Bitcoin and cryptocurrency taxation

Some say it’s the future of money. Others aren’t so sure.

Regardless. Now that Australian authorities have begun to officially recognise cryptocurrencies like Bitcoin, it should come as no surprise to anyone that the Australian Tax Office (ATO) has been hard at work defining the tax obligations of investors and traders who deal in cryptocurrency.

But before we’re able to get to the good stuff, like GST or including virtual assets as part of your taxable income, let’s make sure we’re all up to speed on what cryptocurrencies actually are. And how they work.

 

What is cryptocurrency?

Cryptocurrency is an electronic medium of exchange. A kind of virtual currency with no intrinsic value. Digital cash with no central bank or government to determine its supply or keep its ledger.

The word itself is a portmanteau of “cryptographic currency”. And the process of making cryptocurrency transactions is a lot like using a peer-to-peer network for file sharing.

Cryptocurrency transactions use public codes and private passwords to transfer virtual funds between cryptocurrency wallets. But since virtual currencies only exist in the digital space, there’s no need for a bank or financial institution to act as a transaction intermediary.

Cryptocurrency transactions use an algorithm-driven Distributed Ledger Technology (DLT) to keep their ledger instead. This digital ledger is called the blockchain.

 

What is blockchain?

Blockchain technology is a big part of what makes dealing in cryptocurrencies different to buying and selling with other forms of payment facilitation.

Blockchain is a special kind of DLT that uses a distributed data structure to manage virtual currency exchanges. It’s a public ledger that tracks all cryptocurrency transactions across the peer-to-peer network.

Blockchain technology has created a decentralised environment for the free transfer of digital funds. Which means control that is traditionally wielded by a third party intermediary, like the bank, is placed directly into the hands of cryptocurrency users instead.

With blockchain, individual transactions are settled much faster than they are with a bank. Because blockchain works 24/7. Without time zones or operating hours to slow them down.

And because blockchain allows for true peer-to-peer activity that doesn’t require banks or third parties, there is little need for processing fees.

In some respects makes for safer, more secure transactions too. Since blockchain favors processing data via individual servers and computers versus using one central database as a hub for verifying all transactions, there are no larger networks to be compromised. So information stays in smaller batches that are much more difficult to exploit.

Permanent, unalterable and user-controlled; blockchain’s most significant innovations thus far involve providing traders with the autonomy to transfer funds without employing a centralised third party authority. And preventing users from double-spending virtual funds. Which up until recently was one of the only drawbacks or potential security sticking-points with dealing in digital currencies.

 

Bitcoin

The words “cryptocurrency” and “bitcoin” have become almost interchangeable.

In almost the same way that Band-Aid has come to refer to any adhesive bandage. Or the way Chapstick is now synonymous with the lip balm.

Maybe that’s because Bitcoin was the original cryptocurrency. Started in 2009, Bitcoin became the first virtual, decentralised currency in existence without a central bank or single administrator behind it.

Almost a decade later, it remains the strongest and most popular cryptocurrency in world with close to 17 million Bitcoins (BTC) in circulation.

 

Are there risks involved in cryptocurrency Investment?

While its clear digital currency has its advantages over government-issued legal tender, investors should be aware there are risks involved in the investment and use of cryptocurrency.

For example, digital currency is considered a commodity, just like silver or gold. That means it’s just as vulnerable to market fluctuations as any other commodity or stock would be. Crypto currencies have seen some spectacular increases and decreases in value over the past 12 months.

Buyers of crypto should be aware of the overall trading volume of the currency they purchase.  Coins with low trading volumes have the potential to make it difficult to dispose of your currency or trade it for goods and services.

Digital currency coins are encrypted to keep them secure—but there’s a potential drawback there. This coding identifies the currency itself, not its owner. This built-in anonymity feature means when a coin is stolen, it’s gone—and there is little chance you will be able to trace it.

