Current Australian tax implications of cryptocurrency investing and use
How government inaction is hurting fiscal efficiency and technological progression
The cryptocurrency space continues to quickly evolve during the 2021 year. The evolution in technology and use cases for cryptocurrencies and their blockchains have seen an exponential growth in the last decade.
Early in the decade, these technologies had promise but most investment was akin to a speculative penny stock investment or internet early adoption. This gambling type investing fad resulted in parabolic market cap growth. Cryptocurrencies were being used as speculative capital investment assets.
In recent times, the cryptocurrency projects have grown in popularity due to a rise in real-world applications. User friendly app development and consensus advancements have drawn regular individuals and businesses to platforms by promising an improvement to our antiquated financial systems.
Whilst Australians continue to embrace blockchain technology, the Australian Taxation Office struggles to keep up. The current ATO’s tax treatment, although arguably apt at its introduction, has lacked extensive review or update. Cryptocurrency is predominantly treated in a ‘one size fits all’ manner and considered an asset and not a currency.
The ATO classifies cryptocurrencies in three ways:
- Investment asset – most purchases of cryptocurrency will fall under this category. Any transfer between cryptocurrency and AUD or between two cryptocurrencies is subject to capital gains tax. This is calculated on the difference between the purchase and selling price and will be granted a 50% discount if the asset was held for over a year.
- Personal use asset – There are limited circumstances in which a cryptocurrency transaction can be classified as personal use asset. These are generally nominal or novelty purchases. The temporary use of a cryptocurrency for a purchase can also be argued as personal although there is limited guidance for this circumstance.
- Carrying on a business – The intention to carry on a business is what must be proven in this instance. Mining cryptocurrency or selling NFT’s is what this classification has been mainly used for. These revenue streams are classified as ordinary income, but movements in cryptocurrencies held in business accounts are usually still subject to capital gains tax.
The Income Tax Assessment Acts (ITAA) of 1997 & 1936 is where the relevant tax law definitions for the above determinations can be found.
The ATO issued four tax rulings during 2014 regarding cryptocurrency assets (TR 2014/25-28). These rulings stipulate that:
- Bitcoin is an asset, not currency
- It is subject to capital gains tax
- It is trading stock when held for the purpose of sale or exchange in a business
- It is a property fringe benefit when paid by an employer to an employee
Significant blockchain protocol improvements took effect in 2021 highlighting the dire need for re-evaluation of the taxation laws surrounding cryptocurrencies. These large upgrades to many cryptocurrency projects and their protocols are allowing for greater utility. There has been a slow yet meaningful sentiment shift favouring the use of cryptocurrency to perform traditional financial functions. The 2014 tax rulings do little to provide guidance on how to treat these functions.
Below are some tangible, real-world applications currently in use:
- NFT’s (Non-fungible tokens) – In addition to the fad-like cartoon drawings gathering media attention, NFT’s are empowering visual, musical and other artists to break geographical barriers in an increasingly globalised world. NFT’s enable artists to be paid appropriately, receive a commission upon retail of their works and retain rights to their work whilst selling non-fungible copies. NFT’s are most prevalent application of Ethereum’s smart contract system as well as cryptocurrencies such as Solana, Cardano and Stellar.
- DAO’s (Decentralised Autonomous Organisations) – These organisations allow collectives of individuals to collaboratively work together harmoniously without the limitations of physical locations, hierarchies, discrimination, and fraud. These organisations can work on a project through a blockchain which provides Governance through member voting rights, permissionless payments and access to labour throughout the world due to their online nature and universal currencies.
- Stablecoins – Tokens which are pegged to traditional currencies. These allow cryptocurrencies to interoperate with and facilitate payments and transfers of traditional currencies such as the AUD.
- Staking – Gone is the dichotomy between Cryptocurrency miners and capital growth investors. Individuals can now earn ‘interest’ on their cryptocurrency tokens as many now validate transactions using a proof of stake consensus model. Investors are now able to use their coins to stake and validate transactions to earn rewards. This is a much more ecological consensus method when compared to mining.
- Defi (Decentralised finance) is the rapidly evolving financial system involving borrowing, lending & exchanging which is facilitated by blockchains using cryptocurrency tokens.
- Dex’s & AAM’s – Decentralised exchanges allow trading of currencies and assets without a centralised entity making profits. Automated market makers such as Uniswap provide pools of assets which can be used to instantaneously fill an order to exchange one currency to another instead of having to place buy and sell orders.
- Borrowing and lending – Defi enables using holdings to earn interest through lending or as collateral for borrowing.
- Sound Money Properties
- Bitcoin, Ethereum and other networks have protocols which limit the total supply of their coins. Many of these networks, once fully developed, reach a point where the issuance of new coins is lower than the coins burned, making them deflationary.
- With AUD and USD purportedly having inflation rates of more than 5% in the past year and the Turkish lira inflating over 20%, cryptocurrencies’ deflationary properties are more important than ever.
- Scalable payment networks
- Payment networks such Stellar are enabling transfers of assets and currencies with real time exchange rates between any currency with less than a cent of transaction fees.
- Bitcoin and Ethereum have recognised a huge demand for their services and have built infrastructure to meet it. Ethereum has multiple layer 2 chains doing mathematical proof of transactions to reduce the load on its mainnet. Bitcoin has its lightning network layer up and running. Both can increase transactions per second by over 1000x.
- More centralised companies such as crypto.com are partnering with VISA and merchants to make cryptocurrency purchases ubiquitous.
- Web 3.0 Usernames
- Non-fungible usernames on sale on cryptocurrency smart contract platforms for use as website domains and payment addresses. An example is the Ethereum name service.
The issue with the pervasive and ever-changing utilisation of the above technologies is most definitely writing suitable tax law definitions. Inherent to blockchains and their virtual machines is their programmability to do more than a regular currency. The tax law will need to be able to determine which function of a cryptocurrency a user is using, what their intentions are and how they will be taxed.
The intentions of the taxpayer are becoming blurred by the plethora of uses each a cryptocurrency token may offer. This is mainly due to the properties of cryptocurrencies resembling all of currencies, capital assets and software. For example, it is becoming increasingly accessible to both stake a parcel of cryptocurrency for passive income (similar to interest), use it for minting and purchasing NFT’s, purchase goods and services, send friends cash and collateralise it for a loan. All whilst it passively grows in capital.
To be at the forefront of technology growth in the world the Australian government should be encouraging cryptocurrency and blockchain adoption. Appropriate taxation rates and liberal laws can attract skilled immigrants and can increase Australia’s GDP through adoption and subsequent capital growth.
The ATO must provide guidance through the issuance of rulings and ATO website articles to help taxpayers understand and meet their tax obligations. A failure to do so soon will confuse taxpayers, aid tax evasion and make the collection of tax on cryptocurrencies fiscally inefficient.
We keep up to date in all ATO guidance updates regarding cryptocurrency in order to provide our clients with the most tax effective advice.