Planning for Tax – Decisions to Consider

Cryptocurrency prices have increased significantly in 2020 and many clients have made money from their investments. Tax liabilities for the financial year ending 31 March 2021 are likely to follow; prepare now.

Some clients will keep their profits invested in cryptocurrency. There is risk that if prices fall, they will still have tax to pay but may not have enough cryptocurrency when it comes time to pay the tax.

This article’s purpose is to prepare clients for upcoming tax payments, provide options to consider and ensure there are no unexpected surprises. It covers:

  1. The date that tax is due for payment
  2. Situations when IRD will charge interest (known as use of money interest – UOMI) and/or late payment penalties (LPP).
  3. Options to consider in conjunction with risk and your investment strategy.

Some clients are realising profits which trigger a tax liability but are reluctant to immediately sell cryptocurrency for NZD (to pay their tax). This results in a leveraged position as outlined further below.

This article is technical, and some readers may consider complex. We recommend you read the specific examples based on your position and consider the options available. Please talk to us (the earlier the better) if you are unsure.

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 which includes example. All trades during the financial year are converted to NZD and combined to calculate the overall profit for the year.

When the tax is due for payment?

The tax for the year ending 31 March 2021 is due at IRD on 7 April 2022.

There are situations when IRD may charge use of money interest (UOMI) at 7% pa and late payment penalties (LPP).

Note: a provisional taxpayer is someone who has had more than $5,000 of tax to pay from their previous year’s income tax return. UOMI is use of money interest charged by IRD. LPP are late payment penalties charged by IRD.  

 Tax Liability >$60,000Tax Liability <$60,000
Provisional Taxpayer  UOMI – yes (from 7th May 2021)
LPP – yes (if provisional tax is not paid)  
    LPP & UOMI only apply if provisional tax is not paid
Not a Provisional Taxpayer    UOMI charged by IRD    No UOMI

To have a tax liability of >$60,000 will require a profit of >$180,000.

Tax liability less than $60,000 & not a provisional taxpayer (example 1)

If you are not a provisional taxpayer, and your tax liability is less than $60,000 your tax for the year ending 31 March 2021 is due on 7 April 2022 (provided you are registered with a tax agent).

John makes a profit of $40,000 from his cryptocurrency during the 2021 financial year. He receives $100,000 of salary from his job with PAYE already deducted. His total income for the year is $140,000 and he has $13,200 of tax (33%) to pay due 7 April 2022. John was not previously a provisional taxpayer, and his tax liability is <$60,000 so he is in the safe harbour regime. UOMI does not apply.

Tax liability less than $60,000 & a provisional taxpayer (example 2)

If you are a provisional taxpayer, and your tax liability is less than $60,000, you need to make your 2021 provisional tax payments, and the balance of your tax for the year ending 31 March 2021 is due on 7 April 2022.

John made a profit of $20,000 from cryptocurrency in the 2020 financial year which resulted in a tax liability of $6,600. Because the tax amount is more than $5,000 John also had to pay 2021 provisional tax (tax paid in advance for the following tax year – IRD expects you to have a similar result). The 2021 provisional tax is 105% of the 2020 tax amount or $6,930. John paid $6,930 of provisional tax during the 2021 financial year.

John makes a profit of $40,000 from his cryptocurrency during the 2021 financial year. He also receives $100,000 of salary from his job with PAYE already deducted.

His total income for the year is $140,000 and he has a tax liability of $13,200. John has already paid $6,930 of 2021 provisional tax during the year, so he has a final tax liability (known as terminal tax) of $6,270 due 7 April 2022.

John’s tax liability of $13,200 is <$60,000 so he is in the safe harbour regime and can pay his terminal tax on 7 April 2022 without incurring IRD interest costs.

Tax liability more than $60,000 and not a provisional taxpayer (example 3)

If you are not a provisional taxpayer, and your tax liability is more than $60,000 IRD will charge use of money interest (UOMI) at 7% on shortfall in tax paid.

