Bitcoin taxation: a global challenge for tax authorities

Actor Ashton Kutcher, billionaire businessman Mark Cuban, venture capitalist Tim Draper and rapper Ghostface Killah are among an eclectic and growing group of speculators and investors falling under the spell of cryptocurrencies.

While some see it as a way to make a fortune, others dismiss bitcoin and cryptocurrencies (or altcoins, as they’re also known) as the latest in a line of market bubbles that date back to the infamous Dutch tulip market crash of the 1600s. 

In recent months, the price of bitcoin – the best known of more than 1300 cryptocurrencies – has soared and dived dramatically, raising fears about the sustainability of the market.

Benjamin Dives, chief executive of the London Block Exchange, the UK’s first dedicated cryptocurrency exchange, says altcoins offer a new asset class for investors and traders. 

“They’re new, they’re hot and, to the beginner, they can be awfully confusing,” he says.

Such perplexity has led to tax specialists, lawyers and accountants around the world receiving an increasing number of queries about the tax implications of cryptocurrency investments. The consensus is that if you spend or invest in them, it is crucial to understand how such transactions are treated for tax purposes.

Property or currency?

Cryptocurrencies are a form of digital asset that typically involve peer-to-peer transactions outside the central platforms of mainstream financial institutions. The transactions are secured through encryption and rely on a blockchain, which in essence is a collection of continually growing records on a digital ledger.

Like many other tax authorities, the Australian Taxation Office (ATO) believes bitcoin, ripple, ethereum and other cryptocurrencies are “a form of property” rather than being a true currency. Under the Currency Act 1965, only the Australian dollar is a currency of the nation. 

“Further, as bitcoin is not a monetary unit recognised and adopted by the laws of any other sovereign state for transactions and payments, it is not ‘foreign currency’,” says Will Day, deputy commissioner, private groups and high-wealth individuals at the ATO. 

The ruling has significant implications at a time when reports of massive investment gains have captured the attention of tax authorities, raising questions relating to income and capital gains and losses stemming from cryptocurrency trades.

Day says that like any other asset, financial gains made from selling bitcoin will generally be subject to capital gains tax and must be reported to the ATO. 

“If the transactions amount to a profit-making undertaking or plan, then the profits on disposal of the bitcoin will be assessable as ordinary income,” he says.

CPA Australia’s former head of policy, Paul Drum FCPA, says the evolving regulatory landscape, which includes new anti-money laundering legislation in Australia, is proving to be something of a watershed moment. 

“The changes will enable the ATO and AUSTRAC (the Australian Transaction Reports and Analysis Centre) to access and thoroughly review cryptocurrency exchange account data for the first time. It is also information they’ll potentially be able to share with authorities in other countries, providing a much-needed multi-jurisdictional approach to regulation.

“The appeal of the anonymity of blockchain transactions is starting to fade. These coming changes mean that people shouldn’t assume they can hide forever behind blockchain, nor should they assume there are no tax consequences,” Drum says.

Global reaction to cryptocurrency

South Korea is one of the latest nations considering taxing capital gains from bitcoin transactions. Asia accounts for the bulk of cryptocurrency trading internationally, with research group CryptoCompare late in 2017 identifying Japan, South Korea and Vietnam as hotspots after an earlier surge in China. 

China has been cracking down on cryptocurrency activity in an effort to contain financial market risk. The response includes halting virtual currency trading on domestic exchanges and banning initial coin offerings (ICOs); the equivalent of initial public offerings for new virtual currencies. The Bank of Japan has also warned investors about “abnormal” bitcoin prices.

The Internal Revenue Service (IRS) in the US, which has also declared bitcoin an “intangible property” and not a currency, is expected to ramp up enforcement of altcoin gains this year.

In November 2017, a court ordered Coinbase, one of the world’s biggest cryptocurrency exchanges, to supply to the IRS details of around 13,000 altcoin traders on its site. The IRS told the court it needed the account details to weed out Coinbase customers who were avoiding cryptocurrency taxes.

“It reminds me of the IRS busting Swiss banks to turn over Americans’ secret accounts,” says Robert Green, a certified public accountant with the American Institute of Certified Public Accountants, and chief executive of GreenTraderTax.com in the US. He says an investor or trader will hold cryptocurrencies as a “capital asset”, with sales and exchanges being treated as capital gains and losses.

