In its October 2021 report, the Select Committee on Australia as a Technology and Financial Centre (Senate Report) canvassed the uncertainty and potential harsh tax outcomes presented by cryptocurrencies and other digital assets.
In particular, the Senate Report discussed how the existing tax framework did not contemplate such technology, and as a result, whenever a crypto asset interacts with a protocol where it is swapped, accessed, staked, wrapped, burned or exchanged, CGT event A1 may be triggered.
Regardless of whether you are familiar with these precise terms, the point to note is that when it comes to digital assets, CGT liabilities may be inadvertently triggered in cases where there may have been no underlying disposal, including, for instance, from mere technological upgrades akin to a stock split.
Once triggered, taxpayers cannot rely on CGT rollover relief to mitigate the consequences of this outcome as the strict and limited requirements for rollover do not extend to digital assets.
After outlining these potential tax issues by reference to various submissions, the Senate Report recommended that the CGT regime be amended so that digital asset transactions only create a CGT event when they genuinely result in a clearly definable capital gain or loss.
By way of example, it may surprise some crypto users that an ATO officer had informally flagged that “lending” digital assets may trigger CGT event A1 (a disposal). So while a “lender” may consider that they continue to hold the “lent” asset”, depending on the particular terms under which it occurs, the “lending” may actually result in a disposal within the meaning of CGT event A1.
Although the latest FTX scandal may have constituted fraud, it serves as a timely reminder of the need to carefully and thoroughly understand how each product/arrangement is governed and what risks exist, including counterparty risk. It is only by carefully analysing the terms of the arrangement and understanding your precise legal rights as the “lender” that the commercial risks and resulting taxation implications can be properly identified.
To this end, the specific terms adopted to conveniently describe an offering may not accurately reflect the actual commercial and legal realities.
To properly understand the tax ramifications of “lending” digital assets, including whether CGT event A1 is triggered, it may be necessary to consider whether the “lender” will continue to hold legal title and/or beneficial title. The analysis of whether ownership is retained can be further complicated in circumstances where the “lender” relinquishes control of the digital assets and subjects it to a self-executing “smart contract”.
It is important not to rely on labels but to properly review the terms of all arrangements and new product offerings to ensure you understand your rights. It is only after doing so that you can properly assess the risks as well as the taxation ramifications.
Digital assets, including bitcoin, are not regarded as currencies and that outcome is about to be enshrined in legislation. As a result, they will likely fall within the CGT regime and they will not be eligible for the Commissioner’s administrative indulgence not to treat them as CGT assets.
Crystallising large capital losses during the latest downturn may be of limited use in mitigating the consequences of having triggered inadvertent capital gains at market highs in earlier income years.
The Board of Taxation is considering the tax treatment of digital assets and is due to report this month.
Jeremy Makowski is special counsel in tax at law firm Cornwalls.
23 December 2022
The advice provided is general advice only as, in preparing it we did not take into account your investment objectives, financial situation or particular needs. Before making an investment decision on the basis of this advice, you should consider how appropriate the advice is to your particular investment needs, and objectives. You should also consider the relevant Product Disclosure Statement before making any decision relating to a financial product.