Cryptocurrency - What is it and What Traps to Avoid
Cryptocurrency has recently become popular amongst Australian investors and whist there is a general understanding of the Accounting and Tax implications of other assets like shares and property, most investors may be still in the dark about the Accounting and tax implications and the hidden costs of holding and transacting Cryptocurrency.
What is Cryptocurrency?
Cryptocurrency is a decentralised digital currency that is underpinned by complex blockchain technology that can be exchanged for goods and services or stored. In Australia, as with other countries, the blockchain is a type of database that stores data across multiples servers or computers. You can use Cryptocurrency to buy goods or services, exchange for more Cryptocurrency, or store it for investment purposes as you would do with Shares or Property.
How is it regulated?
Australian Securities and Investment Commission (ASIC) regulates Cryptocurrency via the Corporation Act 2001 and Anti-Money Laundering and Counter-Terrorism Financing Act 2006 and Australia’s existing Financial Services Regulations. Between these three laws, Australian Investors are informed about the legal status of Cryptocurrency, licensing and disclosure requirements, consumer law, design and distribution, and marketing considerations. The wording of the legislation also defines each Crypto as an individual asset for Capital Gains Tax purposes. It is important to note that there is currently no legislation in Australia that deals with Blockchains or the mining of Cryptocurrency.
You can buy Crypto in several entities including a Company, Trust, your own name, or your Self-Managed Super Fund.
How to buy it in Australia
Before you can buy Crypto you will need something called a Wallet. Most Cryptocurrency currency exchanges in Australia will allow you to create a new account and transfer Australian Dollars into that account to exchange for common Cryptocurrencies like Bitcoin. More and more Australian exchanges will now allow you to create your own Wallet to store your Crypto as well as buy and sell on the exchange. Buying Cryptocurrency is complex, and we encourage you to do your research on the exchanges available to you.
Accounting and Tax implications of Cryptocurrency
How you treat Crypto for Accounting purposes will depend on the purpose of the holding. Cryptocurrency does not meet the definition of cash or a financial instrument for accounting purposes. When determining how to account for Cryptocurrency, your Accountant should be asking you, your plans for the investment. In most circumstances, the investment will be treated as an intangible asset because the purpose of the investment is for value growth and a sale in the future. In these circumstances, the Crypto will be treated as an asset and reported on the Statement of Financial position with movements in value each year as deferred incomes or losses. In other circumstances, if the Cryptocurrency was obtained through mining or other efforts, the owner may view it as inventory to be used for the purchase of goods and services or an investor that is trading regularly may also view it as inventory, in both these cases the Cryptocurrency will be as Stock on hand on the Statement of Financial Position and the movements will be recorded in Cost of Goods sold.
How is Cryptocurrency Taxed?
The tax implications of buying, holding, and selling Cryptocurrency will depend on the entity that holds the Asset. If you have used an overseas exchange to buy Cryptocurrency, this will also impact how it is taxed. If the Cryptocurrency is being treated as an intangible asset, when sold, the sale will trigger a Capital Gains Tax event. As per the ATO’s website “A capital gains tax (CGT) event occurs when you dispose of your Cryptocurrency. A disposal can occur when you:
sell or gift Cryptocurrency
trade or exchange Cryptocurrency (including the disposal of one Cryptocurrency for another Cryptocurrency)
convert Cryptocurrency to fiat currency (a currency established by government regulation or law), such as Australian dollars, or
use Cryptocurrency to obtain goods or services.
While a digital wallet can contain different types of Cryptocurrency each Cryptocurrency is a separate CGT asset.”
In this circumstance, normal CGT tax concessions will apply depending on the entity that holds the investments.
If the Cryptocurrency has been held as inventory or forms part of a business you carry on (if you have accepted Cryptocurrency as payment for goods or services), the difference between the sales prices and the purchase price will be treated as ordinary income and will be taxed at the normal rates as per the entity that owns the Cryptocurrency.
What things should you look out for when buying Cryptocurrency?
Do your research
Whilst Cryptocurrency is regulated through ASIC, the Cryptocurrency exchanges are currently unregulated. Due to the complex nature of this type of investment, it is important that you do your research when selecting an exchange to use. Other areas where you should be spending time researching is knowing that your Accountant, Financial Adviser or SMSF Auditor knows what they are doing when it comes to Cryptocurrency. It’s relatively new and Accounting and Auditing are rushing to keep up with the investment side of things so there will be changes coming and you need to make sure that the professionals that you are getting advice from are on top of these changes.
Unfortunately, the cost of accounting and auditing Cryptocurrency can be expensive. This may change in the future but presently the reporting from the exchanges is poor compared to other types of exchanges. The Cryptocurrency exchanges are also unaudited which means that an SMSF auditor is unable to rely on the reporting and will most likely mean that the Auditor will have to issue a Part A qualification on the audit report. So, for now, there will be more work for your Accountant and Auditor when it comes to determining the values and existence of the investment. Prior to buying you should be finding out the additional cost that you will have to pay your professional each year. This cost will also vary depending on how often you are trading.
For tax purposes, there are a few things you need to keep for your Cryptocurrency investments. These include:
date of the transactions
the value of the Cryptocurrency in Australian dollars at the time of the transaction
what the transaction was for and who the other party was
If you are using a reputable exchange, they should be able to provide you with all this detail with every purchase.
Business v Personal Investment
If you purchase Cryptocurrency in your own name, regardless of what your intention is when purchasing your Cryptocurrency if you engage in regular trading, the ATO may regard it as a business activity rather than a personal investment. The difference is that if it is a personal investment the sale of each asset will be a CGT event and you can access potential CGT discounts but if the ATO determines that your trading activity means that it is a business activity, the profit on the sale will be treated as ordinary income and you will be tax at marginal rates.
Investment in Cryptocurrency is gaining popularity but is very complex and the industry is in its infancy. Many first-time investors are getting their guidance from friends and family who are starting to dabble in the market, but it is important that you speak to a professional before you start buying Cryptocurrency to avoid complex and costly outcomes.