Have you been investing in cryptocurrency? Be prepared as Inland Revenue is coming for you!
Tax Alert - November 2020
- Overview of Cryptoassets
- What are your tax obligations if you own cryptoassets?
- Inland Revenue is coming for you
By Ian Fay and Alex Chang
About a decade ago, no one knew what a cryptoasset or a blockchain was. The use of blockchain to create cryptoassets boomed in recent years with the high fluctuation in value and price, particularly at the end of 2017 and early 2018. Guidance from Inland Revenue (IR) has been fairly sparse, largely focused on employees, but they have recently released guidance on the tax treatment of investing/owning cryptoassets, as well as stepping up audit activity.
IR has been considering whether transactions involving buying and selling cryptoassets will give rise to taxable income. While you can invest in cryptoassets anonymously, IR has taken steps to request that cryptoasset exchanges provide data on the users of these platforms who own / transact in cryptoassets.
It is no longer safe to assume that IR is not aware of your cryptoassets, and it is only a matter of time before they start asking questions about what amounts have or have not been included within income tax returns.
Overview of Cryptoassets
A recent OECD publication on taxing virtual currencies highlights that one of the challenges in developing tax rules is that there is currently no internationally agreed standard definition of cryptoassets. Nevertheless, the term cryptoasset is commonly used to refer to types of digital financial assets that are based on distributed ledger technology (DLT or Blockchain).
“Cryptoassets” is the term that IR uses, and they state that “cryptoassets are treated as a form of property for tax purposes. While there are different types of cryptoassets, the tax treatment depends on the characteristics and use of cryptoassets”.
How does Inland Revenue think cryptoasset transactions should be taxed?
1. Cryptoassets and tax residence
The tax residency status of an individual affects how tax is paid in New Zealand on the cryptoasset income.
a) If you are a tax resident
Taxed on worldwide income including cryptoasset income from overseas.
b) If you are new or returning tax resident after 10 years
Eligible for a 4-year temporary tax exemption on most types of foreign income. If the income from the cryptoasset transactions has a source outside of New Zealand, the income will not be liable for New Zealand tax.
c) If you are a non-tax resident
Income from cryptoassets is subject to New Zealand tax only if the income has a source in New Zealand.
The second and third situation raises a key question of what is the source of income from cryptoassets, which is not an easy question when the transactions take place on a distributed ledger.
2. Buying or selling of cryptoassets
Disposals of cryptoassets can be taxable under a number of different tax rules. A disposal will include conversion of cryptoassets into fiat (traditional) currencies as well as any exchange of one type of cryptoasset for another (e.g. the use of Bitcoin to acquire Ethereum).
You will be taxed on the profit that you make, or be entitled to a loss if you:
a) Acquired the cryptoassets for the purpose of disposing them;
b) Carry on a profit-making scheme; or
c) Trade in cryptoassets whether part-time or full time.
The first of these rules requires you to establish your main purpose when you acquire cryptoassets, and whether there was a dominant purpose of disposal. Once established, the purpose of acquisition can’t change due to a change of circumstance at a later date. IR’s view on when assets are acquired for the purpose of disposal was set out in their guidance on the tax treatment of gold bullion, which can also be applied to certain types of crypto assets. IR have provided some examples in their guidance.
Where only some of a particular type of cryptoasset are disposed of you will need to consider whether to use a weighted average cost (WAC) or first in, first out (FIFO) method to establish the cost of the cryptoassets that have been sold (the last in, first out (LIFO) is not an available option).
3. Mining of cryptoassets
Mining cryptoassets is a process that creates new blocks and achieves consensus (agreement) on the blocks to add to the blockchain. Different consensus models are possible, for example, proof of work and proof of stake.
From a tax perspective, mining activities could be treated as:
a) Mining as a business;
b) Mining for a profit-making scheme;
c) Mining for ordinary income; and
d) Mining as a hobby.
