Taxation and Digital Currency
Digital currency is a digital representation of value that can be digitally traded and functions as a medium of exchange, a unit of account and/or a store of value. Despite not having a physical form or the status of legal tender, digital currency possesses many of the characteristics of traditional money.
Cryptocurrency is a form of digital currency. Cryptocurrencies use ‘blockchain’ technology, which involves a decentralised ledger that is updated by the use of a consensus mechanism and cryptography to make a user’s entitlement to value recorded on the ledger tamper-resistant.
Cryptocurrency on blockchain
Cryptocurrencies such as Bitcoin are distributed, peer-to-peer currencies that have no central administering authority. They are different from traditional currencies or shares traded on a share market. The blockchain is used to verify every transaction (ie disposal, purchase, exchange) without the need for a central clearing authority.
There are often thousands or millions of computers in a blockchain network, where each computer or ‘node’ in the network has its own copy of the blockchain. It is the decentralised nature of the information that makes blockchain difficult to manipulate. In order to make a change to the ledger, every copy of the blockchain (on every computer that is hosting it) would have to be manipulated.
Purchasing cryptocurrencies is different from investing in traditional shares. Digital assets can be purchased and sold via digital exchanges; however digital assets can also arise as a result of ‘airdrops’ and ‘forking’.
An airdrop is a process whereby a company chooses to distribute its tokens (ie digital assets) to the wallets of certain users, free of charge. However, the distribution is not always unqualified (users may be required to take an action to be eligible for the airdrop). Companies may choose to conduct airdrops for an array of reasons, including to:
- generate awareness;
- understand the holders; and
- reward active members of the community.
A recipient of tokens via an airdrop needs to consider their tax liabilities. We will address this in subsequent articles.
A hard fork occurs when there is a change in the consensus rules of a blockchain. Chains are decentralised; hence the community controls the direction of the chain. Issues can therefore arise as a result of a dispute around a set of rules that governs the chain. A way to resolve the difference of opinions is to have the chain split, known as a ‘fork’.
When a chain forks, the original may continue to exist and a copy of the original with protocol level code changes will also exist. As a result, there will now be two chains in existence; eg Bitcoin and Bitcoin Cash. After the split, the asset holder will own the same amount of currency in each of the chains. An example is where, if an individual held 10 Bitcoin before the split, after the split that individual would hold 10 Bitcoin and 10 Bitcoin Cash.
A recipient of cryptocurrency resulting from a fork needs to consider their tax liabilities. We will address this in subsequent articles.
Taxation implications on digital currencies
The Australian Taxation Office’s (ATO’s) view is that Bitcoin is neither money nor a foreign currency for the purposes of income tax law, and the supply of Bitcoin under GST law is a financial supply.
Individuals who use digital currency for investing or for business purposes may be subject to CGT when they dispose of their digital currency, as would an individual who disposes of shares or similar CGT assets. Individuals who make personal use of digital currency (ie using digital currency to buy day-to-day items) – and where the cost of the Bitcoin was less than $10,000 – will have no CGT obligations.
As of 1 July 2017, sales and purchases of digital currency are not subject to GST. This means you do not need to charge GST on your sales of digital currency and, similarly, you are not entitled to GST credits for purchases of digital currency.
GST consequences should be considered if you are:
• carrying on a business involving digital currency, or as part of your existing business; or
• accepting digital currency as a payment in your business.
Income tax implications
Businesses that provide an exchange service, engage in the buying and selling of digital currency or mine Bitcoin, will be required to pay income tax on any profits made. Businesses that are paid in Bitcoin as a result of goods or services will be required to include the amount valued in Australian dollars in their assessable income.
Further, individuals who trade in digital currencies for profit will also be required to include the profits as part of their assessable income.
Fringe benefits tax (FBT) implications
Businesses that remunerate staff members in digital currency will be subject to FBT where the employee has a valid salary sacrifice arrangement, otherwise the usual salary and pay as you go (PAYG) withholding obligations do apply.
ATO’s response: understanding taxation implications
It is important to understand digital currency and its taxation implications because the ATO has commenced collecting bulk records from Australian cryptocurrency designated service providers as part of a data matching program to ensure that people trading in cryptocurrency are paying the right amount of tax. Cryptocurrency and blockchain technology are both seen as enablers of existing risks for the ATO, because they can be used to move funds within the black economy and hide money offshore, and can also be linked to unexplained wealth and undeclared capital gains.
This is the first in a series of articles to be published on digital currency and blockchain.
This article was written by Michael Kohn and Ellen Karakoussis
This article is general commentary on a topical issue and does not constitute legal advice. If you are concerned about any topics covered in this article, we recommend that you seek legal advice.
For further information please contact the author or any member of our Tax team.