FTX & Celsius Bankruptcy – IRD Presentation

Note: IRD has now replied to our presentation. They have issues about the timing of the deductibility, and if in fact the tokens are worthless on 31 March 2023 which can be viewed here.

Tim recently presented to Inland Revenue (IRD) on how we see income tax legislation applies to losses from Celsius and FTX bankruptcies. The outcome was that they would not agree or disagree with what we presented, which was frustrating, especially considering how close we are to the end of the financial year.

This technical article outlines our justification to claim a tax-deductible loss relating to FTX and Celsius bankruptcy during the 2023 financial year. It will not be until IRD reviews a taxpayer in more detail (likely after the 2023 return has been filed and losses claimed) that we will be able to provide certainty that it is correct. Until then, there is, unfortunately, a risk that IRD may not accept the loss for some reason or another.

Note: because this was previously a presentation, we have left the writing style so that it may read like a presentation rather than flow like an article. It is intended to be high level for those taxpayers who want to understand the legislation and how it applies to their situation (and to show our workings). If you are only interested in the answer, jump straight to the conclusion at the end.

Example 1

Simon is in the business of dealing in cryptocurrency. He trades multiple tokens on a daily basis and has significant capital invested. In the 2023 financial year, he held 30% of his trading capital ($270k NZD) on the FTX exchange and can now no longer access it due to FTX bankruptcy.

• Is the $270k loss tax deductible?
• In which financial year is the loss claimed?
• What information is the sufficient onus of proof/evidence to show the loss?

Example 2

Luke is a cryptocurrency investor. On 31 March 2022, he owned six tokens distributed over four platforms to earn staking rewards. He held 20 ETH tokens (the cost value of $90k) on the Celsius Platform earning 7% pa. After July 2022, he can no longer access his cryptocurrency on the Celsius Platform. 

• Is the $90k loss tax deductible?
• In which financial year is the loss claimed?
• What information is the sufficient onus of proof/evidence to show the loss?

General Permission DA 1

The general permission allows for both expenditure and loss. In both examples, Simon and Luke have had a loss of their cryptocurrency (it’s gone). For Simon, the loss was incurred while Simon was carrying on a cryptocurrency trading business (i.e. holding tokens on an exchange as part of his trading capital). For Luke, it’s less unclear. Holding tokens itself is not part of the income-earning activity (disposing of them is, and paying an exchange fee on disposal is what this section of the Income Tax Act 2007 (ITA) refers to; an expenditure of the exchange fee on the sale of the token, and earning assessable income, is incurred by Luke in deriving assessable income).

Cryptocurrency Tax Situation

IRD has made it very clear that:

• Cryptocurrency is the property for tax purposes.
• Cryptocurrency is revenue account property, usually always acquired with the intention for disposal.
• New legislation introduced in March 2022 outlines that most cryptocurrencies are an excepted financial arrangement
• Losses for property which would have been taxable are deductible (revenue account loss) – see C of IR v Inglis (1992)
• Cryptocurrency is not the same as a loss of investment in a financial institution (because it is property, an excepted financial arrangement, and not capital).

Cost of Revenue Account Property

Section DB 23 of the ITA, outlines that a person is allowed a deduction for the expenditure that they incur as the cost of the revenue account property. This means that on disposal, their original cost value is deducted from the sale proceeds. For example, profit = sale value less cost value.

The maximum loss you can claim is your original cost value. For example, if you paid $15k for 1 BTC, and you lost the 1 BTC on FTX when the market value was $45k. Your loss is $15k. You haven’t paid tax on the increase from $15k – $45k; therefore, you can’t claim a loss on the full $45k. Your loss is limited to the cost (original cost) of the cryptocurrency.

C of IR v Inglis (1992) confirmed that a loss arising upon the sale of shares was tax deductible, provided that the shares were acquired with the intention and purpose of resale. The same intention and purpose test applies to cryptocurrency.

Cryptocurrencies are Excepted Financial Arrangements

Section EW 5(3BA) outlines that cryptocurrency is an excepted financial arrangement if the crypto does not meet the requirements of subsection (3BAB)

It’s important to note that Celsius the platform that produced the returns, not the cryptocurrency itself. Therefore, although it may look like Celsius leads to an exception of the excepted financial arrangement legislation, it is not a cryptocurrency. The cryptocurrency, such as Bitcoin, Ethereum, etc., that were deposited into Celsius are excepted financial arrangements (and no exception applies) because the cryptocurrency themselves did not provide a consequence of ownership mentioned from the 3BAB exception.

Excepted Financial Arrangements

Section ED 1 (8) outlines that if an excepted financial arrangement has no present or likely future market value and has been written off as worthless, its closing value is zero.

The Oxford dictionary’s definition of “Worthless” is, it has no real value or use.

