Cryptocurrency prices have recently increased significantly in value. This results in many clients currently having significant profits and subsequent tax liabilities.
In some cases, IRD will charge interest at 7% pa on any underpaid tax. This article focuses on those situations when IRD will charge interest on shortfall of tax paid, and when they do not (also known as a ‘safe-harbour taxpayer’). It also outlines recommendations and how you can prepare for any tax payments.
Part 2 will outline a practical guide to prepare for upcoming tax payments.
What triggers a taxable event?
A realised profit triggers tax to pay for the financial year the profit was earned. Tax is only payable when profits are realised. We have covered this concept in more detail here. In summary:
- Buying crypto is not a taxable event.
- Selling crypto for fiat (e.g., NZD) is a taxable event.
- Using crypto to purchase goods or services is a taxable event.
An unrealised profit is when the market value of a token is higher than the original purchase cost. However, because the token has not yet been sold, the profit is unrealised, and there is no tax.
What is the Safe-Harbour rule?
The safe-harbour rule means that IRD do not charge use of money interest on a terminal tax liability.
John buys a BTC for $5,000 in January 2019 and sells it for $15,000 in November 2020 (the 2021 financial year). He has a $10,000 profit and tax liability of $1,050 for the financial year ending 31 March 2021.
He pays his tax liability of $1,050 to IRD on 7 April 2022 (yes, 12 months after the end of the financial year).
Provided John meets the safe-harbour rules, there is no use of money interest charged on the tax liability of $1,050.
When do the Safe-Harbour rules apply?
To qualify for the safe-harbour a taxpayer (including non-individuals) must meet the following requirements:
- Have current year residual income tax (RIT – tax liability) of less than $60,000 (note this is the tax amount, so the profit must be <~$180,000)
- Have no obligation to pay provisional tax or have paid provisional tax installments under the standard method for the tax year.
- Have not estimated their RIT or used a GST ratio method, and
- Not have a provisional tax interest avoidance arrangement.
Provided the taxpayer meets the criteria, their tax will be due for payment in one instalment on their terminal tax date (7April 2022 for the financial year ending 31 March 2021).
In the earlier example, John’s RIT is $1,050 (less than $60,000), he had no obligation to pay provisional tax, has not estimated his tax and does not have a provisional tax interest avoidance arrangement. Therefore, he meets the safe-harbour test and his tax is due on 7 April 2022.
David brough 20 BTC for $5,000 each in January 2019 ($125,000) and sells the 20 BTC for $15,000 each in November 2020 (total of $375,000 during the 2021 financial year). He has a $250,000 profit and tax liability of $73,420 for the financial year ending 31 March 2021.
Because the tax liability is greater than $60,000 David does not meet the safe-harbour and IRD will charge use of money interest at 7% pa on his $73,420 tax liability (~$5,139 of interest payable as well as the tax amount). This interest will commence from the provisional tax due dates (part 2 will include examples of this). David could pay tax to the IRD during the year as a voluntary payment to mitigate IRD interest costs.
David’s tax liability may increase further if the Labour government introduce a 39% tax rate for individuals with income over $180,000 per annual.
Different situations depending on personal circumstances & provisional tax
There are different tax situations that can occur and result in different interest calculations. The examples above, take a simplistic view (for demonstration purposes) that the taxpayer is not a provisional taxpayer. We will publish more articles about provisional tax.
Any structure (company, trust, partnership) requires a commercial reason for doing so, and tax reasons alone are not sufficient to change a structure. In nearly all situations the structure needs to be in place and set-up correctly prior to the profit being realised (i.e., it cannot be applied retrospectively). Planning, strategy and a future vision is fundamental.
Rather than David buying the cryptocurrency, a trust purchases the cryptocurrency. The same amounts and profit are realised as in example 2, $250,000 profit in the 2021 financial year.
The trustees of the trust decide to distribute the income to the beneficiaries of the trust. David has two children who are currently studying at university (not receiving any other income) who are beneficiaries of the trust. Income is distributed $20,000 to each child, $100,000 to David and the balance of $110,000 retained in the trust.
|Total||Trust||David||Child 1||Child 2|
This results in a combined tax liability of $65,260 (tax savings of $8,160 compared to the same $250k income in example 2).
Furthermore, each taxpayer (Trust, David, Child 1 and Child 2) tax liability is less than $60,000. Therefore, provided they meet the other criteria, there is no IRD use of money interest because they meet the safe-harbour rules (further interest savings of $5,139).
This example results in total savings of $13,299.
- Have a tax strategy. Know what your payments are, when they are due, how much they will be, and how you will fund them.
2. If you have a profit of more than $180k get in touch with us early (during the financial year) so we can review your tax situation. This may involve strategies such as:
- Making voluntary tax payments during the year
- Buying back dated tax through tax pooling (saving use of money interest costs)
- Informing you of your future tax payments so you have certainty over what they are going to be, when they are due, and give you options to consider.
- Consider opportunities to restructure your portfolio. This may also include separating trading tokens from holding or staking tokens or tokens acquired with different intentions.
3. Know your investment strategy – our most successful clients have a clear vision of what they want to achieve from their investments. What does a successful ‘win’ look like for you? What is your expected outcome from your cryptocurrency investment? This prevents making rushed or irrational decisions in the heat of the moment in the volatile market.
Contact Tim Doyle (firstname.lastname@example.org) 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.