Terry Baucher says the growth of cryptocurrencies underlines the need for comprehensive tax reform in NZ especially in relation to capital

By Terry Baucher*

We’re going to hear a lot more about cryptocurrencies and blockchain technology as they move (very rapidly) into the mainstream. As Professor Alex Sims pointed out recently regulators are struggling to keep up with both the pace of change and the likely implications.

Inland Revenue like many other tax authorities around the world is still figuring out the income tax and GST implications of cryptocurrencies. Other than noting in 2014 that cryptocurrencies received in exchange for goods and services are taxable, Inland Revenue has not yet released any guidance on the tax treatment of cryptocurrencies.

So, what is the income tax treatment of cryptocurrencies? When I was first asked this a few weeks ago my initial reaction was that cryptocurrencies might represent financial arrangements. If so, investors holding more than one million dollars in cryptocurrency may already have incurred substantial income tax liabilities, even if they have yet not sold the cryptocurrency and realised a gain. This is because the financial arrangements regime operates on an “accrual” basis. Fortunately, Inland Revenue have informally advised that it does not consider cryptocurrencies represent financial arrangements. Instead, it views cryptocurrencies as property.

Treating cryptocurrency as property will bring within income tax those clearly trading in cryptocurrencies in the manner of a share trader. For other investors in cryptocurrency, it’s not clear. The best current interpretation would be that disposals of cryptocurrency will be taxable if the disposals are either part of a profit-making venture, or the cryptocurrency was acquired with a dominant purpose or intent of disposal This is therefore dependent on determining a person’s intention, a highly subjective matter at the best of times, more so when potentially substantial sums of tax are involved.

However, a draft “Question we’ve been asked” (QWBA) from 2016 about whether the proceeds from the sale of gold are taxable might provide an indication of Inland Revenue’s thinking on “intention”.

Inland Revenue’s conclusion was that the proceeds from the sale of gold bullion bought as an investment would be income. A key factor in this conclusion was the nature of bullion itself: “The very nature of the asset leads to the conclusion that it was acquired for the purpose of ultimately disposing of it. Such a commodity does not provide annual returns or income while being held and has use or value only in its ability to be realised.”

The draft QWBA also notes that it is irrelevant why a taxpayer decided to acquire property for disposal in due course. Describing bullion as an investment or some form of hedge does not mean it was not acquired for the purpose of disposal. In Inland Revenue’s view bullion can only be acquired for ultimate disposal as it has no other use.

Although the initial question was about gold bullion, the QWBA concluded the same treatment would apply to other precious metals purchased in bullion form. Cryptocurrencies share some similar traits to bullion so on the Inland Revenue’s analysis any disposal would be taxable. However, the still evolving nature of cryptocurrencies means there are significant differences with bullion. For example, Ethereum is not only a cryptocurrency but a platform integral to blockchain technology.

Other cryptocurrencies have created subsidiary cryptocurrencies, in effect creating a separate revenue stream. Bitcoin, the biggest cryptocurrency of all, did so on 1 August when a split or “fork”, created Bitcoin Cash. What’s more these “forks” can only happen with the approval of existing investors. On Inland Revenue’s reasoning, this would make such cryptocurrencies more akin to shares, invalidating the argument of the draft QWBA.

In the absence of definitive Inland Revenue guidance, the income tax treatment of cryptocurrencies is currently little more than an elaborate “It depends.” Not exactly an answer anyone sweating on a potentially significant tax liability wants to hear.

Other jurisdictions such as Australia, the United Kingdom, and the United States are able to treat cryptocurrencies as falling within their respective capital gains tax regimes if the activity is not already taxable as income.

However, here in New Zealand the income tax treatment is unclear. It will remain so at least until Inland Revenue releases its guidance on the topic. This could be within the next 18 months as an item on the taxation of cryptocurrencies has been included in the Public Rulings work programme for 2017-18. (The ruling will also cover the GST issues which are a whole other matter outside the scope of this article).

As an aside, preparing a policy for the taxation of cryptocurrencies highlights the continuing need for Inland Revenue to recruit and retain the highly skilled staff required to address this and other operational issues. I am not confident Inland Revenue’s proposed staff restructure properly recognises this issue.

