As cryptocurrencies gather momentum among investors, it is no surprise that both the public and the Australian Taxation Office are turning their thoughts towards those who invest in this digital asset.
It should also come as no surprise that tax is an afterthought for many seeking to jump on board, particularly given the sharp rise in popularity and value of cryptocurrencies.
At the time of publishing, there are over 1,200 different cryptocurrencies, with Bitcoin having the largest market capitalisation – in excess of USD$100 billion. While the task of addressing the tax treatment of each cryptocurrency is beyond the scope of this article, set out below is a summary of the tax treatment of Bitcoin and other crypto or digital currencies that have similar characteristics.
The important messages to take away are:
- given the recent upward movement in value of Bitcoin, don’t assume that the profit on your Bitcoin transactions is not taxable or is subject to CGT. Even if you don’t report your gains from Bitcoin transactions, the ATO may issue you with amended or default assessments if they believe that you are living beyond your means and
- keep clear records of your transactions, activities and the intentions behind them, particularly if you are purchasing Bitcoin both for personal use and for speculative gain.
What is it?
Bitcoin is one of many cryptocurrencies, with alternatives to Bitcoin often being referred to as Altcoins. On the Bitcoin blockchain, transactions take place between users directly (peer-to-peer) and are verified by a network. Transactions on the blockchain only become permanent once they are verified by the network.
The network is represented by a community of nodes (ie host computers) which run Bitcoin software. Through the use of computer processing power, each member of the network is repeatedly updating and verifying transactions on its copy of the ledger, which helps to keep the blockchain consistent, complete and unalterable.
The verification service carried out by members of the network is called ‘mining’, and the reward for this service comes in the form of new Bitcoin and a share in transaction costs. Other blockchain-based cryptocurrencies may have different bases of providing rewards.
The Bitcoin blockchain maintains a record of ownership without the need for a central authority or government backing.
Are gains made on Bitcoin taxable?
In its online guidance, the ATO has stated its view that Bitcoin (and other crypto or digital currencies that have similar characteristics) are Capital Gains Tax (CGT) assets.
Investment & personal transactions
Where a person or entity has purchased Bitcoin for investment and is not carrying on a business of Bitcoin investment, any profit from resale will generally be assessable as a capital gain and not on revenue account.
Where Bitcoin has been held by certain individuals and trusts for more than 12 months, a 50% CGT discount may apply to reduce the taxable gain by 50%. However, as set out below, it may be difficult for someone buying Bitcoin to show that it was purchased for investment purposes as there is no expectation of a periodic return.
As Altcoins are commonly purchased using Bitcoin, and not cash, it may be difficult to access the 50% CGT discount unless the original Bitcoin has been held for 12 months. In any event, subject to market movement there may be little gain or loss where Bitcoin is purchased and disposed of in a short period of time to purchase Altcoin.
The ATO is clear in its view that Bitcoin is neither money nor a foreign currency. However, in such circumstances, the CGT rules or the profit-making scheme rules may operate similarly to the foreign currency tax rules in calculating the gain or loss on conversion from Bitcoin to Altcoin.
If your intention in purchasing Bitcoin is to use it to buy goods or services for personal consumption (ie retail goods, home utility services or food and beverages), then any profit from resale will be assessable as a capital gain and the 50% discount may apply. Where the original cost of purchase was under $10,000, any gain made will be tax free as it is a ‘personal use asset’. Set out below is an example of how this could work:
Sarah bought $4,000 of Bitcoin on 1 January 2013 with the intention that, once it became more widely accepted, it would be used to buy goods or services for personal consumption.
Sarah has not yet disposed of her original Bitcoin, as popular uptake has been slow, and her original Bitcoin are now worth $20,000.
Over the course of 2017, Sarah spends her Bitcoin on coffee, food, drink and a gym membership.
Sarah will pay no tax on the gain that she made of $16,000.
It is important to remember that, each time Bitcoin is used to purchase goods or services for personal consumption, or Altcoin, it will be considered as a disposal for tax purposes.
Traders and speculators
For traders, speculators and those who buy Bitcoin with a profit-making purpose, any profit from resale will be assessable income (ie revenue income and not treated on capital account) unless such activity can be classified as a hobby. Expenses incurred in purchasing Bitcoin will be fully deductible for traders/speculators.
A profit-making purpose is likely to prevail in the majority of circumstances, as ownership of Bitcoin does not (at this point in time) entitle the holder to rent or a periodic return as may be the case with assets such as property or shares. Even if Bitcoin is held for a significant period of time, it may still be considered to have been purchased for a profit-making purpose, particularly in light of the absence of a periodic return.
However, as more businesses in Australia and around the world begin to accept Bitcoin as payment, there is an increasing case for the argument that Bitcoin was purchased for a purpose other than speculation or profit making.
Bitcoin in business
If you receive Bitcoin in return for goods or services you provide through your business, you will need to include its Australian dollar value in your businesses ordinary income. Similarly, if you are carrying on a business you will be entitled to a deduction for goods or services you purchase using Bitcoin. The easiest way to determine the Australian dollar value of Bitcoin is through a reputable Bitcoin exchange.
The law on the GST treatment of digital currencies has undergone changes, which result in some digital currencies being treated like ‘money’. For more on this, see Talking Tax Issue 84.
If you are carrying on a business of buying and selling Bitcoin as an exchange service, the Bitcoin you hold will be considered trading stock. All proceeds will be included in your assessable income, and you will be required to bring to account any Bitcoin on hand at the end of each income year. Any expenses you incur, including in the purchase of Bitcoin, will be deductible.
Although the ATO has not released any specific guidance, it is likely that if you are mining Bitcoin you will be considered to be carrying on a business of Bitcoin mining. As such, the Australian dollar value of Bitcoin rewards from mining, and any gains you make from the sale of mined Bitcoin, will be included in your assessable income. Expenses you incur in your mining activities should be deductible.
Your tax reporting and record-keeping obligations?
You have an obligation to report your assessable income each income year and to keep appropriate records to support your income tax return disclosures.
Given the decentralised and unobservable nature of cryptocurrency, it is likely that the ATO and other government agencies will not be able to track all transactions and trades – at least for the time being. However, if you are living beyond your means, and reported income, you may nevertheless face an ATO review or audit. A Decline in bank account activity could also be a trigger for ATO review or audit.
If the ATO conducts a review or audit and has reason to believe that you have not reported all of your assessable income, it may issue you with an amended income tax assessment. If you refuse to cooperate with the ATO, they may issue you with a default income tax assessment where they will estimate your actual assessable income based on what they consider to be reasonable grounds.
If you have been issued with an amended or default assessment, you will have the onus of objecting to the assessment and proving that it is excessive.
Regardless of your circumstances, if you are transacting in Bitcoin you should keep a record of all of your trades and activity. In this regard, many exchanges will allow you to access and download your transaction history.
Finally, if you are purchasing Bitcoins for both personal use and speculation, it is particularly important to keep clear records. This is because it will be up to you to show the intention behind each purchase and transaction.