DEFI Disposal & Acquisition Concepts

I recently presented at the Chartered Accountants Australia New Zealand (CAANZ) tax conference in Christchurch about cryptocurrency tax. The presentation included disposal and acquisition concepts of cryptocurrency DEFI tax which are outlined in this article.

Some cryptocurrency investors will not find these concepts fair. I am not doubting or debating that. IRD’s position is to apply the facts of each case to income tax legislation. They will be independent, unemotional, and stick to the facts. We’ve often described the tax legislation as a square peg trying to fit into a round hole with cryptocurrency tax. I believe our role as cryptocurrency tax advisors is to explain the rules of the game to you and let you play the game.

These DEFI disposals and acquisition concepts apply to collateral financial loans, staking arrangements, liquidity pools, HEX/PULSE arrangements, etc.

Let’s use an example of a collateral finance loan to apply the concepts to.

What is a collateral finance loan?

A collateral finance loan is like using a house as security with the bank and taking out a mortgage. The taxpayer still owns the house and has price exposure with the housing market but has a loan available for what they want.

In cryptocurrency, the taxpayer uses their cryptocurrency as security with a decentralised platform and takes out a loan. The taxpayer still owns the cryptocurrency and has price exposure with the cryptocurrency market but has a loan (normally in USDT) available for what they want.

Although the transactions look and sound similar to the bank taking security over a house and providing a loan – in which case the house is not being sold – a collateral finance loan is taxed differently.

Applied to this example

• Acquisition value is when they first purchased the crypto, and the sale value is on entry into the loan.
• This is because the depositor can no longer transact freely with the cryptocurrency. The receiver has full control and access over it; it’s in a different wallet.
• At the same time as the deposit, in exchange for that deposit, the depositor receives a “right” to receive that cryptocurrency back in the future when the loan is repaid or other terms of the loan agreement.
• Because the deposit is a disposal, we need to value these transactions for tax purposes.
• The value of the disposal is the price of cryptocurrency on the day of the disposal.
• Equally, the right is valued at the same value of the disposal due to the exchange nature of the transaction.
• Profit = sale value less acquisition value
• Acquisition value is when they first purchased the crypto, and the sale value is on entry into the loan.

In summary, when crypto is deposited as collateral, it’s a disposal. The value of that disposal is the market value at the time. At the same time of the disposal, the depositor receives a right to get that cryptocurrency back. And the right is valued at the same value as the disposal of the cryptocurrency. When entering a collateral finance loan, it will be a taxable event.

Acquisition Concepts

• When exiting the loan position (loan is repaid and collateral is released), the ‘right’ to receive the cryptocurrency back is disposed of.
• At the same time, cryptocurrency is acquired.
• These transactions occur at market values.
• Taxable event on the disposal of the “right” being the difference between the purchase value and the disposal value.
• Profit = sale value less acquisition value

Practically, it can be very difficult to follow only looking at blockchain transactions. Keeping information and having a robust record-keeping process is key.

Other

As outlined above, although this example uses a collateral finance loan as a disposal, entering into any arrangement with cryptocurrency has the risk of being taxed as a disposal if there is a future right to receive something in return for that disposal (i.e., token sacrifices, entering into liquidity pools etc).

Contact Us

Contact Tim Doyle 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.