Given the substantial gains already made and with the cryptocurrency boom not showing many signs of slowing down, a cynic might conclude that Inland Revenue is unlikely to pass up the possibility of taxing cryptocurrencies. Cynicism aside, it is an indictment of current tax policy that such uncertainty exists. It underlines the need for comprehensive tax reform particularly in relation to capital. Whether this means the introduction of either a comprehensive capital gains tax or an equivalent of the “fair dividend rate” expanded to apply to all assets, we’ll have to wait and see.

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*Terry Baucher is an Auckland-based tax specialist and head of Baucher Consulting. You can contact him here »

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15 Comments

Still worried about OBR? Don't be! Just open an account with the RBNZ.....

Bank accounts could become unnecessary within the next decade because central banks will create digital currencies and allow customers to hold deposits directly with them....The prospect of depositing funds with the central bank directly is "pretty attractive [for customers] because you won't have to deal with a bank ever again,"

http://www.afr.com/business/banking-and-finance/financial-services/asics...

Nice, but a quick google for a Reserve Bank ATM machine in my area came up short.

Really, people still use those?

Heh, heh, just us old guys who like the thrill of walking down the street with $100,000 in our bag.

Certainly gives a high (or hyper-awareness) of sorts.

And if the banking system has a hiccup at any point a few thousands in the mattress could look like good planning. Unless it's a water bed with an electric heater, in which case it looks like a charred mess.

How many people are using cryptocurrencies? I don't know any, although that does not mean a thing. Yes, the taxation system does need to be changed as an income based taxation system is ripe for exploitation and IS exploited. One of those methods for exploitation is cryptocurriences. But an emphasis on crytocurriencies just fudges the issue. Get rid of all taxes and replace them with an FTT AND an inequality tax on all income over $150,000.00 such income being indexed to inflation. It can be done gradually so as not to frighten the horses!

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I know one guy, young(ish) with a wife and three kids who speculated months ago and has now made hundreds of dollars (more than 300).

Seems almost mean to smack him really.

My experience is those with a portfolio of investments who lean towards alternative investments such as gold are certainly buying into cryptocurrencies.

But which cryptocurrency to buy? there seems no barrier to setting up a new cryptocurrency. We are seeing many being developed, presumably only a few will survive. Bitcoin looks a bit primitive.

It's much the same as which metal to buy. If you go by market share Bitcoin and Etherium are the two largest ones.

Question; as our current monetary system has largely gone digital, what is the difference between a "cryptocurrency" and the current now? True our money is based in something that can be made physical (notes and coins), and is managed by the central bank (in name at least). there still needs to be some form of management and control of it. Is it not preferable for that to be our central bank? Electronic transactions are largely the name of the game anyway. It seems to me that those who see cryptocurrencies as and advantage only do so because of the lack of central control and management and a way to avoid scrutiny and taxation.

Good point Murray.

A crypto currency (currently) means it was not issued by an reserve bank and is not therefore controlled or regulated by any government.

It is not legal tender.

It cannot be used to pay tax.

That requires further definition.

A Cryptocurrency is more specifically defined by the fact that it's generation is controlled by a predetermined encryption technique.
i.e the supply cannot be increased arbitrarily and can only be increased by advances in computational ability and only to the extent that creation is underpinned by marginal productivity of inputs.

Taking money from country to country. I've never done it in a large amount. If I opened a account overseas. Wouldn't I go to my nz bank and fill out forms and transfer it or transfer it to someone bank account if buying something. There might be charges, taxes, gst . But my question is and if I was a bit dodgy could something like bitcoin stay under the radar throwing all the rules out the window. Don't we need rules from country to country, I don't really understand all this at all

To some extent something like Bitcoin can stay under the currency radar because it is not recognised as a currency in most places. Hence Terry's article.

The twist really comes when you don't want to only buy and hold (speculate like gold) but would like to buy something with it.

Say you buy $100 or bitcoin, wait six months and then sell it at $200. Until you sell it to realise that gain in value, like any other investment, you can't spend it.

Once you realise that gain by selling your bitcoin your bank account goes up, which then becomes of interest to your local tax department. They will say, you made an investment, that investment increased in value, therefore you owe us tax on the gain in value.

In the old days you could have a bank account in the Caymans and use a credit card linked to that account to pay your local bills in NZ. The game was not to declare the bank account in the Caymans or the profits that went into it, essentially defrauding the local tax department. But new banking rules make that quite impractical now - even for those whose flexible morals are okay with fraud.