With the emergence of new technology protocol-backed transactions, such as cryptocurrencies, tax authorities around the world are struggling to normalise the complexity and the potentially severe tax consequences these new financial instruments present.
The Landscape in Australia
In particular, the current tax framework does not account for such technology, and as a result, capital gains tax (CGT) event A1 may be triggered whenever a cryptocurrency asset interacts with a protocol in which it is swapped, accessed, staked, wrapped, burned, or exchanged.
Although you may not be familiar with these terms, it is important to keep in mind that CGT liabilities may be accidentally triggered in the case of digital assets even if there was no underlying disposal, such as in the case of simple technological upgrades analogous to a stock split.
Since digital assets do not meet the stringent and limited requirements for CGT roll-over relief, once triggered, taxpayers cannot rely on this relief to soften the blow of this outcome.
After describing these possible tax issues and citing various submissions, the Senate Report suggested revising the CGT regime so that transactions involving digital assets only trigger a CGT event if they result in a tangible, determinable capital gain or loss.
What is an example of Staking-related tax outcomes in Australia?
When digital assets are "loaned" or "staked" to liquidity pools or other third parties, for example, this can result in unintended tax liability.
The ATO had unofficially flagged that "lending" digital assets may trigger CGT event A1, which may come as a surprise to some crypto users (a disposal).
The "lender" may mistakenly believe that they are still the legal owner of the "lent" asset even though, depending on the terms, the "lending" may constitute a "disposal" for the purposes of CGT event A1.
While the recent FTX scandal may amount to fraud, it does highlight the importance of understanding the rules and risks associated with every product and arrangement, especially the possibility of fraud on the part of a counterparty. The commercial risks and resulting taxation implications can only be accurately identified through a thorough analysis of the arrangement's terms and an understanding of your precise legal rights as the "lender."
The precise terms used to describe an offering for ease of use may not reflect the true commercial and legal circumstances.
Tax considerations related to "lending" digital assets, such as whether CGT event A1 is triggered, may require taking into account whether the "lender" will continue to hold legal title and/or beneficial title. If the "lender" hands over control of the digital assets and subjects it to a self-executing "smart contract," determining whether or not ownership is retained becomes even more nuanced.
What you should do if you are affected?
Labels aren't everything, and you should always read the fine print to know what you're getting into with any new agreements or products. Doing so is necessary before you can accurately weigh the potential benefits against the potential drawbacks, not to mention the tax implications.
Bitcoin and other digital assets are not considered to be currencies, and this fact is set to be codified in law. As a result, they will almost certainly be subject to the CGT regime and will be ineligible for the Commissioner's administrative indulgence not to be treated as CGT assets.
If you accidentally triggered capital gains during market highs in earlier income years, crystallising large capital losses during the recent downturn may do little to mitigate the consequences.
What's the outlook going forward?
Despite the lack of clarity on how they will interpret fact patterns, the Australian Taxation Office has released multiple communiques on their focus areas, which include all types of transactions involving digital assets. The government had requested a report from the Board of Tax on the taxation of digital assets by the end of 2022 however the outcomes are yet to transpire from this.
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