Crypto: currency or asset?
How does tax fit into the world of crypto?
As a good starting point, Inland Revenue’s view is that crypto is a form of property, not a currency or money in the ordinary sense, and collectively refers to “cryptoassets”.
Cryptoassets can take many forms, which include:
Based on this view, that crypto is property, we don’t believe we necessarily need lots of new law. The taxation of property is well canvassed in the income tax legislation, so it’s more about recognising these new forms of property and an interpretation of what rules we already have.
The rules in relation to crypto
The rules largely look to apply tax based upon the circumstances you bought the property and what was in your mind. Yes, it’s highly subjective (unless we develop a new digital invasive mind app).
The rules are:
1) Did you buy the property with a purpose of selling it (i.e. a speculative transaction)? If you did, it’s taxable.
This test looks at your overriding reason for purchasing the property, was it to sell it in future? It’s looking to bring into the tax net the one-off speculative transactions.
Inland Revenue had a view, which is evolving, that cryptocurrency could only have a purpose of resale.
This is because it had no intrinsic value, you couldn’t earn any income from it (like a dividend or interest). So logically, you bought it only to sell at a later date.
It’s not quite as simple as this though, as you can earn rewards from holding cryptoassets; such as from “yield farming”.
For the “yield farmers” out there, you’ll know that this strategy involves lending or staking your cryptocurrency to get rewards (transaction fees or “interest”). This may mean that your investment strategy is to hold the crytpoasset indefinitely to earn reward from yield farming. This is your purpose. And in this case, we’d argue the cryptoasset is not taxable on sale (however, the rewards earned from the farming would be taxable).
Think also about the non-fungible token (“NFT”). It’s quite feasible that the NFT was bought for a hobby. I don’t see them being much different to tangible collectibles, baseball cards, Garbage Pail Kid stickers (in my day); all bought with a dominant purpose of hobbying, not necessarily to make money. The money might just be a fortuitous outcome on a future sale.
In terms of circumstance, it is worthwhile highlighting that there is a quite a big difference between the person who solicits a buyer versus the person who is solicited by a buyer. The former may support a purpose of sale, the latter is a change of circumstance and hopefully an offer too good to turn down.
2) Did you buy the property as part of a scheme to profit?
Do you have a plan to make money? If so, it’s taxable.
This one often causes concern. The way the rules are written, it clearly contemplates that a plan/scheme can commence during ownership. It’s not just an examination of the position on acquisition.
Inland Revenue has provided quite a good example as to how they see this one working.
Sarah owns an especially cute hamster. She builds a miniature playground, complete with tiny slide and swing, for the hamster and posts a video of it playing on YouTube. She shares the video with her friends on social media. The video is an instant online success and goes viral, quickly amassing millions of views worldwide. Despite the millions of views, Sarah has not made any money from the video. Her friends encourage her to monetise the video and try to make a bit of money.
Sarah decides to profit from her cute hamster. She creates a Google AdSense account and monetises the video. Ad clicks by viewers of the video result in Sarah earning a share of advertising revenue. Her hamster video quickly generates $10,000 paid to Sarah in the first month after monetising the video. However, the internet’s “cute hamster” phase is short-lived and, after her initial success, viewing of Sarah’s video (and resultant AdSense revenue) quickly comes to an end.
Although the hamster video going viral appears to be a random event, the money Sarah makes from the video is, on the facts set out, not a windfall gain. This is because Sarah, by choosing to monetise the video and allowing ads to run on the video with the dominant purpose of making a profit, has undertaken a profit-making scheme. The advertising income she receives will be taxable.
Perhaps, this is not too dissimilar from the NFT holder (a digital image of a “cute hamster”) that was acquired as a hobby, but later on a plan is put into action to “rent” it out to others? The income from the “rent” is taxable (you’d probably expect this outcome).
What is worrying is how the actual NFT might be treated. What if we change the circumstances and the NFT holder devises a plan to rent the NFT out for two years (under contract), which increases its market value (as it now has a yield) and sells once the contract is signed? Is the sale of the NFT taxable?
Hard forks. These arise from a split in the chain, for example, the hard fork of Bitcoin creating Bitcoin Cash. It’s something out of nothing, because you hold this (i.e. Bitcoin), you get that (i.e. Bitcoin Cash) as well. The sale of Bitcoin Cash is unlikely to be taxable, but it might be, if you had a plan to hold Bitcoin in anticipation of a hard fork (if you’ve done it many times over, you may also be in a business).
3) Are you in the business of buying and selling property?
This is similar to above, you’ve just done it many times over.
Businesses are said to have the following characteristics:
It is undertaken in a “businesslike” manner, i.e. you have a handle on the finances, have a written strategy etc;
An intention to make profit.
From experience, the existence of a business normally jumps out on the basis the individual has transacted many times over.
4) Did you receive the property as a reward for service?
The classic example here is the successful miner, who solved a problem and received a Bitcoin at the end of it. You provided a service and got paid, in kind. It’s taxable.
Airdrops. Did you get something for free, or did you have to do something (perhaps market through a retweet or other)?
What can you do?
Document your non-taxable “why”, if you have one – don’t lie. This is difficult, circumstantial evidence and hindsight play a big part in these rules.
We do consider that it pays to think and protect your position. If you bought the NFT as a hobby, then document this and use it as part of the hobby.
However, actions speak louder than words. If you acquire a NFT to use in a game, but never plan the game, it doesn’t really stack up.
Be aware. Operate with your eyes wide open. Ignorance is no defence from tax. You may have stumbled across something once and had a win, if you seek to replicate the win many times over, then you are moving towards an activity that is likely taxable.
Considering disclosing. There’s careful strategy in this, but it needs to go on the table to consider rather than discount off hand.
You may decide that a transaction is not taxable. If this is disclosed to Inland Revenue, then Inland Revenue has around four years to take a different view and seek to re-assess. If it is not disclosed, then Inland Revenue has an unlimited timeframe to re-assess.
You can enjoy the terminology:
Airdrops – not delivery of cargo, emergency supplies or personnel by parachute from an airplane
Hard forks – not a utensil
Yield farming – doesn’t require a field…
Cryptocurrency – not a currency
Finally, hamsters are not always cute from personal experience. They can be bitey.
If you'd like help navigating the world of cryptocurrency, please reach out to your local BDO office today.