Finally, cryptocurrency can, in theory, become worthless.  Investor interest could drop off, the overall effects of world economies could become so severe as to affect cryptocurrency value—even with safeguards in place, extreme factors could have an effect.

 

The ATO and Cryptocurrency

Since the arrival of Bitcoin, the number of Australians investing in crypto-assets has been steadily on the rise. So it didn’t take long for tax officials at the ATO to take an interest.

So while the ATO has yet to recognise cryptocurrencies as “real money” or even a “foreign currency”, they are considered a digital commodity. An asset that can either yield a financial gain or suffer a loss.

Which means like anything else that can be bought, sold, traded or exchanged, taxation may apply. And it’s how you decide to record gains or losses that will determine the tax you pay.  

 

Is profit from cryptocurrency dealings considered taxable income?

How you use cryptocurrency will determine whether or not profits earned from crypto dealings and transactions will be counted as income, and subject to taxation.

According to the ATO, “If you are not carrying on a business of bitcoin investment, you will not be assessed on any profits resulting from the sale or allowed any deductions for any losses made. However, if your transactions amount to a profit-making undertaking or plan then the profits on disposal of the bitcoin will be assessable income.”

Users of cryptocurrencies are generally classed as either an “investor” or a “trader”. Each status comes replete with its own subset of rules and restrictions that affect how the individual is taxed.

 

Traders

The cryptocurrency trader treats virtual cash like stock traders treat shares. They’re in the business of buying and flipping virtual currency for a profit.

So whether there are losses to claim or profits to answer for, everything gets declared on the tax return. Alongside all the usual earnings and expenses on the business schedule.

The landscape of cryptocurrency taxation is still evolving. And its affected by so many different factors. So if you’re going to go the trader route, you may want to enlist the services of a chartered accountant to determine what’s safe and what isn’t to claim.

 

Investors

Investors holding onto cryptocurrency for longer term profits must report any gains or losses as a capital gain or loss. So it’s important to keep detailed and accurate records. Because these gains or losses contribute to your taxable income.

When it comes to eligibility for the 50% general discount, or issues such as offsetting cryptocurrency capital losses, different standards and rules apply to the individual than do to companies or superannuation funds.

So here again, with so many moving parts to the mechanism, cryptocurrency investors are also encouraged to seek out the professional guidance of chartered accountants if they want to be sure they’re getting the most from, and paying the proper amount of tax on their crypto investments.

 

Ending double taxation

Even though the ATO doesn’t recognise cryptocurrencies as “real money”, new government legislation passed in September 2017 (legislation effective from 1 July 2017) treats virtual cash more like the real thing. At least where the goods and services tax (GST) is concerned.

Prior to 1 July 2017, making a cryptocurrency transaction likely meant paying double GST. Australians paid GST on the purchase of the cryptocurrency itself. And then again when using that digital cash to complete a transaction.

Since July 2017 – no GST is payable on the purchase, or disposal of cryptocurrency (just like buying foreign currency), however, GST will still apply when using the digital cash to complete a transaction i.e. making a sale or purchasing supplies (i.e. if you buy a new car with cryptocurrency – the value of the car will still include GST).  Please note that some cryptocurrency transactions may still incur GST – i.e. initial coin offerings, depending on the features of the offer.

 

Preparation

Whether you’re looking to trade crypto, invest in it, or are just curious about using it as a payment option in the future, there are a few things that anybody using, or considering the use of, digital currencies should keep in mind and try their best to stay on top of.

  • Be aware of your tax obligations. Ignorance of the law won’t absolve you from breaking or avoiding it. So consider consulting a chartered accountant to make sure you’re current with the latest in crypto tax legislation.
  • Accurately file all gains and losses on your tax return.
  • Keep good records, including dates and dollar figures, of all cryptocurrency transactions. This includes purchases, trades and sales. And the details of what was traded, to whom and when.
  • Consider your intentions for making a profit and determine whether you are a crypto trader or an investor.