The tokens on FTX and Celsius cannot be accessed, moved, sold, or transferred; there is no market to sell them, let alone use them, like any property. In our view, this means that they have no present market value and are worthless.

Timing of Deduction

The timing of the deduction needs to reflect when the loss was incurred. This appears to be in the 2023 financial year at the time the access to the taxpayer’s tokens was removed.

“Likely future market value” from ED 1 (8) also needs to be considered. If the tokens will have a future likely market value, it is doubtful they can be written off.

Therefore, we have considered.

1. Cryptopia liquidation (in NZ) which occurred on 15 May 2019 and no repayments have been made to token holders
2. Mt Gox went bankrupt in 2014, and no repayments have been made to token holders.

It appears the industry standard suggests that there is no likely future market value for tokens on Celsius or FTX.

Writing off Debts as Bad (PBR 18/07)

IRD has made a public binding ruling (PBR) about writing off debts as bad, PBR 18/07. This situation applies when a taxpayer does work for a customer, invoices them, and then the customer doesn’t pay the taxpayer. From the taxpayer’s perspective, the amount of the invoice is taxable income, regardless of when payment is made (i.e., payment could be received in the next financial year, but the taxpayer still has taxable income in the year the invoice was issued). IRD PBR outlines what to consider when writing off debt as bad.

We believe that this situation is similar to a taxpayer writing off an excepted financial arrangement for their cryptocurrency as worthless because of the subjective elements involved.

BPR 18/07 outlines

“… the debt has been adjudged as “bad” by a reasonably prudent commercial person who has concluded that there is no reasonable likelihood that the debt will be paid in whole or in part…”

It also outlines that the taxpayer must consider:

• The length of time the debt is bad. The longer it is outstanding, the more likely a reasonably prudent commercial person would consider the debt to be bad.
• Efforts the creditor has taken to collect the debt.
• Other information obtained by the creditors.
• Liquidation or receivable reports outlining that there are insufficient funds to repay the whole amount.

When applied to the FTX and Celsius situations:

• The bankruptcies occurred on 31 July 2022 (Celsius) and 11 November 2022 (FTX). These are now 3 – 7 months ago, and the process is slow.
• Depositors cannot take any further action to collect their tokens because of the US legal system and geographical restrictions. Furthermore, our clients are likely to be small fish in a big pond.
• The liquidator’s reports show that no funds are available to repay token holders (see below)
• The terms and conditions of Celsius mention that when tokens are transferred to their platform, they take all ownership rights of the tokens (on deposit). Therefore, are depositors an unsecured creditors with no rights to get their tokens back?

FTX and Celsius Liquidation Report Headlines

Application to Depositors

On reviewing the available information, we believe that most reasonably prudent commercial persons will conclude that the arrangements (tokens on FTX and Celsius) are worthless and that they have no future likely market value.

Writing off Debts as Bad (PBR 18/07)

The bad debt is written off in the year in which a deduction is claimed in accordance with the accounting and record-keeping systems maintained by the taxpayer.

The PBR outlines what a taxpayer needs to do to write off the debt as bad. We believe the same principles apply to writing off an excepted financial arrangement as worthless.

For most clients, we strongly recommend that you make a note in your record-keeping systems before 31 March 2023, outlining the tokens, the quantity of tokens, stating that you are writing these off because of the worthless token valuation method allowed under ED 1 (8).

Answer to Example 1

See IRD’s position here.

1. Simon is in business.
2. The loss under the general permission under section DA 1 (1)
3. The loss is not capital in nature.
4. Cryptocurrency is an excepted financial arrangement, and the tokens are valued under ED 1 (8) Worthless Arrangements at the end of the financial year.
5. The loss is claimable in the 2023 year because a reasonably prudent commercial person, based on the available information, considered them to be worthless. The tokens have no present market value or likely future market value (considering the facts and information known about FTX bankruptcy).
6. There is no reasonable likelihood that the tokens will be recovered 
7. Simon needs to write off the tokens in his record-keeping system before 31 March 2023
8. The loss is tax deductible in the 2023 financial year

Answer to Example 2

See IRD’s position here.

1. Luke is an investor.
2. His cryptocurrency is classified as revenue account property.
3. The loss is deductible, as confirmed by C of IR v Inglis (1992)
4. Cryptocurrency is an excepted financial arrangement and the tokens are valued under ED 1 (8) Worthless Arrangements at the end of the financial year.
5. The loss is claimable in the 2023 year because a reasonably prudent commercial person, based on the available information, considered them to be worthless. The tokens have no present market value or likely future market value (considering the facts and information known about Celsius bankruptcy).
6. Disposal of revenue account property for no value (section DB 23)
7. The crypto is irretrievably lost.
8. There is no reasonable likelihood that the tokens will be recovered. 
9. Luke needs to write off the tokens in his record-keeping system before 31 March 2023
10. The loss is tax deductible in the 2023 financial year

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.