What is Cryptocurrency?
Cryptocurrency (Crypto) is a digital asset that can be an investment, a medium of exchange or a means to access goods or services. It is treated differently by different countries and differently within a single country, depending on why it was acquired and by extension, how it is used.
Is it foreign currency, a capital asset, or trading stock? Is it treated like money when you use it as a medium of exchange or can payment using Crypto trigger tax consequences (losses or gains) on its disposal as a medium of exchange?
As suggested above, the answers depend on where you are in the world and what you are using Crypto for.
Generally, Crypto is acquired by purchasing through a Crypto exchange, digital mining (using significant hardware and power costs to solve complex algorithms) or by transfer or exchange.
How is crypto treated for tax purposes?
In Australia, it is reasonably settled (for the moment) that Crypto in most commonly understood forms (think bitcoin) is generally regarded as a capital gains tax (CGT) asset and when it is used simply as a store of wealth, or long-term investment, is capable of being held on capital account and generating capital gains or losses on sale.
However, crypto may be considered as being held on revenue account, with the net proceeds from realisation taxed as ordinary income and losses deductible against other income if you are in the business of:
- mining and/or trading Crypto;
- carrying on a Crypto exchange business or;
- acquiring/holding Crypto for the purpose of sale or exchange;
The principles being applied here are simply those laid down in landmark revenue/capital cases that apply to other types of assets such as land and shares. Let’s look at three different taxpayers who have sold Crypto in the same tax year and see how their different circumstances might change their tax outcomes.
Taxpayer scenarios
Our first taxpayer (Alessandra) regularly buys different types of Crypto that she considers is undervalued or that has suffered a recent decline. She does this when she speculates that the price will rise or recover and she commonly sells Crypto to fund new investments, resulting in a reasonably significant volume of trading. By day, Alessandra is a Partner in a large legal practice.
Our second taxpayer (Justin) sometimes accepts Crypto from customers as payment for his software engineering services and will use Crypto to buy business equipment online or pay others for contract programming work that he procures for larger jobs, from time to time.
Our third taxpayer (Amy) received $10,000 as a 30th birthday present about 1 1/2 years ago from her parents to kick start her entry into investing and she decided to buy Crypto. When Crypto started to fall, she became uncomfortable about the exposure of all of her investment to volatility and quickly sold half of her Crypto to acquire some more stable investments.
For each of our taxpayers, a market crash in the value of Crypto has resulted in losses at the end of the year from their Crypto transactions. Do we treat each of our taxpayers the same?
Income or capital account – back to basics
What we know since 2014 is that the starting point from the ATO point of view is no different from other assets. Crypto is a CGT asset, so that selling or trading it will trigger CGT, unless an exemption applies or unless it is subject to income tax outside of the CGT provisions[1].
Although at first Alessandra seems like she could be in the business of Crypto trading, the ATO essentially applies the same principles which would be applied to shares (and other assets that might be acquired speculatively or for re-sale). Even if there is significant speculation in the activities of a person who buys and sells Crypto, the transactions can still be on capital account, if viewed objectively, they lack the necessary elements of a “business operation or commercial transaction”.
Alessandra and the Myer Emporium principle
Conversely, it is well settled in what is now referred to as the ‘Myer Emporium principle’ that a transaction that is not part of a business can still be on revenue account if it “…nevertheless arises from a transaction entered into by the taxpayer with the intention or purpose of making a profit or gain...”. and where the property was acquired “in a business operation or commercial transaction”.
Applying this principle to Alessandra, although it is relevant that she is a full-time lawyer conducting Crypto activities in her own time, the losses she has made could still be tax deductible, at least as a general deduction. This will be the case if the profit-making purpose in acquiring Crypto can be inferred from her activities and the sales generating her losses were made as part of a business operation or commercial transaction to generate those profits.
What the cases show us is that the question of whether one-off loss or profit-making transactions will constitute a ‘business operation or commercial transaction’ will often come down to the systems and sophistication of the taxpayer in executing their profit-making plans. The recent case of Greig v FCT[2] concerned a taxpayer otherwise employed full-time as a managing director, who traded in shares to maximise his retirement nest-egg. The Full Court found that he was able to deduct large losses on revenue account. The case was instructive as to the importance of evidence, detailing the particular circumstances of the taxpayer and turning on:
- the existence of the profit-making purpose upon entry into the transactions to acquire the shares;
- the taxpayers sophisticated overall plan to generate profits for retirement with the transactions being in pursuance of that plan;
- the shares being acquired systematically on 64 separate occasions;
- the increase in acquisitions over time being a result of the taxpayer’s goal to realise what he perceived to be the true value in the company, which he considered was not reflected in the share price;
- the application by the taxpayer of his business knowledge and experience in purchasing the shares; and
- the taxpayer acting as a businessperson would in executing his plan.
Although Amy’s circumstances would seem to indicate that because of her profit-making purpose, she is trading on revenue rather than capital account, the situation is a bit more line-ball, when we consider the additional requirements that must also be present. The more sophisticated her operation in pursing her profit making purpose, the more likely it will be on revenue account.
Justin – does scale really matter?
Our second taxpayer (Justin) is interesting because the facts seem to suggest that his acquisition and sale of Crypto is much less frequent and on a smaller scale than Alessandra’s. Notwithstanding that, the acquisition of Crypto is an ordinary incident of Justin’s business and once acquired, it is held for business purposes of paying contractors or buying business equipment or supplies.
The definition of trading stock for tax purposes includes anything acquired for the purposes of sale or exchange in the ordinary course of a business.[3] For Justin then, even the scale of his Crypto activities appears much less than Alessandra’s, the position would seem to be clearer, in that not only would the loss generate a deduction for the business but the Crypto is most likely trading stock of Justin’s business.[4]
Amy played it safe
In contrast, Amy is more clearly an investor. She has bought Crypto with a gift from family and does not have a history of trading. Her strategy is to expand the capital value of her portfolio over time and to date, she has sold only for the purposes of diversifying her portfolio.
There is no real scale to her activities which objectively, would look more like a hobby or a store of wealth than a commercially driven profit-making activity. The facts would support that she holds Crypto on capital account.
Is it really that simple though?
Although Crypto is inherently complex in its creation and identification, the tax law basics of simple Crypto transactions involving better known and understood cryptocurrencies, mirror those of similar assets bought and sold under our tax system.
The revenue/capital distinctions that have occupied the minds of tax professionals for decades are equally applicable in the world of trading commonly understood forms of Crypto and equally frustrating when you find yourself with a line-ball client. Given the uncertainty, the approach taken by the taxpayer in Greig v FCT (discussed earlier) is worth considering. That is, seek a private ruling and object if you disagree with the outcome, rather than risk penalties and potentially interest, if you fall on the other side of the line.
As things stand, there have been efforts to characterise specific cryptocurrency transactions, such as those involving bitcoin, under existing tax principles.[5] As Crypto is evolving and taking on new features, it remains to be seen whether existing tax law principles remain capable of adequately characterising it.
To this end, the Board of Taxation have recently released a Consultation Guide for a review into the tax treatment of digital currencies. The first questions off the rank ask whether the current tax treatment has areas of uncertainty and whether Crypto has features that are incompatible with current tax laws. The results will be interesting.
[1] ATO Taxation Determination TD2014/26
[2] [2020] FCAFC 25
[3] Section 70-10(1) Income Tax Assessment Act 1997 (Cth)
[4] Taxation Determination TD2014/27 at paragraph14.
[5] Taxation Determinations TD 2014/26, TD2014/27 and TD2014/28 concerning the treatment of bitcoin as a capital asset, as trading stack or subject to FBT respectively.
