There is a perception that Bitcoin and other cryptocurrencies are anonymous and untraceable.
However, the bitcoin ledger is a public record of all of its transactions between wallets and this information is freely available to anyone who wishes to explore the blockchain.
This data, along with that held by cryptocurrency exchanges, is able to be searched and queried by the Australian Tax Office (ATO).
The ATO typically classifies cryptocurrencies as property that is subject to capital gains tax (CGT), however this is often overlooked by both new and seasoned crypto investors.
Last year, the ATO wrote to 100,000 Australians to remind them of their obligations relating to their cryptocurrency holdings.
ATO assistant commissioner Tim Loh recently said: “We also expect to prompt almost 300,000 taxpayers as they lodge their 2021 tax return to report their cryptocurrency capital gains or losses.”
Cryptocurrency holders on the rise
An annual nationwide survey of everyday Australians by cryptocurrency exchange Independent Reserve, found that nearly one in five Australian adults were currently holding cryptocurrencies in November 2020.
With a further influx of new investors coming into the market early this year, attracted by Bitcoin’s astronomical price rise in 2021 – the crypto market cap saw a 420% increase this financial year, growing from $345 billion in July 2020 to $1.8 trillion June 2021.
This suggests there will be even more Australians on the ATO’s crypto radar for the first time at EOFY 2021.
For investors that are not already familiar with the ATO’s guidance on the tax treatment of cryptocurrencies, the following highlights a few of the key considerations for those who play in the space.
Crypto tax classifications
Generally speaking, the ATO has different obligations for cryptocurrency depending on the intent and use case applied to it.
The three key categories are investment, business, and personal use.
Business typically implies that the sole use of the cryptocurrency is to conduct business. This could include but is not limited to the acquisition and sale of crypto assets to clients or accepting cryptocurrencies as a form of payment.
Personal use relates to holding cryptocurrencies for small purchases and transactions. In both instances, the cryptocurrency is effectively treated as a currency transaction, and if there is a change in value of the underlying currency, it would be considered income or an expense like foreign currency rather than a capital gains event. The generally accepted threshold for personal use is $10,000 before capital gains obligations impact individuals.
Many Australians that are buying and selling cryptocurrency will end up in the ATO’s investment bucket, that is, those who acquired a cryptocurrency in the hope that it will appreciate in value.
Regardless of personal opinions and anarchistic undertones, the current Australian regulatory framework classifies cryptocurrency as property and will be taxed accordingly. This is where CGT comes into play for the average investor.
Day trading versus HODLing
The ATO has a clear definition of long-term investment in relation to cryptocurrencies and offers capital gains relief for doing so.
Any cryptocurrency which is held for 12 months, or more, is subject to discounted CGT for these assets. This makes accurate record-keeping incredibly important for everyday investors.
The stage is split between cryptocurrency enthusiasts.
On one hand, some investors will trade frequently to take advantage of volatility and make regular trades with each upswing or downswing in the market.
The ATO does allow for both capital gains and capital losses to be claimed, so this only reinforces the need for good record keeping.
On the other hand, there is another large segment of crypto investors that live by the “HODL” mantra (a meme for the word “hold”, or sometimes explained as an acronym standing for “hold on for dear life”) where traders avoid selling on impulse when a cryptocurrency moves dramatically in price. Instead, they maintain their crypto holdings and continue to “stack sats” (a “sat” is the smallest unit of bitcoin) and build their holdings.
Regardless of your individual investing philosophy, you must be aware that both approaches fall under the remit of the ATO as it steps up its cryptocurrency regime.
Many Australian’s have previously only considered their tax obligations when cryptocurrency was exchanged to fiat currency and vice versa, but the ATO has made it clear that crypto-to-crypto transactions will have the same implications.
If you exchange one cryptocurrency for another cryptocurrency, this is seen by the ATO as the disposal of one CGT asset for another.
Essentially, this means you receive property instead of money in return for your cryptocurrency, and as such, the market value of the cryptocurrency you receive needs to be accounted for in Australian dollars.
