In March 2022, IRD released a new bill that classifies cryptocurrency as excepted financial arrangements (EFA). This was the same bill that removed GST from most cryptocurrencies and is retrospectively applied to 1 January 2009.
The classification of cryptocurrencies as EFA aligns the taxation with other financial instruments such as share or options trading. In our opinion, the Income Tax Act still doesn’t align well with the volatile nature of cryptocurrency markets. More changes are needed (including a de minimis threshold for reporting on realised gains). You may often hear us referring to the legislation like a square peg trying to fit into a round hole; it doesn’t work.
IRD website states that cryptocurrency held by a person in the business of trading is likely to be trading stock.
If you are in the business of trading cryptoassets, your cryptoassets are likely to be trading stock.IRD Website: Trading in Cryptoassets
Under ordinary trading stock rules, traders may value their stock at cost or at the market price at the end of the financial year.
However, the new amendment to the Income Tax Act EW 5 (3BA) outlines that cryptocurrency is an “excepted financial arrangement” (EFA) unless the crypto assets in question entitle the owner to receive specific returns known to the holder stipulated in 3BAB, see below.
Defining cryptocurrency as an EFA has implications for trading stock valuations. Firstly, ED 1 (1) states that a person who has revenue account property that is an EFA must determine the value of the arrangement at cost.
The implication of this new amendment is that people in the business of trading cryptocurrency may only value their cryptocurrency at cost, not at the lower of cost or net realisable value, at the end of each financial year.
Secondly, if a cryptocurrency at the end of the financial year has no present or likely future market value, it may be deemed a “worthless arrangement”. This means that it may be written off as worthless.
For example, if a person in the business of trading cryptocurrency purchases 100 XYZ tokens at a price of NZD$ 500 and the tokens become worthless over time, they may write off those tokens completely at the end of that financial year.
An exception to the EFA rule
EW 5 (3BAB) states that a cryptocurrency is not an EFA if a consequence of ownership of the cryptocurrency is that the owner receives or is entitled to receive, during the period of ownership, amounts that are determined—
- by reference to the quantity or value of the cryptocurrency; and
- on the basis that is known by the owner in advance; and
- not by reference to the profits of business activity.
For example, Person A purchases 1,000 ABC tokens for NZD$ 500 and deposits the tokens into a staking contract. The staking contract pays 8.5% annually for a period of 2 years. In this example, the 1000 ABC tokens are not an excepted financial arrangement because the exception applies. At the end of the Financial Year, person A may value the 1,000 ABC tokens at cost (NZD$ 500) or at market value.
Application for prior years
If traders have used the trading stock income tax application in prior years, we expect IRD to be lenient on their application and interpretation. This is based on the incorrect guidance on their website and the fact that the bill is retrospective. Informal conversations with IRD have confirmed this approach. Also, it is a timing difference between when the loss occurred and realising the losses, not an omission or evasion of income.
Contact us for a 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.