This article was published on accountant daily.
CGT risk
In its October 2021 report, the Select Committee on Australia as a Technology and Financial Center (Senate report) spoke about the uncertainty and possible harsh tax consequences of cryptocurrencies and other digital assets.
Specifically, the Senate report discussed how the existing tax framework failed to contemplate such technology, and as a result, whenever a crypto-asset interacts with a protocol where it is traded, accessed, stacked, packaged, burned, or bartered, a capital gains tax (CGT) Event A1 can be triggered.[1]
Regardless of whether or not you are familiar with these precise terms, it is important to note that digital assets can inadvertently trigger CGT liabilities in instances where an underlying disposal may not have occurred, including for example through mere technological upgrades similar to a stock split.[2]
Once triggered, taxpayers cannot rely on CGT rollover relief to mitigate the impact of this outcome as the strict and limited rollover requirements do not extend to digital assets.
After outlining these potential tax issues through various inputs, the Senate report recommended changing the CGT regime so that digital asset transactions create a CGT event only if they truly result in a clearly definable capital gain or loss.[3]
An example of an unintended tax liability – “lending” or “staking” digital assets to liquidity pools or otherwise
For example, it may come as a surprise to some crypto users that an ATO official had informally suggested that digital assets “lending” could trigger CGT event A1 (a sale).[4] Thus, while a “lender” may expect to continue holding the “borrowed” asset”, the “borrowing” may actually result in a disposal for purposes of CGT Event A1, depending on the specific terms under which it is made.
While the recent FTX scandal may have presented fraud, it serves as a timely reminder of the need to carefully and thoroughly understand how each product/arrangement is governed and the risks involved, including counterparty risk. Only by carefully analyzing the terms of the agreement and understanding your precise legal rights as a “lender” can the commercial risks and resulting tax implications be properly identified.
To this end, the specific terms used to conveniently describe an offering may not accurately reflect actual commercial and legal realities.
In order to properly understand the tax implications of “lending” digital assets, including whether CGT event A1 is triggered, it may be necessary to consider whether the “lender” retains title and/or beneficial ownership. Analyzing whether ownership is retained can be further complicated in circumstances where the “lender” relinquishes control of the digital assets and subjects them to a self-executing “smart contract”.
Bring away
It’s important not to rely on labels, but to carefully review the terms of any agreement and new product offering to ensure you understand your rights. Only then can you correctly assess the risks and tax implications.
Digital assets, including bitcoin, are not considered currencies and this outcome is about to be enshrined in law. As a result, they will likely fall under the CGT regime and will not qualify for the Commissioner’s administrative leniency not to treat them as CGT assets.[5]
The build-up of large capital losses during the recent downturn may be of limited use in mitigating the consequences of unintended capital gains at market peaks in previous earnings years.
The Tax Agency has been tasked with examining the tax treatment of digital assets and was due to report to the government by December 31, 2022.
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