Melbourne lawyer Max became an overnight millionaire when $600 worth of cryptocurrency he’d acquired in 2014 topped out at nearly $7 million late last year. Now he’s fighting the Australian Taxation Office (ATO) over how the loot ought to be taxed.
He’s not alone. CPA Australia policy head Paul Drum estimates that hundreds of thousands of taxpayers, including members of self-managed superannuation funds (SMSFs), will make declarations relating to transactions of cryptocurrency such as bitcoin in their tax returns for the first time.
The wildly fluctuating fortunes of crypto investors in late 2017 will make this tax time extraordinary, he says. “We’re at the pointy end of a financial year of seismic profits and if people were thinking they could fly under the radar, I’ve got bad news.” He is, of course, referring to the tax treatment of profits or losses on cryptocurrency once it’s sold or used. There is no tax imposte on cryptocurrency while it’s held.
The ATO views bitcoin and other cryptocurrencies as property, not currency, and therefore liable for capital gains tax (CGT) when sold for a profit. If the cryptocurrency is held by an Australian resident taxpayer for more than 12 months before being sold or used, he or she may be eligible for the 50 per cent CGT discount. In this scenario, the taxpayer is a cryptocurrency “investor”.
There are a couple of “buts”. The first is what’s known as the “personal use exemption”. The exemption applies to assets worth less than $10,000 that are kept for personal use or enjoyment.
“Cryptocurrency may be a personal use asset if it is kept or used mainly to purchase items for personal use or consumption,” the ATO says on its website. “The longer the period of time that a cryptocurrency is held, the less likely it is that it will be a personal use asset.”
There is a point at which an investor becomes a trader or speculator. The ATO may find the cryptocurrency assets are being held for short-term profit rather than long-term capital growth. Although there is no bright-line test to determine precisely when one becomes a trader, in such cases gains will be taxed as income – at marginal rates and with no access to the CGT discount. In accounting jargon, a person’s tax liabilities will have switched from “capital” to “revenue” account.
Max is seeking to make the case that he is entitled to the personal use exemption. He recalls first learning about Ethereum, a bitcoin successor, while eating sushi with a mate in 2014.
Enthralled by the ideas espoused by Russian computer programmer Vitalik Buterin, Max contributed $600 to what was then called the Ethereum Project (now the Ethereum Foundation). “Peer-to-peer, trustless, decentralised methods of binding two parties – from a nerd perspective I loved it,” he tells AFR Weekend. “It wasn’t an investment, we just bought them because we really believed in it; we wanted to be a part of it. If I knew it was going to be worth what it has become, trust me, I would have put in more than $600.”
The value of Max’s Ethereum tokens peaked at close to $7 million in late 2017, but has since fallen back to around $2 million. He says he sold about $500,000 but kept the rest, believing his tokens will appreciate even further.
In the meantime, Max is seeking a private binding ruling from the ATO to confirm he qualifies for the personal use exemption.
One reason Max may have trouble proving “personal use” is that there are so few businesses that accept cryptocurrency, although this is changing.
Bitcoin and Ethereum are now available in 1200 newsagents across the country and some real estate agents are accepting cryptocurrency.
In a speech earlier this month, Reserve Bank executive Tony Richards revealed he’d used bitcoin to buy coffee in Sydney.
Sydney art gallery owner Peter Maddison decided to accept bitcoin three years ago. Nobody has opted to pay using the method yet, but he believes the time will come.
“I have a bitcoin wallet so somebody can send me a number of bitcoins or part of a bitcoin as payment for a painting or lithograph,” Maddison explains. In tax terms, he would treat the bitcoin income as he would any other payment.
“The reason I haven’t had any transactions in bitcoin is probably because not that many people have them, and those who have them don’t necessarily want to part with them,” Maddison says.
“I personally think of it as a utility but some of the people who own bitcoin think of them potentially being worth $100,000 one day. I think they’ll settle down over time and they’ll just be another currency.”
Max’s lawyers, Anthony Bradica and Adam Dimac from Hall and Wilcox, can vouch for his story. They say they have other clients with cryptocurrency who are also grappling with how their circumstances will be treated by the ATO.
