With news of the IRS ordering more than 10,000 taxpayers in the United States to pay back taxes and amend their returns to reflect their virtual currency transactions, the tax treatment of digital assets has quickly become a burning issue for people all over the world.
For those Australians working on their EOFY 2019 returns right now, I caught up with blockchain lawyers Will Fennell, partner at the Tax Group, and Michael Bacina, partner in the blockchain and fintech group at Piper Alderman, to get the lowdown on all things crypto at Aussie tax time.
To report or not to report
In years gone by, some people might have thought they could get away with not reporting their crypto activity to the tax office. But in April this year, the ATO announced they had been obtaining data from digital currency exchanges for the purposes of identifying buyers and sellers of cryptocurrency.
“There’s no doubt that data will be used to compare against tax returns lodged with the ATO,” Bacina says.
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Of course, if a taxpayer hasn’t crystalised any losses or gains, then there would be nothing to report. But Fennell reckons almost everyone who has been transacting with crypto will need to report their activity at tax time, and a failure to report may incur both fines and penalties as well as a general interest charge, which is currently about 8.5% per annum compounding daily — which adds up very quickly.
Which type are you?
It’s important to recognise the ATO views you differently depending on how you acquired or received your crypto and what you do with it. The following is an overview of some of the most common types.
If you bought crypto at some point and chose to HODL it — that is, you held onto it rather than selling it — you’re what the crypto crew would call a HODLer.
“Many HODLers think they have the benefit of the personal use assets exemption, but the ATO appears highly sceptical about its use in the context of cryptocurrencies,” Fennell warns. So, even if a taxpayer acquired a token as a hobby, where the token is then held for a period of time, it may be deemed to have an investment purpose and therefore the exemption would stop applying at some point.
In any case, this is usually tested at the time of the asset’s disposal.
2. Professional trader
This group will generally hold their tokens on revenue account. This means that gains and losses can be offset against other ordinary income of the taxpayer, for example, employment income. However, it also means the 50% capital gains tax discount cannot be applied to reduce taxpayer gains (as it would be if the crypto were held as an asset on capital account instead).
3. Earning crypto
“One of the biggest myths I keep coming across is the belief that being paid in crypto or a token isn’t triggering taxable income at the token price at the time it is received,” Bacina says. With this in mind, if you are accepting crypto as payment, and you hold onto that crypto, you will need to make a record of the price on the day you received it, so you have an acquisition price. From there, a capital gain or loss can be calculated when the crypto is sold.
Many merchants are accepting crypto via payment gateways, such as Sydney-based Paid by Coins, which means the merchant receives cash rather than crypto. This simplifies their accounting.
Generally, taxpayers conducting a business of mining cryptocurrency will hold the tokens as trading stock. Under the trading stock rules, proceeds from the sale of cryptocurrency held as trading stock in a business are ordinary income. The ATO has released guidance which provides information on some special rules that apply to crypto mining.
Can I claim deductions?
If you are conducting a business involving cryptocurrency, then yes, all expenses necessarily incurred for the purpose of producing income are deductible. Generally, a taxpayer is seen to be conducting a business if they carry on an activity for commercial reasons in a commercially viable way, including having a business plan and profit-making intention.
If the taxpayer is not conducting a business, there are far fewer opportunities in terms of claiming expenses. “Also, if the crypto is held on capital account, any losses can only be offset against other capital gains, but not against revenue gains,” Fennell explains, making an important distinction between the treatment of investment assets versus business revenue.
Any grey areas?
There are three areas where binding taxpayer guidance is needed. The first two of these are hard forks and airdrops. “Apart from some general guidance on the ATO website, there are no pronouncements from the ATO that a taxpayer can rely on, and many jurisdictions including the US have this issue,” Fennell says. The third is in relation to the value of tokens both at acquisition and disposal time. Because of the sheer number of exchanges and varying prices between them, it is difficult for taxpayers to reliably estimate these amounts.
Oh no! I already lodged for 2019
If you realise you’ve made a mistake, you can always go back and amend your tax returns, and the sooner that is done, the better. In any case, it’s critical that taxpayers seek professional tax advice to ensure that their returns are correct.
Bring on EOFY 2020
If you’re looking for opportunities to minimise your tax over the coming year, Bacina says the biggest opportunity is where crypto has been acquired, then increased in value, before being used to purchase other crypto, which then has fallen in price.
“Just like traders will look to lock in losses before June 30, it may pay for crypto holders and traders to consider selling crypto which is at a capital loss before June 30, 2020, in order to offset against capital gains which may have built up in transactions during the year,” Bacina explains.
It all starts from having a good accounting system. Record keeping is essential and there are increasingly automated reporting solutions available. Independent Reserve has partnered with KPMG to offer a tax estimator tool so traders can get a quick and easy estimate on the tax obligations of their portfolio.
For companies that deal with crypto, Kaunto is an example of a software solution tailored to the accounting and bookkeeping requirements of a crypto business needing to report a wide range of commercial data between wallets, exchanges and bank accounts.
In any case, your crypto interests needn’t land you on the ATO’s naughty list. Get your records up-to-date, report all relevant activity with your annual return, and when in doubt, seek professional advice.