If the cryptocurrency you received can’t be valued, because it is not listed on a commonly referenced price-tracking website for crypto assets such as CoinMarketCap, then it should be priced as per the market value of the cryptocurrency sold at the time of the transaction.
Decentralised finance (DeFi) has added a new level of complexity to taxation accounting.
Within the realms of DeFi you can ‘stake’ or deposit a crypto asset to a DeFi protocol and earn interest on that deposit. As such, your crypto asset may incur CGT if the underlying asset increases in value. If interest is earned via the utilisation of that asset, this may also be taxed as income earned.
One of the biggest considerations of these DeFi crypto interactions is that they are commonly conducted on shorter time frames with users “yield farming” or switching between protocols to find the highest yield. This can inadvertently lead to a dramatic increase in the number of capital gains events for the typical crypto investor.
The nuance of cryptocurrencies
While some aspects of reporting obligations are quite straightforward, cryptocurrency has a few unique asset traits which the ATO has been proactive enough to address.
Airdrops refer to tokens that a user receives for free. Airdrops are usually distributed by projects that are hoping to increase their awareness, so oftentimes, the tokens are received without the final holder even asking to receive them.
Even so, generally speaking, CGT will still apply. In recording these transactions, the acquisition date would be the date the tokens were received, and the acquisition value would be zero.
Upon disposal of a token that was received via airdrop, given the nature of the acquisition, its sale would be considered a capital gain.
Forks or hard forks
These are an event where a significant change in the blockchain’s protocol results in the creation of an entirely new cryptocurrency.
The most well-known example of a hard fork was when the Bitcoin community divided in August 2017, so some participants opted to duplicate the Bitcoin core and take it in a new direction – as a result, a new cryptocurrency was created, and they called it “Bitcoin Cash.”
In this instance, the user retained any original Bitcoin that they owned prior to the event (its treatment unaffected) and an equal amount of the new cryptocurrency, Bitcoin Cash, was credited to them and deemed to have been acquired for $0 on the day of the fork.
When disposing of the Bitcoin Cash that they received on that day, the user would pay tax based on the market value on the day of the disposal.
Loss of keys or theft
This typically refers to a situation where an investor was managing their own custodial wallet and loses access to that wallet.
This may be a somewhat common occurrence in cryptocurrency (especially for new investors), and it does have clear capital gains obligations. Under these circumstances, the ATO has set high expectations on the user to provide clear evidence.
While the ATO has addressed each of the above points, it is an increasingly complex and always-evolving area of taxation. Investors should ensure they seek professional advice regarding their specific situation.
Like many investment categories, the tax obligations associated with cryptocurrency investments can be incredibly nuanced depending on your personal circumstances.
The most important aspect of this type of reporting is to accurately record each transaction so it can be assessed as required. In particular, it is critical to keep records of acquisition and disposal dates and values.
For users who weren’t proactively journaling each transaction, various cryptocurrency exchanges (especially those aimed at more savvy investors) have put solutions in place specifically to handle this reporting.
Independent Reserve partnered with KPMG to produce automated reports for their customers.
“Cryptocurrency tax obligations can be tough to keep up with, but if you don’t want to end up in hot water, it is important you and your accountant get it right,” Independent Reserve chief executive officer Adrian Przelozny said.
“The KPMG logo on the top of our Capital Gains Tax Report gives a lot of confidence to local accountants that have less experience in cryptocurrency,” Mr Przelozny added.
Despite the general misconceptions about the anonymity aspect of cryptocurrencies, it is very clear that any activity recorded on a blockchain is both transparent and highly trackable.
This year, the ATO has made it clear that they will be looking at crypto transactions in Australia. If you have been trading cryptocurrency in the last 12 months, the best suggestion is to engage the services of a certified tax professional with a good understanding of cryptocurrency to ensure you don’t get caught out this tax season.
Failure to correctly report taxable income and capital gains could result in serious consequences.