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 article is part 2 in our series about cryptocurrency purchased with the intention to earn an income stream. Read Part 1 here. In summary, there is a possibility that an increase or decreases in cryptocurrency values may be on capital account (tax-free), if the cryptocurrency was purchase with the intention to earn an income.
This article explores applying this non-taxable position. Part 1 outlined the tactical implications such as how staking income works, calculation methods of staking income, when the capital amount increases and decreases in value and compounding staking rewards. The rewards earnt from staking will be taxable income as outlined in Part 1.
Part 2 of this article outlines:
- A framework for a non-taxable position: purpose, actions, and duration
- Combined intentions for the same cryptocurrency
- Combined intentions across a cryptocurrency portfolio
- Uncertainty with a non-taxable position
The Venn diagram above shows three criteria for a non-taxable position: purpose, actions, and duration.
IRD have outlined in their guidance that purpose is the key element, however, from a practical perspective, it is difficult to show a purpose due to the subjective nature. Therefore, your actions (what you do), and for the duration (how long) add evidence and support your intention.
IRD also outline that if your purpose changes later, it does not matter.
IRD mention that having an income stream is a factor to consider when thinking about your purpose. However, just because there may be an income stream does not mean you have not acquired them for the main purpose of selling or exchanging them.
Your actions support your intention. If your intention is for a non-taxable position, however you are buying and selling cryptocurrency regularly, then there is no evidence that supports a non-taxable staking position.
You must do what you say you will do and just saying why you have purchased cryptocurrency is not sufficient (for example, a long-term investment is not an intention or action).
While IRD make no mention of a timeframe, the longer your position is continued, the more support it adds to your intention.
For example, if your intention is to purchase cryptocurrency to earn staking rewards, this is what you do for the next five years (stake the crypto and earn rewards), the duration the tokens were staked supports your intention. If the tokens were only staked for five weeks, and then sold for a significantly higher price than purchased for, it will be hard to show that your intention when purchasing was to earn income, not a speculative investment.
The five-year period mentioned above is used as an example only. The nature of this non-taxable position is subjective, and the entire cryptocurrency position, activity and history needs to be considered.
Combined intentions for the same cryptocurrency
IRD have outlined that you may have more than one purpose when you acquire cryptocurrency; it is the main purpose that matters.
Therefore, it is important to be consistent and apply the same tax treatment to speculative investment, trading, and staking positions.
If you are considering have different intentions for the same token, talk with us about structuring your portfolio. This is like a property investor buying one property to rent and earn rental income, and another property to renovate and sell (they both have different tax considerations). A speculative trading intention will directly affect the tax treatment of the rental property which may otherwise be on capital account (tax free). This principle also applies with cryptocurrency.
Combined intentions across a cryptocurrency portfolio
If you have one cryptocurrency token that is purchased as a speculative investment, and another cryptocurrency that is purchased with the intention to earn staking rewards. It may be difficult to show evidence of separate intentions for each different cryptocurrency token.
If this applies to you, we recommend discussing this further with us.
Uncertainty with a non-taxable position
There is still uncertainty associated with a non-taxable position. IRD state clearly that: “You may still need to pay income tax even if you did not acquire your cryptoassets for the main purpose of disposing of them, such as if you’re carrying on a profit-making scheme”.
While purchasing cryptocurrency to earn an income stream is different from a profit-making scheme, clarification is needed on the following:
- What evidence is required to show an intention to earn income rewards at purchase date? IRD mention this is the key factor to consider, however provide no information on what is required to demonstrate this.
- How long does a staking position need to be maintained to show sufficient evidence of a non-taxable position? IRD have the benefit of hindsight if they review any activity. They mention that intention is key, however it is the actions and duration that support the intention. Therefore, an appropriate duration of time for staking (or suitable circumstances that allows change) need to be provided.
- Do staking rewards follow the intention of the original cryptocurrency investment? What if the rewards are withdrawn after significant price increases or decreases? By default, it appears they are acquired with on a capital position.
- How does rebalancing the portfolio or disposing one staking token for another with a higher return (or other factors) affect the overall intention? The cryptocurrency market is fast changing, and the investor may choose to change from staking one reward earning token to another. Their intention has not changed, but they have purchased and sold cryptocurrency with a potential significant price change (between acquisition and disposal).
We have considered answers to these uncertainties and can discuss our thoughts and strategies further if of interest to you.
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.