David makes a $250,000 profit from his cryptocurrency during the 2021 financial year. He receives $100,000 of salary from his job with PAYE already deducted. His total income for the year is $350,000 and he has $82,500 of tax to pay (33%).

John was not previously a provisional taxpayer so there are no IRD late payment penalties (because he has not paid any tax late). However, because his tax liability is >$60,000 IRD will charge UOMI on the shortfall in tax from the installment date (as summarised in the below table).

IRD expected David to make three equal installments of tax payments during the year which he has not made. Therefore, IRD will charge interest from these dates to when the tax is actually paid.

In the table below, the shortfall refers to one-third of the tax amount ($82,500)

Installment DateShortfall IRD Interest Cost
28 August 2020$27,500$3,159
15 January 2021$27,500$2,421
7 May 2021$27,500$1,830

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 tax liability (~$7,410 of interest payable as well as the tax amount).

David needs to consider his options in conjunction with his overall cryptocurrency strategy which are outlined further below.

Tax liability more than $60,000 and a provisional taxpayer (example 4)

If you are a provisional taxpayer, and your tax liability is more than $60,000, if you make your first two provisional tax installments on time IRD will only charge use of money interest (UOMI) from the third provisional tax (P3) payment date. Because 7 May 2021 is after the 31 March 2021 financial year, IRD expect you to be able to calculate your profit and tax liability for the year and pay the tax.

If you do not make the first two provisional tax payments, IRD will charge LPP on the shortfall of tax paid, plus UOMI calculated on the actual tax amount (like example 3).

David made a profit of $100,000 from cryptocurrency in the 2020 financial year which resulted in a tax liability of $33,000. Because the tax amount is more than $5,000 David also had to pay 2021 provisional tax (tax paid in advance for the following tax year – IRD expects you to have a similar result). The 2021 provisional tax is 105% of the 2020 tax amount or $34,650. David paid $34,650 of provisional tax during the 2021 financial year ($11,550 at each installment date).

David makes a $250,000 profit from his cryptocurrency during the 2021 financial year. He receives $100,000 of salary from his job with PAYE already deducted. His total income for the year is $350,000 and he has $82,500 of tax to pay. His tax is >$60,000 therefore UOMI is charged.

David has already paid $34,650 of 2021 provisional tax during the year, so he has a final tax liability (known as terminal tax) of $47,850 due 7 April 2022.

Because David has paid the first two provisional tax installments (based on the 2020 year + 5%), IRD will only charge UOMI from 7 May 2020. David has paid his provisional tax, so there are no LPP.

David can choose to pay his tax of $47,850 on 7May 2021 which would save him $3,075 in IRD interest costs. Or he could pay the interest and tax to IRD on 7 April 2022 which would cost $50,924. This requires David to be organized and have his tax liability calculated before 7 May 2021, so he knows his options.

Example 5:

Same facts as example 4, but David did not make his 2021 provisional tax payments ($34,650) during the year.

IRD would charge UOMI and LPP. The LPP are calculated on his 2021 tax provisional tax liability of $34,650 – what he was required to pay based on 2020 + 5%) and the UOMI is calculated on his actual 2021 tax liability of $82,500. The LPP are an initial 1% on the amount and a further 4% penalty is charged. Each penalty is applied on a compounding basis.

Options to consider

For those who are not provisional taxpayers, tax payments are due up to 13 months after the financial year has ended.

Therefore, there are options to consider:

  1. Immediately cash out the tax amount to NZD and hold in cash until due for payment.
  2. Keep the tax funds invested in cryptocurrency.
  3. A hybrid of the two above

Option 1 is a safe approach which prevents any unexpected surprises. A profit has been made, tax is due for payment, and the management of paying the tax is a cashflow decision. How are you going to fund the tax payment?

If the tax funds are set aside, it provides certainty over your cryptocurrency portfolio.