“If you invested in cryptocurrencies and sold, exchanged or spent [coins] in 2017, you have to report a capital gain or loss on each transaction, including coin-to-currency sales, coin-to-coin trades, and purchases of goods or services using a coin,” he says. 

“As intangible property, coin lacks the convenience of money, which does not require a capital gain or loss transaction on each purchase of goods and services.”

In Hong Kong, the Securities and Futures Commission (SFC) has been schooling investors on digital tokens, as it refers to them, noting that in typical ICOs, the tokens are a “virtual commodity”. However, certain ICOs have terms and features – including offering ownership rights to a start-up or dividend rights – that may mean that the tokens are “securities” and, therefore, subject to the securities laws of Hong Kong.

The SFC has been ramping up efforts to regulate cryptocurrency exchanges involved in ICOs that violate domestic laws. In February 2018, it sent warning letters to seven exchanges advising that some tokens being traded on their platforms may be securities. Some investors had also complained to the regulator that they were unable to withdraw funds from their accounts held with digital exchanges. The SFC’s move is seen as being part of a wider effort to caution investors about the risks of trading altcoins.

“We will continue to police the market and enforce when necessary,” says SFC chief executive Ashley Alder. “But we are also urging market professionals to do proper gatekeeping to prevent frauds or dubious fundraising and to assist us in ensuring compliance with the law.”

The UK’s taxation office, HM Revenue & Customs (HMRC), has not yet created new tax legislation for cryptocurrency transactions, but experts have warned that such activities will not be exempt from tax. The EU plans to require online platforms where bitcoins are traded to carry out due diligence on customers and report suspicious transactions.

Professor Jason Potts, director of the Blockchain Innovation Hub at Melbourne’s RMIT University, welcomes the fact that different international tax agencies and governments are converging on a similar treatment of cryptocurrencies.

“That consistency is highly valuable because you avoid arbitrage between different national jurisdictions,” he says. “If one (country) is treating it very differently to others, then you’ll end up creating crypto-havens for tax reasons and that would be disruptive.”

Cryptocurrencies' implications for capital gains tax

There is little doubt that cryptocurrencies present unique challenges for tax authorities. One of the key debates has been around whether cryptocurrency traders are earning personal services income, or whether they should pay capital gains tax. 

Anthony Watson, a tax partner in the Sydney office of law firm Mills Oakley, says a taxpayer who receives bitcoin as payment for goods or services they provide as part of their business, or who uses bitcoin to make purchases for their business, should use the “arm’s-length Australian dollar value of their bitcoin transactions” to calculate their tax outcomes. The value, based on a conversion rate at the time of the relevant transaction, can be taken from an online exchange such as LocalBitcoins.com or Coinbase. 

Watson confirms that because bitcoin is property, it is an asset for capital gains tax purposes. However, if the original cost of the bitcoin purchase is under A$10,000, any gain will be tax free where the bitcoin is considered to be a personal use asset. As with other assets liable for capital gains tax, a 50 per cent discount may also apply if the bitcoin is held for at least 12 months.

Although there may be some grey areas around cryptocurrency conversion rates, Watson expects greater clarity as markets evolve. For instance, the ATO publishes average foreign exchange rates that it will accept without question for tax calculations in the case of foreign exchange transactions.

“They haven’t done that yet for digital currencies, but maybe as more and more transactions are effected in digital currencies, so too you’ll see the tax office adopt the same approach,” Watson says.

“Many people think of cryptocurrency trading as similar to having a bet at the casino, but there are usually tax consequences – and the stakes can be very high,” adds Drum. 

“Our members tell us they’re approached by clients weekly with more and more questions about cryptocurrency investing and the tax implications.”

In these early days, and with tax treatments differing between jurisdictions, traders with several cryptocurrency accounts will need to keep on top of their accounting. Solutions are already emerging, including tools such as CoinTracking and BitcoinTaxes. 

Some analysts believe treating cryptocurrencies as an asset creates a favourable tax environment for retirement account investors. The ATO notes that there is increasing interest from people investing in bitcoin and other cryptocurrencies through their superannuation funds, particularly self-managed super funds (SMSFs). 

