Australian tax season is upon us and if you’re a crypto investor, it’s time to get your affairs in order. If you have purchased cryptocurrency as an Australian resident, it is important that you consider the tax implications of your transactions.
The ATO has estimated that around 800,000 Australians will have entered the crypto market in 2021 and it is likely that almost all will need to report their activity to the ATO to remain compliant. That number doesn’t even include the number of Australians who invested in the space prior to 2021 or 2022, so the number of crypto investors who need to report activity to the ATO is likely much higher.
Cryptocurrencies and existing tax laws are not the most elegant pair. The ATO has issued non-binding guidelines to assist investors in correctly reporting their investment activities. However, it is extremely important that you consult a tax professional if you are unsure whether you need to report crypto-related transactions.
This guide aims to outline crypto taxes in Australia and some considerations on more complex crypto transactions, particularly Decentralized Finance (DeFi) and NFTs. It is important to note that the guidance is not specific tax advice, rather general information that cryptocurrency investors in Australia should consider when assessing their tax obligations.
Crypto is not anonymous
A trap that many crypto investors fall into is that “crypto is anonymous” and there are no taxes to consider. The fact is that this is completely wrong. Crypto exchanges require users to fill out know-your-customer (KYC) documentation at the time of signing up and purchasing crypto. After investors provide this information on an exchange, purchase their crypto, and then send it to an “anonymous” wallet, it is extremely easy to link their personal information to the (so-called) “anonymous” wallet.
Since the vast majority of blockchains (Bitcoin, Ethereum, etc.) are all open source, all data is publicly available and linking investors to their wallets is extremely easy. The tax authorities are using this information to take action against illegal activities and tax evasion as we speak. Even if you haven’t completed KYC with any exchanges, it’s still remarkably easy for authorities to trace the location and time wallets were accessed. Blockchains and cryptocurrencies inherently make tracking transactions incredibly easy. This is something to keep in mind if you have not reported your crypto activity to the ATO.
Capital Gains Tax and Crypto Assets
As cryptocurrencies are currently treated as fixed assets in Australia, disposal or sale of cryptocurrencies may result in reportable capital gains/losses. Capital gain/loss is calculated by taking the difference between the price at which the asset was purchased and the price at which the asset was sold. For example, if I bought a bitcoin for $10,000 and later sold it for $11,000, I would have a capital gain of $1000.
It is important to note that crypto-to-crypto trades, where one crypto is sold for another, are considered a disposal event by the ATO, with the capital proceeds of the disposal being used to acquire the new asset. Take this scenario:
An investor buys an ETH for $1000 and later the price has increased to $1200. The investor exchanges it for 12 Token X. This results in a capital gain of $200 since the ETH was sold at a value of $1200 when it was bought for $1000. The cost basis for each token X is $100 since 12 were bought for $1200.
It’s important to note that because cryptocurrencies can be used in a variety of ways, there are potentially many transaction types that could be considered a disposal beyond a typical “sale.” This is especially important for investors who have been involved in transactions via decentralized protocols such as decentralized swaps, loans, liquidity pools, fees, etc.
The good news for crypto investors right now is that capital losses as well as capital gains can be triggered by selling crypto. As all global markets have taken a tumble in recent months, some crypto investors may be able to offset gains against capital losses if their losses were triggered within the tax year. It is important to note that capital losses can only be offset against profits in the current or future tax years and cannot be offset against profits from previous tax years.
Ordinary income tax and crypto assets
There are some transaction types that could be taxed as ordinary income under the ATO. It is particularly important to understand these types of transactions and how they affect you as normal income cannot be offset against capital losses. Activities such as cryptocurrency staking, cryptocurrency lending, or asset freezing to generate interest or income will be the focus here. It is very likely that the income or interest generated from these activities will be treated as ordinary income by the ATO. A scenario showing how this could become costly is shown below:
An investor stakes some token A to get some return in token B. You earn $100 worth of Token B per day for a period of 100 days, resulting in a $10,000 increase in ordinary income. The investor does not sell any of the tokens, and on day 101 token B loses all value and is now almost worthless. The investor sells the tokens to get back a small amount of money and realizes a capital loss as the cost basis is assigned as value at the time the tokens are received. The problem is that ordinary income still has to be reported as $10,000 and the capital loss can’t offset that number.
