How Tax Laws Apply to your Cryptocurrency Gains
- According to the Australian Taxation Office, more than 600,000 taxpayers have invested in crypto assets in recent years, and many have failed to declare their capital gains.
- The technology that supports cryptocurrencies is relatively new, but the tax laws that apply are well established under capital gains tax provisions for cryptocurrency investors.
- Australia is supporting work under way at the Organisation for Economic Co-operation and Development to develop a tax transparency framework for crypto assets and digital money products.
The Australian Taxation Office is working hard to shatter the misconception that cryptocurrency gains are exempt from tax or taxable only when cashed back into dollars.
On paper, the capital gains are nothing short of staggering.
Over the full course of the 2020-2021 financial year, anyone with a stake in the cryptocurrency Bitcoin would have seen the value of their holding surge by more than 250 per cent.
After starting the last financial year at about US$9146 (A$12,409), the closing price for one Bitcoin on 30 June 2021 was US$35,040 (A$47,544).
Yet, savvy Bitcoin traders could have achieved a much higher cash profit of more than 600 per cent last year.
That’s the gain based on having bought at the financial year’s low point of just over US$9000 (A$12,000) in July 2020 and then having sold at the crypto’s peak of almost US$65,000 (A$88,000) in mid-April 2021.
Even better than that, those holding another cryptocurrency called Ethereum could have booked a profit of more than 600 per cent as its trading price soared from US$226 (A$306) to more than US$2200 (A$2985) over the last financial year.
However, there is one big catch – the capital gains tax (CGT).
Generally, as an investor, if you buy, sell or swap for fiat currency, or exchange one cryptocurrency for another, the transaction is subject to CGT and must be reported.
Cryptocurrency gains are treated in the same way as gains from other investments, such as shares.
The Australian Taxation Office (ATO) is concerned many taxpayers believe their cryptocurrency gains are tax free or only taxable when their holdings are cashed back into Australian dollars. That’s not the case.
This is the message the regulator wants to get through to taxpayers, as well as to accountants and other finance professionals providing tax advice to individuals and businesses.
The ATO estimates more than 600,000 Australian taxpayers have invested in crypto assets in recent years, some of whom have failed to declare their capital gains.
“While it appears that cryptocurrency operates in an anonymous digital world, we closely track where it interacts with the real world through data from banks, financial institutions and cryptocurrency online exchanges to follow the money back to the taxpayer,” warns Tim Loh, ATO’s assistant commissioner.
The ATO has had a data-matching program in place to track cryptocurrency transactions since early 2019, and receives bulk records from Australian-designated service providers as part of the program.
Data provided to the ATO includes cryptocurrency wallet information, including names and addresses, bank details and transaction information in relation to purchases, sales and transfers.
The ATO also uses information collected from international tax jurisdictions, including Common Reporting Standard and Fair and Accurate Credit Transactions Act in the US, as well as data collected through the double tax agreements, to identify when cryptocurrency transactions are converted to a foreign currency or repatriated back to Australia.
“This year, we have written to about 100,000 taxpayers with cryptocurrency assets explaining their tax obligations and urging them to review their previously lodged returns,” the ATO says.
“We also expect to prompt more than 500,000 taxpayers as they lodge their 2021 tax return to review their cryptocurrency transactions and correctly report any capital gains or losses.”
Advice on crypto assets
Even though the technology behind cryptocurrencies is innovative and new, the tax laws that apply are well established under capital gains tax provisions for cryptocurrency investors.
Registered tax agents can help clients to understand that cryptocurrencies purchased as a financial investment are considered to be a form of property and therefore an asset for CGT purposes.
CGT events are usually characterised by a change in ownership. Like other investments in assets, ordinary income may also arise from certain cryptocurrency transactions, such as staking rewards and airdrops.
There are other circumstances where the ordinary income rules apply, and this includes where the client is conducting a cryptocurrency trading business. In this case, the trading stock rules apply, and not the CGT rules.
Proceeds from the sale of cryptocurrency held as trading stock in a business are ordinary income, and the cost of acquiring cryptocurrency held as trading stock is deductible.
“The broader universe of crypto assets is not clear cut – what percentage falls clearly in ASIC’s remit or clearly out, or falls somewhere in the middle? The reality is that the clarity that’s needed here is a matter for government.” Hema Raman, Australian Securities and Investments Commission
This is much the same treatment that would apply to a person who is carrying on a business of share trading.
There are also situations where an isolated cryptocurrency transaction or series of transactions can give rise to ordinary income if the transaction was entered into with a purpose or intention of making a profit, and the transaction is part of a business operation or commercial in character.
“We also recommend that agents access pre-fill reports available through online services for agents,” the ATO says. “These reports can help agents update their tax time questionnaires to include a question that will prompt their clients to disclose their crypto activities to the agent, including buying, selling and other investment activities.
