funds, which makes it difficult to counterfeit. It is decentralised, which means that it operates independently of a central point of control over the money supply (e.g., a bank).
In case you’re curious, neither William Inglis & Son nor Magic Millions currently accept cryptocurrency as a form of payment.
In 2009, Bitcoin became the first decentralised cryptocurrency and since then numerous cryptocurrencies have been created and, according to CoinMarketCap, the total number of cryptocurrencies is 7,812 with a total market cap of $324.716 billion (as of January 2021). Being decentralised, the Bitcoin system is peer-to-peer and transactions take place between users directly, without an intermediary.
Crypto transactions are verified by network nodes and recorded in a publicly distributed ledger called a ‘blockchain’. A blockchain is a data structure that makes it possible to create a digital ledger of data and share it among a network of independent parties. Nodes safeguard the network by mining for the cryptocurrency Bitcoin. New Bitcoins are created as a reward for processing transactions and recording them inside the blockchain. Nodes also earn a small fee for confirming transactions.
2.1 How are transactions involving cryptocurrencies treated for taxation purposes?
It is important to note that there is not a ‘one-size-fits-all’ approach to determining the income tax implications of transactions involving cryptocurrencies. Rather, cryptocurrencies are dealt with under ordinary income tax principles, with implications varying depending on the specific facts and circumstances of the case. That is, the tax treatment of cryptocurrencies in one situation may differ to the tax treatment in another situation, even in the hands of the same taxpayer.
TAX WARNING – Cryptocurrencies are NOT a form of money
There continues to be a lot of confusion surrounding the correct tax treatment of cryptocurrencies and some of that confusion is likely attributed to its name. Despite being referred to as a ‘currency’, cryptocurrencies are not ‘money’ from a tax perspective. In addition, it is not considered a form of ‘foreign currency’ and so the FOREX rules do not apply.
Instead, the ATO regards cryptocurrencies as an asset, which means that most transactions will generally be dealt with under the capital gains tax (‘CGT’ rules). Its tax profile would be more akin to a commodity or shares and, in some ways, it is generally more helpful to approach the tax treatment of cryptocurrencies in the same manner as commodities and shares.
2.1.1 Dealing with profits and losses from the disposal of cryptocurrencies\
Considering the rapid development and growth of digital currencies worldwide, there was a desperate need for some certainty surrounding their tax treatment in Australia. After considerable consultation with industry and other interested stakeholders, the ATO released a series of Tax Determinations in 2014 (re Bitcoin only) to address some of the uncertainty surrounding the treatment of cryptocurrencies from a tax perspective. These are broadly summarised below:
- Bitcoin is not a ‘foreign currency’ for the purposes of the Tax Act
- Bitcoin is a ‘CGT asset’ for the purposes of The Tax Act
- Bitcoin is ‘trading stock’ for the purposes of The Tax Act where it is held as part of a trading ‘business’
- The provision of Bitcoin by an employer to an employee in respect of their employment is a property fringe benefit under the FBT Act
The income tax and CGT consequences of cryptocurrency transactions are vastly different depending on whether the taxpayer acquired and held the cryptocurrencies for the purpose of:
- sale or exchange in the ordinary course of a ‘business’; or
- for longer-term investment or for speculative purposes.
Broadly, the consequential tax implications are as follows:
- If held for the purpose of sale or exchange in the ordinary course of business (e.g., a cryptocurrency trader who carries on a business of buying/mining and selling cryptocurrencies).
If you can demonstrate a business, losses are immediately deductible and GST can be claimed on the operations. The cryptocurrency will be considered to be trading stock and must be accounted for accordingly.
Business characteristics
The courts have held that a ‘business’ for tax purposes has the following relevant characteristics:
- whether the activity has a significant commercial purpose or character;
- whether the taxpayer has more than just an intention to engage in business;
- whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity;
- whether there is repetition and regularity of the activity;
- whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business;
- whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit;
- the size, scale and permanency of the activity;
- whether the activity is better described as a hobby, a form of recreation or a sporting activity;
- keeping of proper records;
- time expended and research undertaken;
- capital invested; and
- existence of a Business Plan.
For further guidance, also refer to ATO’s factsheet: ‘Shareholding as investor or share trading as business?’.
- If held for investment purposes (e.g., an investor who hold the cryptocurrency for medium to long-term investment purposes) – the disposal of cryptocurrency held for investment purposes will attract CGT implications.
