The IRD recently released a guidance on taxation of cryptocurrency. Here were the key points:
- There are no special rules for cryptocurrency. It is classed as property and taxed the same way.
- Taxation depends on intention at time of purchase (did you purchase for disposal or for investment/income?)
- Bitcoin is most likely to be given the same tax treatment as gold bullion.
- Moving between cryptocurrencies (such as swapping BTC for ETH) is considered a disposal.
Now, if you read the full guidance it seems obvious that whoever wrote it does have some preliminary knowledge of cryptocurrency, but they lack a fundamental understanding of the technology itself and how it actually functions.
Let’s break down some of the key points:
IRD: For tax purposes, cryptocurrency is property, not currency. This means foreign currency gain or loss provisions do not apply.
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I thought it was quite interesting they took this approach. There are over 2,000 cryptocurrencies, and they all function very differently and are intended for very different purposes. For example:
Bitcoin: Peer to peer currency, store of value, “money of the internet”.
NEO: Usually purchased to participate in staking/validating/using the NEO network, non-divisible (so obviously not money), produces passive income.
Nano: Purely a currency, provides zero other utility.
Now these three coins are all mined/produced differently and all provide wildly different utility, so logically they would be all classed as different asset classes. Some would be foreign currencies, some would be property, some would be commodities. But they are all considered as the same asset class by the IRD.
That is going to make tax time very interesting.
IRD: Taxable income depends on your purpose for acquiring the cryptocurrency. Cryptocurrency is considered property for income tax purposes. Where you acquire cryptocurrency for the purpose of disposal (selling or exchanging it) the proceeds you make from selling it are taxable.
Bitcoin and similar cryptocurrencies generally don’t produce an income stream or provide any benefits, except when they’re sold or exchanged. This strongly suggests that cryptocurrencies are generally acquired with the purpose to sell or exchange them.
Sp the first error we need to point out is that cryptocurrencies do in fact provide an income stream, which I would think is pretty well known by now.
You can earn interest on almost any major cryptocurrency today by depositing it on an exchange, such as Bitfinex. Usually the returns are around 5-10% per year.
In addition to that, most new cryptocurrencies are now operating on proof-of-stake (PoS) rather than proof-of-work (Pow).
As we know, proof-of-stake is the blockchain validation system where users stake coins instead of mining them. Holders are then rewarded with staking rewards, similar to dividends.
Some major PoS coins in circulation today are Dash, NEO, Vechain, CPchain, PIVX, Komodo, Ark, Stellar, NavCoin, Neblio, Ontology.
That’s just off the top of my head.
In fact, one of the big drawing cards of Ethereum for me was that Vitalik was committed to moving it from proof-of-work to proof-of-stake, which he discussed as early as 2016. Ethereum’s proof-of-stake protocol Casper is apparently close to being deployed, and will likely become the industry standard, meaning you will finally be earning passive income on all Ethereum holdings. Exciting!
This means despite the IRD guidance that all cryptocurrency is acquired for resale, it’s based on a very false assumption. Therefore we should be able to safely assume this will not apply to some (or even most) cases.
IRD: Any disposal that creates a realised gain or loss needs to be recorded at the time it occurs. ‘Disposal’ includes swapping one type of cryptocurrency for another or exchanging cryptocurrency for New Zealand dollars or another fiat currency such as US dollars or Euros.
While I somewhat understand this position by the IRD, it is highly impractical and I’m guessing it will be changed in the future, as literally hundreds of man-hours are going to be required to calculate this accurately, even for tiny portfolios.
I think what IRD might not realise, as they might not have hands-on experience with crypto yet, is that often cryptocurrencies are exchanged for one another out of necessity. Even in the biggest exchange in the world (Binance), coins are only paired with four currencies: BTC, ETH, BNB and Tether.
Therefore if somebody wants to purchase, say, Cardano, they need to first purchase Bitcoin, then send that Bitcoin to Binance, and finally use that Bitcoin to purchase Cardano.
Now, when you buy Bitcoin so you can use it to buy Cardano, what is the intention of buying Bitcoin here? Is it for disposal?
