Bitcoin is up 52% this month (so far today). This reminds me of the bull run during late 2017 where checking the blockfolio app on my phone was as addictive as cocaine.
Currently we are seeing bitcoin dominate; compared to 2017, when bitcoin, altcoins and ICO’s all increased in significant value on daily basis.
We have outlined below fundamental cryptocurrency tax consequences to be aware of which some taxpayers learnt after the 2017 bull run.
Have a strategy
Understand why you are buying cryptocurrency; your intention and purpose. Most situations we see are speculative investments with a purpose to make money.
Part of this strategy may be to buy and hold long term; what we classify as ‘an investor’. Or, as a trader; in the business of trading cryptocurrency. Other strategies could be holding a specific type of token to earn rewards. Or provide a cryptocurrency token as security for asset backed lending to earn interest.
Perhaps you’re involved in multiple activities.
A non-cryptocurrency example: You wouldn’t buy a house without having a strategy. That strategy could be to buy the house and then; rent out (long term residential rental), renovate and sell (in business of dealing in housing), or subdivide – build on the back to sell the new house while renting out the existing front house (combined development and rental).
Prior to buying the house, a prudent purchaser would make sure the numbers stack up (do their research), assess the risks involved and get tax advice on the best way to structure the deal (from both a debt and ownership perspective).
Cryptocurrency strategy for a savvy investor should be no different.
Understand how your strategy and cryptocurrency activity will be taxed
Different cryptocurrency activities have different tax treatments.
A trader and an investor have different closing stock valuation methods and can claim different expenses; one is in business and the other is not.
Cryptocurrency backed loans are financial arrangements and taxed differently from traders and investors. Financial arrangements may result in paying tax on unrealised gains or losses. They also have a cash basis person exemption, which means you can elect not to apply the financial arrangement rules if you qualify.
Staking or earning reward tokens is different; holding coins on capital account may result in potential tax-free capital gains.
Returning to the non-crypto example outlined above, the different strategy and intention of the taxpayer (renting, renovate to sell, subdividing) all have a different tax treatment. Furthermore, the tax payer could rent the house, renovate and sell the same house, or subdivide the same land. In these situations, the house is the same, but the tax treatment depends on the activity of the tax payer.
When applied to cryptocurrency; two different tax payers could own the same cryptocurrency token but have a different tax treatment because their underlying activities are different.
Understand when your tax payments are due (including provisional tax payments), the risks involved and when IRD interest or late payment penalties apply
For most taxpayer, tax liabilities from the 2020 financial year (ending 31 March 2020) will be due for payment on 7 April 2021 (or 7 February 2021 if you’re not registered with a tax agent). This is nearly 12 months after the end of the financial year.
Your tax liability is due in cash (fiat) to IRD. Should you choose to keep the $NZD equivalent of your tax liability in cryptocurrency, the value of your cryptocurrency portfolio will fluctuate with cryptocurrency price volatility, but your tax liability will remain the same.
For the year ending 31 March 2018, some tax payers had significant tax liabilities due to large profits. Their tax liability was subsequently due on 7 April 2019, but between 31 March 2018 and 7 April 2019, cryptocurrency prices decreased significantly. In some situations, the tax amount owed to IRD was more than the tax payers entire cryptocurrency portfolio. Understand this risk and manage accordingly.
If you tax liability is more than $60k, IRD use of money interest (UOMI) will apply. If this applies to you, we recommend you contact us immediately to discuss purchasing back dated tax from services such as tax management New Zealand (TMNZ). Or, pay tax in advance directly to IRD or TMNZ throughout the year.
For those tax payers already in the provisional tax regime, consider how your cryptocurrency profits may affect these tax payments.
Each individual tax payer will have a unique situation depending on their other income (PAYE or self-employed), their cryptocurrency activity, tokens held, initial investment and overall profit.
Plan to pay your tax (cashflow management)
Cryptocurrency is unique in that a trade between tokens can result in a taxable profit and subsequent tax liability, however you will not receive any cash to physically pay the tax.
By way of a non-crypto example; a tax payer purchases land for $100k. They sell the land for $200k (therefore making $100k taxable profit). They receive the $200k cash, but immediately purchase two new blocks for $100k each. In this example, they have a $100k taxable profit, but have no cash. The cash has been spent on the new land.
The same occurs in cryptocurrency; the sale proceeds from one token are automatically ‘reinvested’ into a new token. This results in a taxable profit, but no cash to pay the tax.
Therefore, it is important to prepare for how to pay your tax. This depends on each tax payers overall strategy, how their tax is calculated (depending on their specific activity), and their risk profile for price fluctuations.
Some strategies we have discussed with clients include:
- Cashing out the tax amount into fiat on regular occasions and paying direct to TMNZ to earn interest before the tax is due
- Reinvesting the tax amount into cryptocurrency with appropriate stop losses as a back-up
- Funding tax payments from outside cryptocurrency (wages or savings) to prevent further taxable events occurring. This is because the disposal of crypto (to fiat) is a taxable event itself.
Each individual’s unique situation needs to be considered.
Contact us for a no obligation phone call or meeting to discuss any questions about your cryptocurrency strategy, tax treatment, tax payments and cashflow management.
Phone 07 823 4980 or email Tim.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.