“There are a lot of technical issues for which there is just no guidance at all,” Dimac says. “One example is initial coin offerings. From a tax point of view, there’s basically no guidance on how they are treated. It’s really new ground.”
Bradica figures there is a stack of applications for private rulings sitting on somebody’s desk at the ATO.
“We’re hearing it’s going to be hard to argue the personal use exemption,” he says. “There are individuals who can genuinely say ‘yeah, I went into this out of intellectual curiosity and as a hobby. I’m a Millennial and this is how I think, I like to challenge the status quo. Five years later, it’s become $10 million.’ But nobody quite knows how the ATO is going to view it because everyone’s circumstances are different. And even then, the ATO is developing their thinking over time as they come to consider different scenarios and new cryptos come into the market.”
Lawyer Laura Spencer of Sladen Legal agrees the ATO guidelines offer limited assistance for early adopters.
“The insufficient guidelines and absence of case law in this area of tax leaves early adopters of cryptocurrencies in great uncertainty,” she says. “As the treatment of cryptocurrencies will play an even greater role in the future, we await further comments from the commissioner.”
The cryptocurrency factor is so significant this tax time that CPA Australia has advised member accountants to raise the issue with each of their clients. Drum says there is a big myth out there that trading in cryptocurrency is a bit like having a bet at the races. “People wrongly believe they’re getting a windfall gain that isn’t taxed,” he says. “That could be a costly mistake.”
Drum also believes people do not fully understand that a separate CGT tax event is triggered each time a “disposal” occurs. This includes trading one type of cryptocurrency for another, converting it into fiat currency like Australian dollars or using it to buy something. “So even if you traded your Ripples for bitcoin, you have to figure out whether you made a profit on the trade,” he says.
New laws will make it more difficult to hide cryptocurrency gains.
An amendment to Australia’s anti-money laundering and counter-terrorism financing laws requires digital currency exchanges to register with the Australian Transaction Reports and Analysis Centre. They will need to verify the identity of their customers and report suspicious transactions over $10,000.
Drum believes the development, which started in April, will be a game changer in tax terms because the information will be shared with the ATO.
Another area of interest has been in the use of SMSFs to invest in cryptocurrencies.
While the ATO has confirmed there is nothing to prohibit such behaviour, many advisers are urging caution.
AFR Weekend spoke to Neil, who owns eight bitcoin through his SMSF. Like Max, he does not want to be identified publicly for fear of attracting the attention of the ATO or hackers.
Neil says he bought the bitcoin for about $6000 each and they are now worth $9000. That’s $70,000 in round numbers, or less than 10 per cent of the value of his SMSF.
He says he and his accountant believe the amount to be reasonable as part of his wider investment strategy. By law, SMSF trustees are require to formulate, review regularly and give effect to such a strategy. Acquiring bitcoin through an SMSF is no easy task, Neil warns. “Everything has to be carefully managed and documented,” he explains.
Shaun Backhaus, a lawyer with DBA Lawyers, says the volatility associated with bitcoin makes it inherently risky.
Not only that, a sharp rise in value could create a situation where contributions limits are unintentionally exceeded. “As has been shown in recent times, the price of bitcoin can fluctuate widely and rapidly,” he explains. “Trustees and members should be aware of the value of a member’s interest in the fund to ensure relevant superannuation caps aren’t breached.”
Sharp rises in the value of bitcoin could result in a member’s total superannuation balance being over the $1.6 million total superannuation balance cap and a member not being eligible to make any further non-concessional contributions to the fund. This may also affect other caps, he says, such as the $500,000 limit for unused concessional contributions that applies from July 1 this year.
Another possible issue with SMSFs investing in bitcoin is the requirement for trustees to be able to identify the assets of the fund. “The bitcoin market ultimately allows anonymous holdings of bitcoin,” Backhaus says. “Accordingly, processes should be put in place to ensure that a trustee can evidence any bitcoin is held as trustee of the SMSF.”
Backhaus says this could include using the fund’s bank account when purchasing, passing relevant trustee resolutions, ensuring any exchange account is in name of the SMSF trustee, creating a fund-specific email address, completing statutory declarations and otherwise ensuring there is good documentary evidence to satisfy an auditor and the ATO. “Prospective advice should be obtained on these requirements prior to investing in Bitcoin,” he adds.