“However, the nature of bitcoin or other cryptocurrencies may mean that compliance with the regulatory rules and restrictions that apply to all SMSF investments is more difficult,” Day says. 

“For example, the regulatory requirement that the fund’s assets are managed separately from the member’s personal and business assets, and ensuring that the SMSF has clear legal ownership of the bitcoin or relevant cryptocurrency, as well as ensuring that the investment is appropriately valued for both accounting and taxation purposes.”

Crime concerns: blockchain to the rescue? 

Cryptocurrencies have become a vehicle of choice for many regular traders in recent years. The most popular way to trade in these altcoins is to register with an online exchange, verify your identification and create an account (often called a wallet). People can then transfer dollars, pounds and so forth to an exchange account and start buying.

According to Dives, many people have decided to “jump on the cryptocurrency ride”. 

“From private investors to hedge funds, many are choosing to climb aboard, but any negative impacts on the traditional financial markets are mostly overblown,” he says.

Dives rejects suggestions that bitcoin and its altcoin peers are primarily being used for tax evasion and other illicit purposes. 

“We need to make it clear that the cryptocurrency sphere is, overall, not suitable for criminals and is actually arguably more accountable than other investment vehicles.”

This is because cryptocurrency exchanges are required to comply with anti-money laundering protocols, as is the case with traditional financial institutions. In addition, the technology behind most cryptocurrencies, blockchain, makes hiding money “very difficult”. 

Dives says that cryptocurrency can hide users’ identities, but that it is not fully anonymous. 

“All other transaction details – such as the time the transaction was made, amount sent and destination address – are recorded publicly on the blockchain and therefore all transfers made using bitcoin can be traced back to specific wallet addresses.”

New technology, new era

As the cryptocurrency market matures, Potts says it is important for governments and tax authorities to appreciate that there is now an “entire new class of economic good”. He would like to see them take a light touch in terms of regulatory and taxation responses.

“The real risk is accidentally killing something through over-prescription, rather than getting the wrong regulations or tax frameworks.”

Despite sensational headlines about rising and falling altcoin prices, Dives believes that “this volatility won’t be around forever”. He expects traditional investments, such as bonds and property, to continue to be a time-tested “safer” form of investing, while others will pursue cryptocurrency trading in the knowledge that “we have only touched on the fringes of its possibilities”.

“As cryptocurrency projects develop and gain mainstream approval, we will see a revolution in what we consider legal tender,” Dives says. 

“We know that fiat currencies aren’t going anywhere – it’s just now they’ll have some more competition.” 

Cryptocurrency mining

The cryptocurrency phenomenon has led to the emergence of altcoin miners, who engage in computing processes that approve transactions and create new coins in the system. They earn income from their ability to solve algorithms. B

itcoin mining tends to be dominated by large-scale operations, because of the complexity and high hardware investment costs; altcoins such as litecoins, dogecoins and feathercoins may be more viable for relative beginners.  

However, in a blow to the phenomenon, China has started a crackdown on the practice. Reports suggest Chinese authorities want to cleanse financial markets of undue risk and are concerned about the huge amount of energy these mining farms consume. 

Regardless of whether the activity is a hobby or business, altcoin miners will be subject to taxes in most countries. 

In Australia, the ATO has decided that altcoin miners must include in their assessable income any profit that is derived from the transfer of the mined coins to a third party. Any expenses related to the mining activity would be allowed as a deduction. 

The Internal Revenue Service in the US has also decreed that people who successfully mine altcoins and earn income from them must declare the gains as part of their gross income. 

Singapore’s Inland Revenue Authority has decided that profits derived by businesses which mine and trade cryptocurrencies in exchange for money are subject to normal tax rules. 

A heads-up from the ATO

The Australian Taxation Office advises keeping records for cryptocurrency transactions, including:

• the date of the transactions
• the amount in Australian dollars (which can be taken from a reputable online exchange)
• the purpose of the transaction
• who the other party was (even if it is just their bitcoin address).

“The ATO is here to help those who are genuinely trying to meet their tax obligations,” says ATO deputy commissioner Will Day.