Richard MacManus looks behind the IRD’s guidance on cryptocurrencies and finds trading profits can be taxed, but uncertainty remains over how to tax the tools used by currency miners, traders and hoarders.
The Inland Revenue Department has finally released its guidance on cryptocurrencies, months after its Australian counterpart did the same. No surprise, the upshot is cryptocurrencies will be treated like property for tax purposes. But the IRD has yet to give specific guidance on Initial Coin Offerings (ICOs), using utility tokens and whether currency users should pay GST.
“Just like with property – when you acquire cryptocurrency for the purpose of selling or exchanging it, the proceeds you make from selling it are taxable,” said Inland Revenue customer segment leader Tony Morris.
What that means from a practical standpoint is you will have to declare – and pay tax on – any profits you make trading cryptocurrency.
I reached out to Deloitte Private partner Ian Fay, who specialises in tax, for comment. He noted the IRD is not treating cryptocurrency as “currency” or a “financial arrangement,” which means “if there’s any tax that’s going to arise, it’s only going to arise when you dispose of a crypto asset.”
So in other words, if you simply hold – or “hodl” as they say in crypto circles – your virtual currencies, then any unrealised gains won’t be subject to tax.
In a Q&A on its website, the IRD clarified in most instances it will treat proceeds from the sale of cryptocurrency as trading income, since “Bitcoin and similar cryptocurrencies generally don’t produce an income stream or provide any benefits, except when they’re sold or exchanged.”
Perhaps the most surprising aspect of the IRD’s announcement is you won’t be able to escape your tax obligations by not converting your cryptocurrency back into fiat. So if you originally bought some bitcoins and later traded those for an equivalent amount of Ether, you’ll have to calculate your profits (or otherwise) in NZD and declare that to the IRD.
Curiously, the IRD did not directly state cryptocurrency losses will be tax deductible. Given the current bear market in cryptocurrency, trading losses is the much more likely declaration – at least for the tax year just passed.
The IRD’s lack of comment around that has ruffled some crypto trader feathers. But according to Deloitte’s Fay, the rules around tax deductibility are clear enough. “From a technical tax perspective,” Fay told me, “it’s not gains that are taxable – it’s proceeds.”
Seen from this perspective, said Fay, “if the cost of acquiring cryptocurrency is higher than the proceeds from disposing, then yes you generate a loss – and the loss is deductible.”
Guidance for ICOs and utility tokens?
On the question of ICOs (Initial Coin Offerings), the IRD’s guidance is less firm and could result in some interesting test cases.
The IRD says tax implications for ICOs “will depend on the unique features of the cryptocurrency being issued and how it’s distributed.” However, given the ingenious methods I’ve seen many ICOs devise to skirt around financial regulations, I worry this guidance is too vague.
The biggest question mark is around so-called “utility tokens,” which is a common way for ICOs to describe their virtual currency. This means, theoretically, the purpose of the token is to eventually swap it for some kind of utility – such as the ability to participate in the company’s internet platform.
However, whether this utility ever becomes available is debatable. ICO startups will typically release an elaborate white paper promising all kinds of amazing future functionality. But in most cases, nothing has been developed yet. So the purported “utility” in their cryptocurrency is theoretical at best, downright fanciful at worst.
What actually happens is all these utility tokens end up being traded on altcoin exchanges, and are sometimes part of “pump and dump” schemes by devious traders.
The meaning of utility?
The good news is ICO buyers won’t be able to avoid paying their tax when they trade those coins. However, I’d wager there will be some imaginative definitions of “utility” that the IRD will have to grapple with in the year to come.
Fay said utility tokens would need to be resolved by the IRD on a case-by-case basis. “If you acquire a token as part of an ICO,” he said, then the question becomes “what is the purpose of acquiring that token?” If it’s speculative and you end up trading it, then you will have to pay tax on the proceeds. But if you exchange the coin for its promised utility, then that may in effect be paying for a service. Which according to Fay, “may not be a taxable transaction.”
Another example would be acquiring a cryptocurrency like Dash in order to run a Dash node. The purpose in that case would be to earn further Dash coins for running that node. So the proceeds from the eventual disposal of the Dash coins acquired for the node, may not be taxable. But all the Dash you earn from running the node is income that must be taxed.
On that note, the IRD did clarify that cryptocurrency accepted as payment for goods and services will need to be declared as business income.
However, Fay said there was still no clarity on the GST consequences of those payments.
The GST aspect is also “a big concern” to local blockchain consulting company, BlockchainLabs. Its operations manager Matthew Griffin told me GST and cryptocurrency “has already been addressed in Japan and Australia, and New Zealand needs to catch up.”
“As it is now, businesses receiving funds in cryptocurrencies are required to pay GST twice on each sale,” Griffin said. “In addition to that, when reverse charge rules are applied to their logical conclusion, it may result in many members of the public being required to register for GST.”
So clearly the IRD will need to address these GST implications.
In summary, the IRD has done well to clarify most of the taxation questions around cryptocurrency. However, it has hedged its bets with ICO coins and it still needs to provide guidance around GST.
So now it’s time to organise your crypto data into a spreadsheet, or print out your CoinTracking.com details for your accountant. Although given the current state of the cryptocurrency market, most of you will probably be requesting tax deductions.