“It’s also important for agents to include capital losses in the tax return, so their clients don’t forget to apply these losses when they make a future capital gain.”
James Tng, a partner at accounting firm Moore Australia, says it is the responsibility of tax agents to ensure the returns being lodged on behalf of clients are correct.
“There is a bit of risk for accountants out there, where clients choose not to be forthcoming. In the eyes of the ATO, it’s tax evasion by not declaring the income on cryptocurrency gains.”
Tng adds that accountants should explain the tax position on cryptocurrency gains and losses to clients, including the need to revalue assets in Australian dollars, which may also lead to currency gains.
Accountants should also be across how cryptocurrency investments apply for self-managed super funds (SMSFs).
While SMSFs are not prohibited from investing in cryptocurrencies, the investment must be allowed for under the fund’s trust deed, be in accordance with the fund’s investment strategy and comply with the Superannuation Industry (Supervision) Act and regulations.
The advice from the ATO is for cryptocurrency traders to keep accurate records, including dates of transactions, the value in Australian dollars at the time of the transactions, what the transactions were for and who the other party was, even if it’s just their wallet address.
Similar to record-keeping requirements for other types of income and deductions, bank statements generally do not include all the required information.
Instead, it’s best for cryptocurrency traders to keep records as they go, saving copies of receipts and even using spreadsheets or crypto accounting software.
Seeking digital clarity
The taxation of cryptocurrency transactions in Australia is based on existing taxation law, which is consistent with countries such as the US, Canada, the UK and European countries that have not introduced cryptocurrency-specific taxation legislation.
Australia is supporting work underway at the Organisation for Economic Co-operation and Development to develop a tax transparency framework for crypto assets and digital money products.
The proposed framework seeks to address the risks associated with the lack of transparency surrounding these products.
Joni Pirovich, special counsel on tax, blockchain and digital assets at law firm Mills Oakley, says there needs to be a taxonomy of different types of digital assets and what the high-level legal and tax considerations are for both issuers and taxpayers.
“We think that is the immediate approach required and that resources should be dedicated to that task and continuing that task, because the space is emerging quickly,” she says.
Pirovich recently led a submission on behalf of the Digital Law Association to the Senate Select Committee on Australia as a Technology and Financial Centre.
“It is far beyond accountants, lawyers and financial planners to stay informed about this world.
“I’m a specialist and spend an exorbitant amount of time keeping up to date with what’s happening,” Pirovich says.
“If there was a common resource that lawyers and accountants could access that’s been prepared through a multi-agency working group that was contributed to by specialists in industry, I think that will actually help bring up the quality of accounting and tax advice and compliance across Australia.”
Bitcoin came first, but there are now hundreds of cryptocurrency assets around the world that are actively traded by investors.
The job of regulating them in Australia from a product perspective falls squarely into the realm of the Australian Securities and Investments Commission (ASIC).
“Essentially, if a crypto asset has features that look very similar to the features of a managed investment scheme, it is a financial product,” says Hema Raman, senior lawyer and crypto asset coordinator at ASIC. “The issuer will need to have the relevant financial services licence.
“Then, any market or platform that trades that particular crypto asset will need to have an Australian market licence.
“Our position is that it’s the responsibility of the particular platform to determine whether the crypto asset trades as a financial product, and they need to come to us for the relevant licences.”
Raman says this is because crypto assets differ greatly, and their functions and features can completely change over time.
She says the people who are closest to a crypto asset are the ones who need to make the call on what licences they need to have approved by ASIC.
In addition to being able to invest on currency trading platforms, Australians may soon be able to access exchange-traded products (ETPs) that provide retail investors with exposure to crypto assets.
ASIC has issued a consultation paper (CP 343) seeking feedback on ETPs that have crypto assets as their underlying assets.
Key areas of focus for ASIC are identifying crypto assets that are appropriate underlying assets and establishing good practice in respect of pricing, custody, risk management and disclosure.
“Market operators and product issuers need to be mindful of meeting their existing regulatory obligations when creating, operating and allowing such products, so they can be facilitated in a way that maintains investor protections and Australia’s fair, orderly and transparent markets,” ASIC says in a statement.
Raman notes that there is a wide range of crypto assets, some of which are financial products that ASIC regulates, and others that are not. “It is a very large ‘grey area’. Exchange-traded products are clearly financial products and come within ASIC’s remit,” she says.
“But the broader universe of crypto assets is not clear cut – what percentage falls clearly in ASIC’s remit or clearly out, or falls somewhere in the middle? “The reality is that the clarity that’s needed here is a matter for government.”
Raman says the consultation paper on ETPs (including exchange-traded funds) is to ensure ASIC identifies the right standard of practice required.
“This is a ‘live’ question for us, and it has been prompted by the amount of interest we’ve seen in Australia,” she says.
“Our interest is to put sufficient guard rails around it. Being a product that provides exposure to crypto assets on a regulated platform has a field of protection as compared to accessing cryptos directly.”
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