There’s no doubt that the explosive growth of Bitcoin and other similar cryptocurrencies has been the financial fad of the last few years.
With explosive growth in recent years (and periodic crashes), it’s been possible to make (and lose) substantial sums of money over startlingly short time periods and many inexperienced investors (or should we call them speculators?) have been drawn into the net of this latest monetary craze.
One thing to bear in mind if you’re considering getting into crypto-currencies, or are already involved, is that there are tax implications to trading and investing in these new digital products. Here’s our guide to tax and cryptocurrency.
What is cryptocurrency?
Digital currencies (or cryptocurrencies as they are commonly called) are created and held electronically. No one controls them; they aren’t printed, like dollars or euros – they’re produced by people, and increasingly businesses, running computers all around the world, using software that solves mathematical problems. Bitcoin is the best known example but there are many others.
There are three ways to get cryptocurrencies – by mining them, buying them or providing goods and services to earn them.
Mining refers to the process by which the currency created – a computer crunches through a set of difficult mathematical problems and success is rewarded with a unit of the currency.
The alternative is to create an ‘online wallet’, visit a cryptocurrency exchange system that puts sellers in touch with buyers and the buyers pay for the cryptocurrency purchased by transferring money via online banking.
The third way is possible because cryptocurrency (especially Bitcoin) is becoming an increasingly accepted virtual currency used by businesses and individuals around the world, including in Australia.
Is the ATO focusing on cryptocurrency?
The ATO estimates that there are between 500,000 to one million Australians that have invested in crypto-assets and that many of those people have failed, or will fail, to properly report the profits they have made for tax purposes.
As a result, the ATO is collecting bulk records from Australian cryptocurrency designated service providers (DSPs) as part of a data matching program to ensure people trading in cryptocurrency are paying the right amount of tax.
Data to be provided to the ATO includes cryptocurrency purchase and sale information.
The data will identify taxpayers who fail to disclose their income details correctly.
Following the data matching exercise people may be contacted by the ATO and given the opportunity to amend their tax returns to include the information highlighted by the ATO.
People will be given at least 28 days to clarify any information that has been obtained from the data provider. Several thousand such letters have already been issued and more are sure to follow.
If recipients of such a letter fail to modify their tax return to include the missing transactions, more forceful compliance action (such as a full tax audit) could follow.
How are cryptocurrencies taxed?
Using cryptocurrency to pay for personal transactions
Generally, there are no income tax or GST implications if you are not in business or carrying on an enterprise and you simply pay for goods or services using cryptocurrency (for example, acquiring personal goods or services on the internet using bitcoin).
Cryptocurrencies are regarded as capital gains tax (CGT) assets so CGT potentially applies whenever an Australian resident sends a unit of the currency to another person. However, transactions are exempt from capital gains tax if:
The cryptocurrency is used to pay for goods or services for personal use – e.g. Expedia hotel bookings, or at a café which accepts bitcoins, and
The cost of the cryptocurrency used to pay for the transaction is less than $10,000 (this is the exemption for personal use assets).
If the cost of the cryptocurrency used in the transaction exceeds $10,000, the personal use exemption will not be available and CGT will apply. The capital gain is calculated as the increase in value of the cryptocurrency between the time they were acquired and the time they were disposed of.
Using bitcoin to buy and sell goods and services in a business
If you receive cryptocurrency for goods or services provided as part of a business, you will need to record the value of the units in Australian dollars as part of your ordinary income for tax purposes. The value in Australian dollars will be the fair market value which can be obtained from a reputable cryptocurrency exchange, for example.
Where you carry on a business and purchase business items (including trading stock) using cryptocurrency, you are entitled to a tax deduction based on the arm’s length value of the item acquired.
There may also be capital gains tax consequences where you dispose of cryptocurrency as part of carrying on a business. However, any capital gain is reduced by the amount that is included in assessable income as ordinary income (so you aren’t taxed twice on the same amount).
Where you are in the business of mining cryptocurrency, any income that is derived from the transfer of the mined currency to someone else is included in assessable income.
Any expenses incurred in respect of the mining activity are allowed as a deduction.
Losses made from the mining activity may also be subject to the non-commercial loss provisions, so they won’t automatically be available to offset against other income (there are tests you’ll have to meet first).
The non-commercial loss provisions basically prevent you using up losses from activities that never had a realistic chance of making a profit or which don’t arise from genuine business activities (such as people who trade for a hobby or are engaging in speculation that is basically in the nature of gambling).
Cryptocurrency held if you are carrying on a business of mining and selling the currency is considered to be trading stock.
You’d need to bring into account any currency on hand at the end of each income year.
Taxpayers conducting a cryptocurrency exchange (including ATMs)
Where you are carrying on a business of buying and selling cryptocurrency as an exchange service, the proceeds derived from the sale of the currency are included in assessable income.
Any expenses incurred in respect of the exchange service, including the acquisition of the cryptocurrency for sale, are deductible.
Cryptocurrency held by someone carrying on an exchange is considered to be trading stock and you would be required to bring to account any currency on hand at the end of each income year.
Disposing of cryptocurrency acquired for investment
If you acquire cryptocurrency as an investment, Capital Gains Tax will apply, although where the cost of the cryptocurrency does not exceed $10,000 the personal use asset exemption may apply if you can demonstrate that the cryptocurrency was to fund personal consumption.
The ATO pays particular attention to taxpayers who try to rely on the personal use asset exemption to avoid CGT; expect to be asked to provide proof that you either did – or intended to – use your cryptocurrency to fund personal spending on goods and services.
Where the cost of the cryptocurrency exceeds $10,000, the personal use exemption will not be available and CGT will apply. The capital gain is calculated as the increase in value of the cryptocurrency between the time it was acquired and the time it was disposed of.
If the transactions amount to a profit-making undertaking or plan then the profits on disposal of the cryptocurrency will be assessable income since you will be regarded as a trader rather than an investor.
Note: the rules around trading cryptocurrency for business or profit versus buying and selling cryptocurrency as an investment are essentially the same as those applying to share traders versus investors. There are other factors to take into account but broadly, If you are holding the cryptocurrency with a view to long term gain, you are likely to be an investor and if you are buying and selling cryptocurrency over the short term with a view to making profits, you are likely to be a trader.
Everyone dealing with cryptocurrency needs to keep the following records:
the date of each transaction
the amount in Australian dollars at the time of the transaction (which can be taken from a reputable online exchange)
what the transaction was for, and
details of the other party