Update (March 2021): We have recently submitted binding rulings with IRD on the position outlined below (further reading here). At this point in time, tax-free capital gains from cryptocurrency are unlikely. A potential tax-free position requires the taxpayer to show clear and compelling evidence that cryptocurrency was not acquired for the intention of disposal. The onus of proof is on the taxpayer to do so.
This series of articles is about cryptocurrency purchased with the intention to earn an income stream.
The IRD cryptocurrency update provides information about intention and purpose when acquiring cryptocurrency. For the first time, it makes specific reference to tokens that provide an income stream. But the update still lacks clarity about the tax position of the underlying invested tokens (that earn the income stream).
Part 1 outlines information about how staking income works, calculation methods, when the cryptocurrency investment increases and decreases in value and compounding staking rewards.
Part 2 will outline a framework for a potential non-taxable position: purpose, actions, and duration. It also outlines cryptocurrency purchased with a combined intention (i.e., the same cryptocurrency purchased as both a speculative investment and to earn an income stream), cryptocurrency portfolios with multiple intentions (i.e., some tokens for speculative investment and some tokens to earn income within the cryptocurrency portfolio) and outlines uncertainties with a non-taxable position.
Please contact us if you wish to discuss your specific cryptocurrency strategy and tax position.
Part 1 of this article outlines:
- Earning Cryptocurrency Staking Rewards – how it works
- Calculating taxable income from cryptocurrency staking
- The tax treatment when the capital amount (the cryptocurrency invested) increases or decreases in value
- Compounding staking rewards (reinvested to grow the capital base)
- Disposal of the earnt staking rewards, (not the original capital base)
Earning Cryptocurrency Staking Rewards – how it works
John currently has $50,000 NZD invested in a term deposit with ASB bank earning interest at 1.15% pa. His capital amount is $50k, and he will receive $575 interest (taxable income). At the end of the year, John receives $50,575 (his capital amount back plus the interest received). The $50k received is capital and repayment of what he invested – this is not taxable income. The $575 is interest received and is taxable income.
John decides to buy $50,000 of Tezos (XTZ) because it pays a reward of 5.55% pa (higher than the banks 1.15% pa). Based on today’s market value of $3.78 NZD per XTZ, John buys 13,227 XTZ with the intention to earn rewards. He stakes the tokens and receives 734 XTZ throughout the year.
Throughout the year, for this example, the value of XTZ remains the same ($3.78 NZD per token). John’s 734 XTZ have a market value of $2,775 which is taxable income to John (like the $575 of interest received from the bank).
Calculating Income from cryptocurrency staking
The staking rewards are taxable income to John on the day that he receives them (when they are deposited into his wallet). The amount of taxable income is the market value in NZD on the day received (calculated as the quantity of tokens received multiplied by the market value, converted to NZD).
When the capital amount (base cryptocurrency) increases or decreases in value
Although IRD do not specially mention this in their updated guidance, if you are acquiring cryptocurrency with an intention to earn income (from staking, or earning interest), it appears that the cryptocurrency may be held on capital account (similar to a term deposit or investment in shares). This means that any increases or decrease in the underlining capital cryptocurrency may be tax-free (because New Zealand does not have a capital gains tax).
Continuing from the example above, John purchases XTZ for the intention to earn rewards, he stakes his XTZ and earns 734 XTZ throughout the year. During the year, the market value of XTZ fluctuations and at the end of the year XTZ is worth $5 per XTZ.
- The taxable income received from staking would need to be calculated based on the market value of the token on the day it was received throughout the year.
- At the end of the financial year, John has 13,961 XTZ (his original 13,227 plus the rewards earnt). This has a value of $69,805 ($5 per token).
- From the $69,805, we know that the staking income is taxable income ($2,775) which leaves a capital gain of $17,030 (John’s original $50,000 investment into XTZ is now worth more). John has purchased this token with the intention to earn an income stream, and his actions have followed this intention.
- If John were to sell the XTZ, the increase in the value of XTZ may appear to be a tax-free capital gain, however, caution is needed.
- If XTZ was to decrease in value, a consistent capital loss position may apply, where the loss is not deductible for tax purposes.
Compounding staking rewards (reinvested to grow the capital base)
With a term deposit invested at the bank, or an investment in shares in some listed company, the taxpayer will have a choice about how they want to receive their interest or dividends. Their choice is normally between the reward (interest or dividend) being paid into a nominated bank account (then the receiver can choose how to spend the reward), or, the reward is reinvested back into the investment; compounding interest on a term deposit, or reinvested as part of a dividend reinvestment plan (i.e., buying more shares with the dividend received).
By their nature, cryptocurrency staking rewards automatically default to being reinvested because they are deposited into the cryptocurrency wallet (with the remainder of the cryptocurrency). Subsequently, they are generally re-staked so future staking rewards are compounded.
Although this provides a taxable income stream, it does not allow cash (fiat) for the receiver to spend and/or pay income tax on the staking income earnt.
Disposal of the staking rewards earnt (not the original capital base)
The taxpayer may need to sell the staking rewards received (either immediately after being earnt, or in regular intervals) to pay income tax on the staking tokens received, or it could be part of their strategy to reinvest the income elsewhere (cryptocurrency or another investment).
The tax treatment of a subsequent disposal of a token received from staking is less certain and may depend on the tax-payers intention. This is because the rewards are received as property and immediately have a cost basis within the tax regime.
John’s intention is that rewards earnt from staking his XTZ are to be reinvested to earn compounding returns. This is the action that he takes; continuing to stake the rewards that he earns. After some time, he needs to pay his tax, so sells tokens (the tokens he has previously earnt from staking). The price of XTZ has increased (or decreased) between the time the staking reward was earnt, and the sale value now.
It appears this subsequent increase (or decrease) in the market value of the token maintains the same intention as the original XTZ that John purchased (from examples 1 and 2) and therefore, may have a tax-free capital gain position, when disposed.
Part 2 of this series of articles will look at a framework required for cryptocurrency purchased to earn an income stream.
Contact Tim Doyle for a no obligation call or meeting to discuss any cryptocurrency tax or accounting questions. Our office is in Cambridge, Waikato, or we can arrange a video conference call.
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.