This is no different from an ordinary business say a retail store, which needs to balance its cashflow between reinvestment into further stock (to expand its range) and paying tax on profits (and the profits have been reinvested into growing the stock on hand available for resale). By setting aside the tax (say into another bank account), it knows that when the tax is due for payment the funds are there.

Keeping your tax funds invested in cryptocurrency has potential for both significant risks and rewards. This leverages your position.

Most people would not borrow money to invest in cryptocurrency, however we notice that some clients treat their tax liability as a separate mental space in their head. In my opinion (perhaps a conservative accountant view), once a tax liability is calculated, it becomes a loan to the IRD until paid.

There is risk that the value of cryptocurrency decreases, but there is still tax to pay. Therefore, you need to liquidate more of your portfolio (as a percentage over the total) to pay the tax.  In contrast, there are potential rewards that the cryptocurrency increase in value and your tax funds will compound in value.

The high volatility of cryptocurrency prices makes this a personal decision based on your objectives and risk profiles.

What is more important: missing out on potential gains, or avoiding leveraged losses? Only you will be able to decide this for yourself based on your investment strategy.

 Cryptocurrency prices increaseCryptocurrency prices decrease
Cash out tax funds and keep in NZD until tax due  Have tax funds ready to pay when required   Miss out on gains    Have tax funds ready to pay when required   Avoid leveraged losses
Keep tax funds invested in cryptocurrency        Tax funds increase in value with the market   Leveraged gains        Tax funds decrease in value with the market   Leveraged losses  

Examples

David has a $800k cryptocurrency portfolio. He makes a profit of $300k for the 31 March 2020 tax year. He has tax to pay of $99,000 (33%).

  • He keeps his tax funds invested in crypto (and pays UOMI) with the expectation of future increases in value. He expects to cash out ~$100k of crypto on 7 April 2021 to pay his tax. On 7 April 2021, David’s portfolio is now worth $1.6m it has doubled in value from 31 March 2020. He cashes out the $100k of tax to pay and still has $1.5m in crypto (leveraged gains).
  • David cashes out $100k on 31 March 2020 and pays the IRD immediate. He still has a $700k cryptocurrency portfolio. On 7 April 2021 David’s portfolio is now worth $1.4m it has doubled in value from 31 March 2020. Compared to ‘A’ he has missed out $200k in gains (the tax money increases with the market) (miss out on gains).
  • David cashes out $100k on 31 March 2020 and pays the IRD immediate. He still has a $700k cryptocurrency portfolio. On 7 April 2021 David’s portfolio is now worth $350k; it has halved in value from 31 March 2020. David has already paid his tax to IRD. He has no outstanding tax liabilities because they were paid on 31 March 2020 (avoid leveraged losses).
  • David keeps his tax funds invested in crypto (and pays IRD UOMI costs) with the expectation of future increases in value. He expects to cash out ~$100k of crypto on 7 April 2021 to pay his tax. On 7 April 2021, David’s portfolio is now worth $400k as it has halved in value from 31 March 2020. David still has $100k owing to the IRD for his 2020 tax bill. He liquidates $100k to pay the tax and has $300k remaining in cryptocurrency (leveraged losses).

What to do?

Ultimately the decision is based on your investment strategy. Being a trader or involved in a volatile asset like cryptocurrency represents risks that need to be considered. In a bull market such as now (December 2020), leveraged gains may seem attractive. However, in 2017, those who made significant profits in the 2018 financial year and left their tax funds invested in crypto had significant leveraged losses.

Some strategies we have discussed with clients include:

  • Cashing out the tax amount into fiat on regular occasions that are planned.
  • Reinvesting the tax amount into cryptocurrency with appropriate stop losses as a back-up (or other less volatile investments).
  • Paying tax to IRD upfront and have certainty over your exact position.
  • 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.

Everyone’s unique situation, goals and strategy needs to be considered.

Contact Us

Contact Tim Doyle (tim@evansdoyle.co.nz) 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.

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