Inland Revenue still mulling over how to tax bitcoin

So you were mostly nice last year. And you woke up on Christmas morning to find Santa had rewarded you with a bitcoin in your stocking. You want to do the right thing — because you want another reward from Santa this year — so should you worry about tax on your bitcoin?

If you don’t know, you aren’t alone; even Inland Revenue hasn’t yet provided guidance on how the tax rules apply to cryptocurrencies, although they are working on it.

Bitcoin is experiencing explosive growth in value — and hype. This naturally raises questions of how revenue authorities should be taxing cryptocurrencies generally.

For background, a cryptocurrency is a digital “currency” in which encryption techniques are used to regulate the generation of units and verify the transfer of ownership, operating independently of a central bank. When you buy cryptocurrency it is held in a “digital wallet”, and can then be used to buy goods or services from anyone willing to accept it. You won’t actually find a bitcoin in your Christmas stocking, since they’re all just lines of code).

In terms of legal status, the Financial Markets Authority considers cryptocurrencies are not legal tender (and this is the same around the world). Rather, most cryptocurrencies are intrinsic tokens (ie, they are not pegged to a dollar or paying any sort of dividend).

The correct tax treatment will depend on the characteristics of the currency. The most likely is that it would be treated as property, which means any gains could be taxable on sale — again, this isn’t certain, as the rules on property sales depend on the reason the property was acquired. If the IRD takes the view intrinsic token type cryptocurrencies are property, it is likely to treat it in the same way as gold bullion — ie, in almost all cases your bitcoin will be acquired for the purpose of cashing it in at some future time. The holder of a cryptocurrency would have to demonstrate it wasn’t held for sale to convince the IRD of any other outcome — for example, if it provides an income stream during the period of ownership (like the dividend on a share). The alternative way of taxing cryptocurrency would be to treat it as a financial arrangement, akin to currency, which, depending on the value of the cryptocurrency held, could mean unrealised gains are taxable. Other nations are also grappling with how to tax cryptocurrencies. In the US, the IRS has released guidance that cryptocurrency is property when held on capital account, and gains are subject to capital gains tax. Miners of currency should pay tax on the value of the currency they receive. Britain and Australia also tax gains from the sale of cryptocurrencies under their capital gains tax rules.

In terms of GST, buying cryptocurrencies and then using them to buy other goods and services could result in double tax. The purchase of the unit of cryptocurrency would be subject to GST, and then any subsequent purchase with the cryptocurrency would also be subject to GST.

Deeming cryptocurrencies to be currency for GST purposes would remove GST from the sale or purchase of any units, solving the double tax problem. Australia will treat them like a currency for GST purposes from July for this reason.