In most cases, the cryptoassets you get from mining (such as transaction fees and block rewards) are taxable. You may also need to pay income tax on any profit you make if you later sell or exchange your mined cryptoassets.
4. Cryptoasset exchange businesses
A cryptoasset exchange business generally holds cryptoassets for sale or exchange including via crypto ATMs.
Amounts received from selling or exchanging cryptoassets including mining rewards are business income.
5. Using cryptoassets for business transactions
If you accept cryptoassets as a form of payment for a business transaction, you will be treated as receiving income. You will then need to deal with the subsequent disposal of the cryptoassets, for example converting them to fiat currency.
You need to calculate the value of the cryptoassets in NZD at the time you receive/sell them, whether you transact from crypto to fiat, crypto-to-crypto or vice versa.
6. Providing cryptoassets to employees
If you provide cryptoassets to your employees, you will need to account for PAYE or FBT on these payments. IR issued public rulings on several different circumstances:
b) Employer issued cryptoassets – This is a fringe benefit when the condition is met (i.e. remain employed, lock-in period) and the employee becomes entitled to the cryptoassets. The taxable value of the cryptoassets provided to the employee is the market value.
c) Employer issued cryptoassets as shares – When an employer issues cryptoassets as a “share” to its employee and the employee is not required to pay the market value, then the provision of the cryptoasset will be subject to Employee Share Scheme rules.
What are your tax obligations if you own cryptoassets?
You need to include your cryptoasset activity in your tax return when it creates taxable income for you. This includes calculating the NZD value of your cryptoasset transactions and working out your cryptoasset income and expenses.
If your cryptoassets are stolen during the period, you may be able to claim a deduction for the loss (provided certain criteria are met).
You should maintain a record for all your cryptoasset transactions for at least seven years even if you no longer have any cryptoassets. Records should include:
- the type of cryptoasset
- date of the transaction
- type of transaction (for example, received or disposed of)
- number of units
- value of the transaction in New Zealand dollars (conversion rates can be obtained from centralised data repository sites such as CoinMarketCap or Yahoo Finance: Cryptocurrencies)
- total units of each cryptoasset held at the beginning and end of the year
- exchange records and bank statements
- wallet addresses.
If you have not returned the correct amount of taxable income from cryptoassets in returns that you have already filed with IR, you would be advised to make a voluntary disclosure to IR to correct the position before they come knocking. This should reduce the risk of penalties, as now that IR has issued guidance they are likely to be much less receptive to pleas of ignorance. You should consult your Deloitte tax advisor if this is the case.
Inland Revenue is coming for you
While IR has released guidance to help people to get things “right from the start” and get their returns filed correctly, there is a lack of clarity in the guidance.
IR have set out in their guidance the situations where amounts derived from holding or disposing of cryptoassets will be taxable. However, in some situations the proceeds from disposing of cryptoassets may not be taxable, for example, if the cryptoasset is acquired as a long-term investment for the purpose of earning income. Hence, it is important to determine the purpose of acquiring the cryptoassets at the time of acquisition and also ensuring that you retain supporting evidence of that purpose.
As mentioned earlier in this article, IR is gathering data on anyone who transacts in cryptoassets. If you have significant transactions relating to cryptoassets and you are of the view that the transactions are not taxable, then be prepared to support this position if IR ask questions.
There are a number of parallels between the treatment of cryptoasset transactions and transactions involving shares. For more information on the tax treatment of share transactions and Inland Revenue activity refer to our article on share trading in this edition of Tax Alert.
If you have any queries on the taxability of cryptoassets or unsure of your tax obligations, please consult your usual Deloitte advisor.
Taxation of virtual currencies
On 12 October 2020, the OECD published “Taxing Virtual Currencies: An overview of tax treatments and emerging tax policy issues”. The report covers the approaches to income taxes and consumption taxes around the world, noting that the value invested in virtual currencies is estimated at USD350 billion.
November 2020 Tax Alert contents
- Have you been investing in cryptocurrency? Be prepared as Inland Revenue is coming for you!