Cryptocurrencies: Legitimisation through taxation

Cryptocurrencies have just reached their tenth birthday, but surprisingly their taxation treatment remains uncertain and they continued to be viewed with suspicion by revenue authorities.  The Australian taxation system has been making steps to better define their tax treatment, together with a wider strategy to curtail their secret use within the black economy.  This all serves to legitimise digital currencies as they navigate their preferred path in the stateless ether of the global digital economy on the outer reaches of traditional regulations.  Perhaps taxation will act as the ‘leveller’, holding cryptocurrencies close enough to maintain sufficient visibility to collect tax payments, but far enough away to allow continuous innovation in competition with sovereign currencies.

What does a cryptocurrency look like through a taxation lens?  For Australian goods and services tax (GST) purposes, we have a statutory definition of “digital currency”.  In response to concerns from the fintech industry that transacting in cryptocurrencies was leading to double taxation of GST, digital currencies now have a GST free status akin to money or foreign currency.  This leads to more efficiency and less paper work.

Not all cryptocurrencies will qualify for this treatment as the rules are very prescriptive requiring features very close to traditional money, such as:

  • They must be fungible and suitable to be used as consideration for supplies and acquisitions.
  • They must be freely available for use by the public without restrictions as to their use – which rules out loyalty points.
  • The value cannot be pegged to other assets or currencies – meaning stablecoins pegged to say the USD or gold will have difficulty qualifying for the special GST treatment.
  • Digital currencies cannot have entitlements to receive things or provide unique benefits – which might disqualify many ICO tokens that provide special returns to investors.
  • Inherent digital features incidental to holding the unit or its use as consideration are allowed – for example, a digital currency with features that facilitate its use in smart contracts.

Traders in digital currencies need to be aware that, like money or foreign currency, the supply of cryptocurrencies in coin-to-coin or coin-to-currency transactions may be an input taxed financial supply, meaning GST credits on things purchased by a business to make the trade (e.g. brokerage and other transactions costs) may not be claimable.  For a GST registered business, this requires closer analysis to assess the impact and whether exemptions are available.

The Australian Taxation Office (ATO) has been busy releasing guidance and determinations on the income tax treatment of cryptocurrencies such as bitcoin, which serves to better define and recognise digital currencies within the mainstream; legitimisation through taxation.

The income tax rules are less friendly than GST, as the ATO views digital currencies as capital gains tax assets for investors and as trading stock for businesses which trade in cryptocurrencies.  Annoyingly, this means that every transaction involving a cryptocurrency needs to be converted to Australian dollars (AUD) at market value precisely on the date of the deal.  This requires a knowledge of the AUD market value of the relevant cryptocurrency, which may not be readily available. Wild fluctuations in the volatile markets for this medium may unfairly distort the AUD income recognised on cryptocurrency transactions, and therefore the amount of tax to pay. The ATO also requires records to be kept of cryptocurrency transactions, which can be difficult to find with the passage of time.

Much to the frustration of the cryptocurrency community, regulatory intrusions into their world are increasing, both in Australia and across the globe, as sovereign states seek to impose their own sense of order, including:

  • The Joint Chiefs of Global Tax Enforcement (J5) taskforce formed between Australia, Canada, the Netherlands, the UK and the USA, combating international tax and financial crimes, including cybercrime through the use of cryptocurrencies.
  • Anti-money laundering and counter terrorism financing (AML/CTF) legislation in Australia requiring digital currency exchanges to implement detailed proof of identify and reporting measures.
  • The Treasury’s Black Economy Taskforce which largely demonises cryptocurrencies citing their use in organised crime and money laundering, though arguably the digital blockchain is less anonymous than cash.

Despite the regulatory storm clouds, it is quite clear from their popularity that cryptocurrencies are used by many for legitimate purposes.  Necessarily, when they touch on nation states, usually through the taxation system and transactional tracking, digital currencies will gain greater legitimacy.  Just as cash is not ‘bad’, but rather it’s the ‘bad guy’ who conceals it for illegitimate ends, the bad or good use of cryptocurrencies depends on the user.  In the long run, the underlying blockchain technology may provide powerful benefits leaving a digital trail helping to disrupt tax avoidance, corruption and international crime.