But is it for disposal with the intention to make a profit?
You only purchased Bitcoin because it was a requirement for you to purchase Cardano. It’s like purchasing USD so you can buy something on Amazon.
However, according to IRD guidance, any disposal of one cryptocurrency for another is considered taxable.
Therefore it might have only been an hour between the time you purchased BTC for NZD, sent the BTC to Binance and then purchased Cardano for BTC, but you are going to need to calculate taxable gains and losses on all those events. Here’s what that is going to look like:
NZD to BTC (opening transaction).
BTC to ADA (calculate your gain/loss in NZD).
I think how this would work is, when you purchase your ADA, you need to get the ADA/NZD rate. There is no official ADA/NZD rate so you will need to get the ADA/USD rate and convert it. From there, you work out the NZD value of the ADA you just purchased, and compare that to the NZD cost of the BTC you used to purchase it. The difference between the NZD value of the ADA and the NZD cost of the BTC is your taxable gain/loss.
ADA to BTC (calculate your gain/loss in NZD).
Again, I’m guessing here, but I think you would need to work out the ADA/NZD rate at the time you sold the ADA, then you would need to compare the NZD value of the ADA at the time of purchase to the NZD value at the time of sale, and the difference is your taxable gain/loss. Even though you’re selling into BTC I don’t think the BTC/NZD rate would even be needed here.
BTC to NZD (calculate your gain/loss in NZD).
Finally, when you sell your BTC back into NZD you will probably take the NZD rate of the BTC at the time you “purchased” it (sold your ADA) and then compare that to the time you sold it into NZD. The difference will be your taxable gain/loss.
While this is technically what the IRD guidance is telling us is correct, I don’t think they will actually expect you to do this for every single transaction. Considering you might have hundreds or even thousands of these transactions per year, I think in the long run IRD will consider this impractical.
It would be the equivalent of, say if doing business in USD, you would work out the NZD gain/loss when moving NZD to USD, then work out the NZD gain/loss when using the USD to purchase the goods, then work out the NZD gain/loss when you sell the goods, and then work out the USD/NZD loss when you move the money back into NZD.
Not only is it going to be a nightmare for taxpayers, it’s going to be an even bigger nightmare for IRD to audit.
In my opinion the practical approach would be to tax purely in NZD transactions (put $1,000 NZD into crypto, get $1,500 NZD out, pay tax on $500 gain) and disregard all the stuff in the middle. But it’s still early days, so we’ll see how it develops.
Until then, you’ll need to use your own judgement on how to calculate.
So do I need to pay tax or not?
One thing that’s been made clear in this guidance is that there are no special rules for cryptocurrencies. They are simply being taxed in exactly the same way as property and gold (gold is property).
So here is my understanding of it.
If you purchase a cryptocurrency with the intention of selling it later for a profit, you will need to pay tax on that profit (or claim the loss).
If you purchase a cryptocurrency with the intention of holding it to produce income, you can hold that cryptocurrency on capital account. Any capital gains you have will not be taxable, but all your crypto income will be.
You purchase 1,000 NEO with the intention of holding it as an investment.
This nets you around 150 GAS for the year (using the NEO calculator). The GAS you receive is worth $350.
Tax position: Because you are holding NEO as an investment, the GAS you receive is considered income. You will need to declare the $350 as revenue for tax purposes. GAS cannot be classified as rent, nor dividends, nor interest. It is a staking reward. Because this is not yet a recognised income class with IRD, I would just declare it as “other income”.
You decide NEO is no longer a good project and decide to sell your NEO to invest in something else.
You sell your NEO and make a gain of $1,000.
You take that money and invest in a different project. Let’s say you buy 1,200 tokens in Neblio.
During the year you earn 125 NBLO rewards for your staking (based on this calculator). Your NBLO rewards are worth $100.
Tax position: Because you’ve been holding NEO as an investment rather than something to trade for profit, your gain on sale is on capital account and non-taxable. Because you’re now earning income with NBLO, you will now need to declare your NBLO staking rewards as income.
