In 2010, you could have purchased one Bitcoin for USD $0.08. That’s if you even knew what a Bitcoin was.
In February 2021, that same Bitcoin would cost you around USD $51,000 – and you’re probably well aware of Bitcoin’s existence.
These two phenomena – the explosive rise in the value of cryptocurrencies, and the growing public awareness of them – are the key to comprehending their status as a taxable asset.
To understand why, here’s our legal analysis based on research we undertook for a New Zealand-based Bitcoin owner who was contemplating a voluntary disclosure of his Bitcoin holdings to the Inland Revenue Department.
Is cryptocurrency personal property or simply a means of exchange?
In 2019, the High Court of New Zealand deemed cryptocurrency property after a ruling in the ‘Cryptopia Case.’ This case arose after a Christchurch-based cryptocurrency exchange was placed in liquidation following a hack by cybercriminals and the subsequent loss of NZD $30 million of cryptocurrency.
Account holders argued that their losses amounted to a loss of personal property while the liquidators argued that this was not the case. The Court ruled in favour of the account holders.
In September 2020 Inland Revenue updated its website with guidance on how ordinary income tax rules apply to cryptocurrency. The crux is that if cryptocurrency was acquired for the purpose of disposing of it, then it is captured by CB 4 of the Income Tax Act 2007 and income tax must be paid (i.e. the purpose test).
But what if the owner’s purpose for acquiring the cryptocurrency was NOT disposal?
Buying Bitcoin before it became popular.
Bitcoin was first described in a 2008 White Paper by Satoshi Nakamoto. This paper outlined the concept of a peer-to-peer electronic cash system governed by an algorithm, independently of governments or banks.
A few individuals with an interest in technology became fascinated by the possibilities of this revolutionary currency. One of them was our client, who subsequently bought a quantity of Bitcoin in 2011. Remember, this is an era when almost no-one outside a small group of tech enthusiasts even knew Bitcoin existed.
If you were one of those visionaries, you could fairly claim to have bought Bitcoin for reasons of intellectual curiosity. In effect, you were a hobbyist.
By holding onto your Bitcoin even as it rose, and not adding to your holdings as the Bitcoin craze took off, you could reasonably make the case that your cryptocurrency holdings were not property in the way physical cash or bullion is. While bullion or cash are also ‘means of exchange’, no one could reasonably claim to have bought them without being aware of the value they represent.
The tax status of cryptocurrency today.
In our opinion, those who can show they purchased Bitcoin long before its value took off, and who have not acted as investors or traders in cryptocurrency, may be able to prove that their dominant purpose in acquiring it was not to sell it at a later date. The profit they derive when disposing of their holdings is therefore not income under ordinary concepts, so it is not taxable.
This group will probably be a minority among cryptocurrency owners.
The default position of Inland Revenue will remain that most people who acquire cryptocurrency do so with the intention of one day selling it, as it does not provide an income stream or annual return. Therefore, it is analogous to gold bullion – and is captured by CB 4 of the Income Tax Act 2007. So income tax must be paid.
However, the law continues to evolve in this area and tax treatment is a work in progress. In the 2020 publication ‘Taxing Virtual Currencies’, the OECD found there is no international standard for taxing the different types of assets that comprise cryptocurrencies and there is no formal guidance on how cryptocurrencies should be classified for accounting purposes.
Careful investigation and analysis is required in each individual case.
If you or your clients have opinions or questions regarding the tax treatment of Bitcoin and other cryptocurrencies in New Zealand, we would be interested to hear from you.