This scenario is all too common and it’s important to understand the tax implications of what you’re doing when dealing with crypto. The same also applies to airdrops where the ATO has indicated that the dollar value of the airdrop will be taxed as ordinary income at the time of receipt (12 July 2020). There have been a few large airdrops over the past fiscal year, so it’s important to ensure you report these events correctly to avoid penalties.
Decentralized finance (DeFi) tax.
Once investors withdraw funds from typical centralized exchanges, the opportunity to interact with millions of different decentralized protocols built on the blockchain opens up as investors have the ability to take control of their own funds. Many crypto users have interacted with decentralized finance (DeFi) protocols to participate in a whole range of different types of transactions, including staking, providing liquidity, decentralized swaps, futures and options, and even collateralized lending. While the nuances of crypto transactions and the tax authorities’ lack of clarity regarding different transaction types might leave this area open to some interpretation, there are some considerations crypto investors need to make.
It is important to understand what constitutes a disposal of your crypto. Typically, a disposal means that you no longer have beneficial ownership of the asset. If you have interacted with smart contracts on a DeFi protocol and deposited assets to earn income, borrow or something else, does that constitute a sale of the asset? If not what is it? Do you have evidence that stands up to the ATO as to why it isn’t a disposal?
If you deposited assets into a liquidity pool or similar and received a “receipt token” in return, does that constitute a trade? Essentially, you sold an asset (or assets) and received one in return. If you are not treating this as a trade then you need an explanation as to why it is not one that stands up to scrutiny by the ATO.
There are countless complex scenarios that could get crypto investors up the proverbial brook without a paddle. Rebasing tokens, reflections, self-repaying loans, on-chain options, and staking vaults are complex areas that can result in costly tax liabilities if handled improperly. As a responsible investor, it is important that the tax implications of any transaction are understood.
NFT taxes
Non-fungible tokens (NFTs) are digital collectibles that have become particularly popular over the past 12-24 months. These digital assets can be in the form of art, photos, music, and also physical assets that have been digitized and represented on the blockchain. The ATO has issued specific guidance on NFTs, stating that the tax treatment of these digital assets will follow the same principles as other cryptocurrencies. This means that the transactions and tax implications described for cryptocurrencies also apply to NFTs.
In most cases, NFTs are purchased using a different cryptocurrency. This results in a crypto-to-NFT trade, where the value of the cryptocurrency sold to purchase the NFT is then assigned to the NFT as a cost basis. Cryptocurrency disposal is a capital gains event. Similarly, when an NFT is sold for crypto, the sale of the NFT is a capital gains event and the profit/loss of the trade depends on the dollar value of the crypto asset received in exchange for the NFT.
Just as almost all investment markets have taken a hit in recent months, the NFT markets have also taken a hit. The good news is that NFT investors could potentially lose capital on eligible NFT trades entered into in that prior tax year.
Get help with your crypto tax
As outlined above, crypto taxes are at the very least extremely complicated. Throw a few thousand DeFi transactions, multiple wallets, exchange accounts, poor reporting practices and 20 Excel spreadsheets into the mix, you can see this turn into a nightmare very quickly. Luckily there is light at the end of the tunnel.
There are a few different software packages that can help in reconciling crypto transactions to make the whole process as quick and painless as possible. There are also some that can help match transactions from both centralized exchanges and also focus on providing support for any DeFi protocols or NFT marketplaces you have interacted with.
You can also go directly to your tax advisor. Many accountants are still unsure of the crypto space, so finding someone confident to provide support can be difficult. However, there are a few accountants and accounting firms that specialize in crypto that might be worth looking into.
Whatever you decide, the most important thing is to start early so you have ample time to decode your activities without the stress of a looming deadline.
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