By Anthony Watson, Partner and James Lawrence, Partner
Bitcoin has been heralded as the ultimate digital payment technology: decentralised, immutable and free from the restraints of existing financial services structures. Other cryptocurrencies possess similar attributes. This relatively new technology presents fascinating legal challenges on numerous fronts. But how does the Australian Taxation Office treat cryptocurrency holdings? Tax partner Tony Watson and Intellectual Property partner James Lawrence discuss.
What is bitcoin?
Bitcoin is a type of decentralised cryptocurrency; the first one ever created, back in 2009. A cryptocurrency is a type of digital asset whose transactions are secured through encryption and they are in the main decentralised because transactions occur peer-to-peer rather than through a central platform such as Visa/MasterCard or other financial institution. Most digital currencies such as bitcoin rely on a blockchain.
What is a blockchain?
Put simply, a blockchain is a collection of continuously growing records (that’s right, just like a database) that are all linked and secured using encryption. Each new set of records added to the overall chain of records is called a block. The bitcoin blockchain (along with most other cryptocurrency blockchains) is often referred to as a distributed ledger because all participants are able to keep and view the entire history of the ever-growing blockchain set of records because of its peer-to-peer, decentralised nature. So it is basically a database that is controlled by everyone – there is no one, central database; instead, everyone has a complete copy of the database.
What is mining?
Bitcoins are created through a process known as mining. According to the bitcoin algorithm, 12.5 bitcoins are created for every block created in the blockchain (approximately every 10 minutes). The algorithm is designed to reduce the mining reward per block over time such that only 21 million bitcoins can ever be created. In this way, bitcoin is a finite resource, unlikely traditional fiat currencies. Miners keep the blockchain consistent, complete, and unalterable by repeatedly verifying and collecting newly broadcast transactions into a new group of transactions called a block.
How is bitcoin stored?
While wallets are often described as a place to store bitcoins, bitcoins are inseparable from the blockchain. A wallet stores the cryptographic keys that are required to unlock the bitcoin and allow the owner to conduct a transaction. To that end, a wallet is perhaps more properly described as a place for storing your bitcoin holdings’ credentials.
Do Blockchains, Bitcoins and Distributed Ledgers matter for tax?
Taxation issues are normally analysed by clarifying: Who is the correct taxpayer; the Residence of that taxpayer; the Source of the income; the Character of the income or outgoing; and the Timing of the income or outgoing. Although bitcoin and its underpinning blockchain may raise new tax issues in time, the matters addressed in this note are recognisable under these familiar heads.
How is Bitcoin treated for Australian income tax purposes?
Bitcoin is neither money nor a foreign currency. Bitcoin is considered to be property for taxation purposes. A taxpayer who receives bitcoin as payment for goods or services they provide as part of their business, or who uses bitcoin to make purchases for their business, will use the arm’s length Australian dollar value of their bitcoin transactions in calculating their tax outcomes.
How is the arm’s length dollar value of bitcoin determined?
For Australian tax purposes, transactions using bitcoin have to be recorded in Australian dollars. The value can be taken from a reputable online exchange, in which the exchange rate is established by market supply and demand. Two examples of reputable exchanges are LocalBitcoins.com or Coinbase. The well-known exchange rate aggregator xe.com now also communicates bitcoin exchange rates.
Can a taxpayer realise a taxable gain or loss upon an exchange of bitcoin for other property?
Yes. But this is where the Character of the gain or loss is important.
As bitcoin is property, it is an asset for capital gains tax (CGT) purposes. You make a capital gain if the proceeds from the disposal of the bitcoin are more than the bitcoin’s cost base. But if the bitcoin is a personal use asset (a CGT asset used or kept mainly for personal use or enjoyment), any capital gain is disregarded if the cost of the bitcoin is $10,000 or less. So if you use bitcoin for online purchases of clothes or music for personal consumption, any gain you would make on the bitcoin can be disregarded.
If the bitcoin is kept and used for the purposes of investment, you will make a taxable capital gain or loss on disposal.
If you carry on a business of buying and selling bitcoin as an exchange service, the sale proceeds are assessable income, and the cost of the bitcoin is an allowable deduction. Bitcoin held by a taxpayer carrying on a bitcoin exchange is trading stock.
If you carry on a business of mining bitcoin, the proceeds you receive upon the transfer of the mined bitcoin to a third party is assessable income. Expenses incurred in the mining activity are allowable deductions. Bitcoin held by a taxpayer carrying on a business of mining and selling bitcoin is trading stock.
What if I receive bitcoin as payment for goods or services?
If you receive bitcoin for goods and services you provide as part of your business, it is assessable as ordinary income, and you have to record the value in Australian dollars. Supplies and acquisitions of bitcoin are generally disregarded for the purposes of GST.
What if I use bitcoin to pay for goods and services in my business?
If in the course of carrying on a business you purchase business items (including trading stock), you are entitled to a deduction based on the arm’s length value of the item acquired. The deduction may be outright, or in accordance with the depreciation or other write-off provisions.
Consistent with supplies of money, supplies of bitcoin are only recognised for GST purposes if the supply is made in exchange for money or other digital currency.
What if an employee is paid in bitcoin?
If the employer and employee have concluded a valid salary sacrifice arrangement (whereby the employee will receive bitcoin and not salary), the payment of the bitcoins is a fringe benefit and the employer will have a liability to fringe benefits tax. In the absence of a salary sacrifice arrangement, the remuneration as bitcoin will constitute salary or wages, and the employer will still be obliged to remit PAYG as usual.