Note that it is unlikely any interest expense incurred to acquire the cryptocurrency will be deductible as they do not generally generate any assessable income (unlike dividends from shares). Therefore, interest expenses would generally form part of the cost base of the cryptocurrency. The general 50% discount is potentially available where the cryptocurrency has been held for the requisite 12-month period. - If held as part of an isolated profit-making transaction (e.g., isolated cryptocurrency transactions of a speculative nature where the intention is to profit from fluctuations in the market) – these transactions are taxed in a unique way and a number of separate calculations are required under multiple tax regimes. The ‘net profit’ (which is broadly the difference between the proceeds of sale and the cost of acquisition, taking into account selling costs) are assessable as ordinary income.
In addition, the CGT will also apply to the transaction, but to avoid double taxation, any resultant gross capital gain is reduced by the ‘net profit’.
2.1.2 Cryptocurrency as a personal use asset (‘PUA’)
If the crypto is held for an investment purpose (refer above) a capital gain arising from the disposal of a personal use asset (‘PUA’) is disregarded where the first element of the cost base of the PUA is $10,000 or less. Any capital losses from a PUA are also disregarded. In general terms, a PUA is a CGT asset (except a collectable) that is used or kept mainly for one’s personal use or enjoyment. A PUA can also include an option to acquire such an asset and certain types of debts.
In the context of cryptocurrencies, it is possible for them to be considered PUAs, however, it will depend heavily on the circumstances under which they are acquired and used. Essentially, as cryptocurrencies are only capable of being acquired, held and transacted with, it will only be a PUA if it is kept or used mainly to purchase items for personal use or consumption.
If Bitcoins were acquired to facilitate the purchase of income-producing investments, then they would not be PUAs. For example, if an individual taxpayer purchased Bitcoins to buy an investment property, then the Bitcoins would not be PUAs.
TAX WARNING – Are cryptocurrency transactions really anonymous?
There is a common misconception that cryptocurrency transactions provide a high level of anonymity, which makes them totally undetectable by the ATO.
Cryptocurrency transactions are, by design, not specifically linked to a person or identity. Rather, public addresses are used instead for transactions and are publicly recorded on the blockchain. Whilst a person’s name, physical address or email is nowhere to be found in the transaction, the person’s identity can still be tracked down using public address information and IP addresses. In particular, the ATO can track transactions against taxpayers through its extensive data-matching program once the cryptocurrency has been converted.
2.2. SMSFs and Cryptocurrencies
Whilst there is nothing that specifically prohibits an SMSF from investing or transacting in cryptocurrency, a number of important considerations must also be considered first due to the additional compliance requirements that are imposed upon SMSFs.
Perhaps most notably, SMSF trustees should consider whether the high level of risk associated with investing in cryptocurrencies is acceptable and appropriate for the fund. As with any other investments held by SMSFs, it must be allowed for under the fund’s trust deed, be in accordance with the fund’s investment strategy and also comply with the relevant superannuation laws and regulatory requirements concerning investment restrictions.
2.3 ATO confirms tax sting for investors who exchange one cryptocurrency for another
Another misconception that appears to have emerged in recent times is that the exchange of one cryptocurrency for another has no tax implications. However, this is not the case.
The ATO has confirmed that a taxpayer who exchanges one cryptocurrency (e.g., Bitcoin) for another cryptocurrency (e.g., Ethereum) has disposed of one asset (e.g., Bitcoin) and acquired another CGT asset (e.g., Ethereum). The fact that this transaction does not involve the exchange of any currency does not affect the analysis that a CGT event has occurred.
Example 1 - Exchange of Ethereum for Litecoins
On 21 January 2019, Ralph purchased 100 Ethereum tokens for $12,000 (i.e., unit price of $120) to hold as a long-term investment. To diversify his cryptocurrency investments, he exchanged 30 Ethereum tokens for 70 Litecoins on 16 March 2019.
Based on the exchange rates published on the reputable digital currency exchange at the time of the transaction, the market value of 70 Litecoins was $4,200 (i.e., unit price of $60). As such, the capital proceeds from the disposal of Ralph’s 30 Ethereum tokens is $4,200.
Consequently, Ralph will have a capital gain of $600 because of the exchange. This is calculated as capital proceeds of $4,200 less cost base of $3,600 (being 30 Ethereum tokens @ $120 each). As Ralph has owned the Ethereum tokens for less than 12 months, he is not entitled to the 50% general CGT discount.
You are welcome to contact me if you wish me to clarify or expand upon any of the matters raised in this article.
Prepared by:
PAUL CARRAZZO CA
Carrazzo Consulting Pty Ltd
801 Glenferrie Road, Hawthorn, VIC, 3122
TEL: (03) 9982 1000
FAX: (03) 9329 8355
MOB: 0417 549 347
E-mail: paul.carrazzo@carrazzo.com.au or team@carrazzo.com.au
Web: www.carrazzo.com.au