Neblio’s network experiences a hack and the price falls significantly. You decide to get out while you can and move your investment back into NEO.
You sell all your NBLO tokens, making a loss of $700. During the year you still earned 25 NBLO tokens, with a value of $20. You also earn $15 in GAS after moving your money back into NEO.
Tax position: Because your Neblio was held as capital, you are not able to claim the $700 loss as a taxable loss. You will still be required to declare your $20 in NBLO rewards and $15 in GAS as income.
While I can’t confirm this is correct in the eyes of the IRD, this is my best interpretation of their guidance.
What about Bitcoin?
Again, it is going to depend on your intention when you purchased the Bitcoin.
If your intention was to buy some Bitcoin, then wait until it goes up in price and sell it, any gains you make will be taxable, as you purchased it with the intention of disposal for profit.
If your intention was to buy Bitcoin as a long term investment and lend it out on exchanges because of the high interest rates, the capital gains/losses you make won’t be taxable but the interest income will be.
One interesting thing here, however, that I think many people won’t understand, is that there are other reasons people buy Bitcoin that have nothing to do with money.
To be honest, part of the reason I first bought Bitcoin was because I’m always interested in new technology and just wanted to see how it worked. I wanted to set up a wallet and send coins, and experience seeing my coins move on the blockchain. When I read that Litecoin almost transacted instantly, I bought one Litecoin so I could send it to myself and see if it was actually true. So my intention when buying Litecoin was literally to just see what it was like to use.
It’s the same reason people sign up to a new social network even though there’s hardly anyone on it, or people spend money on collectibles like Warhammer even though they will probably never be able to sell it. Sometimes it’s just about being a part of something, being an early adopter, or feeding your curiosity.
There are very likely people that bought Bitcoin back in 2012 just for fun, or maybe sold something for Bitcoin because you thought it was a cool idea. Just like the guy who bought a pizza for Bitcoin back in 2010. Technically they didn’t acquire that Bitcoin for the purposes of disposal. Therefore any gains wouldn’t be taxable. However (and this is a big however), it would be up to you to convince the IRD that is truly the case.
Other scenarios where cryptocurrency tax is unclear
Forks are happening left and right in cryptocurrency. In fact, it seems the majority of top end cryptocurrencies have experienced forks at some stage – Bitcoin, Litecoin, Bitcoin Cash, Monero, Dash, Ethereum – I could go on forever.
When a blockchain forks, holders of the forked coin generally receive free coins on the new chain, sometimes worth many thousands of dollars. According to the IRD, what will they consider the intention the user acquired these coins? If you sell them, is that taxable? Since the coins are literally dropped in your lap (or wallet), and often people don’t even know they have them, intention is almost non existent.
The same can be said for airdrops, such as the OMG airdrop in 2017. When these coins get dropped in your wallet, it could be said you have acquired them, but what was your intention? Again, intention is non-existent since you possibly didn’t even know you were receiving them. If you sell them, is that taxable?
As cryptocurrencies move into the mainstream, we are starting to see them used more in everyday life. Bitcoin debit cards are actually not so uncommon anymore. What happens when you go to a restaurant and pay for your meal on your Bitcoin credit card? Is spending your Bitcoin on groceries considered disposal? What if that was the only money you have? Does buying your coffee every morning suddenly become a taxable event?
As you can see, cryptocurrency is about a lot more than just buying and selling Bitcoin, and in many areas the tax rules don’t seem adequate to deal with his new asset class.
What I expect is this area of tax is going to evolve quite a lot in the next few years, as IRD develops special rules for cryptocurrency, as they are a unique asset class. I highly doubt they will continue using the property tax laws for cryptocurrency, as once you being to really explore the industry it becomes clear it is very dissimilar to property in so many ways.
Until then, follow the guidance the best you can. Hopefully things become clearer in the future!
Disclaimer: The information in this article is solely the opinion of the writer. I am not a tax advisor, this is not tax advice and should not be construed as such. For official tax advice, you should consult your own tax professionals.