Earlier this month, we presented to IRD about claiming tax loss for taxpayers who held cryptocurrency on these platforms. A summary of that presentation can be found here. We have now received a reply to that presentation, and this article outlines their position. This position is yet to be tested but is an update on IRD’s current thinking today.
In summary, IRD’s view is that FTX and Celsius’s investors are unlikely to be able to claim losses on inaccessible funds in their 2023 income tax returns.
IRD’s position is that the tokens can be written off when they are worthless. However, based on all available information today, depositors still have a right to potentially receive something back from the bankruptcy claim (albeit significantly less than their original deposit); therefore, they are not worthless.
Therefore, you cannot claim a tax deduction in the 2023 year for these tokens because they are not worthless. As outlined in our earlier article, the tokens must be worthless to claim a deduction under s ED 1 (8).
However, if investors sell their rights before 31 March 2023 in any tokens and their right as a creditor in the bankruptcy proceeding, a deduction will be allowed (see more information below).
This is because disposal occurs before 31 March 2023. As we have outlined many times previously, selling cryptocurrency is the time when you are taxed. Therefore, if you sell your tokens/rights before 31 March 2023, you are able to claim the loss. Keep in mind that should these companies trade or restructure out of their chapter 11 bankruptcy, you, are selling your right to receive anything back in the future.
From a common-sense perspective, this makes sense. You cannot have your cake and eat it too – you can’t claim a loss on the tax write-off in the 2023 and potentially still receive some tokens back in the 2024 year. Therefore, taxpayers need to decide what is best for them; sell the rights, and claim the loss, or hold out and hope for something back in the future (and/or claim the loss when more information is available).
It may be that a liquidator’s report will be released in say, the next six months which could give us all more answers about if these tokens are worthless on 31 March 2023. It is unclear though if the report and that information will be sufficient to claim a deduction in the 2023 financial year and may still present some issues around the timing of the deduction.
Below is a more details analysis of IRD’s position
FTX
FTX, a cryptocurrency exchange, held customer cryptoassets on a custodial basis. While customers retained ownership interests in their assets, FTX’s bankruptcy proceedings have left them unable to access their cryptoassets.
The typical tax treatment for cryptoassets involves income arising upon disposal and a deduction for the cost when the assets are disposed of or deemed valueless. However, in FTX’s case:
- No disposal has occurred.
- The cryptoassets still exist and have value but are inaccessible.
- Investors have a legal right to reclaim their assets.
- A bankruptcy process is underway to recover investors’ cryptoassets.
Based on these circumstances, no loss can be claimed by taxpayers for their FTX deposits in the 2022 or 2023 income tax returns. As of 31 March 2022, FTX was fully operational in the cryptoasset domain, and no loss event had occurred. While no bankruptcy reports have been released yet, it seems unlikely that a loss event will occur by 31 March 2023. Further information on asset recovery is needed before determining whether these assets can be written off as valueless.
Celsius Situation
Celsius, a cryptoasset lending platform, allowed investors to earn income on deposited cryptoassets or obtain collateralized loans. Celsius took possession of and transacted in the deposited assets. Upon transaction maturity, investors expected their equivalent cryptoassets to be returned. Like FTX, Celsius also entered Chapter 11 bankruptcy proceedings.
Investors’ entitlement rights in their deposited cryptoassets with Celsius are complex and unclear. These rights could relate to:
- Receiving back actual equivalent deposited cryptoassets.
- The right to receive back equivalent deposited cryptoassets, represented by another temporary cryptoasset.
- The right to receive back equivalent deposited cryptoassets, creating a financial arrangement.
Deduction entitlement would likely arise when there is reasonable certainty that the investors will not receive a return on their rights, and the rights have no present or likely future value. As with FTX, no liquidators’ reports have been released for Celsius, suggesting that no deduction is yet available for investors. More information is required to make a definitive conclusion on this matter.
Selling inaccessible cryptocurrency that is on FTX and Celsius?
When discussing this issue with our clients, some are expecting to receive something back from Celsius or FTX. In this case, they would only be interested in selling any inaccessible cryptocurrency to someone for more money than what they expect to receive back. Just how much exactly this is will depend on the client’s expectations.
Other clients have written off the amount in their minds and not expecting anything back. For completeness and closure (and perhaps an unexpected bonus if they can get some funds on sale), is to sell all their inaccessible cryptocurrency and future rights to any bankruptcy claim to an independent third party. As outlined above, this is a disposal for tax purposes. The amount received from the contract sale is the disposal value. Profit = sale value less purchase value.
Any agreement entered into solely for tax purposes has risks of being a tax avoidance arrangement. The contract needs to be a legitimate contract,
Practically, we are unsure if there are independent third parties buying up contract claims to FTX or Celsius. We did hear of a company buying up claims to Mt Gox. It’s likely that as part of the sale contract, the purchaser would receive a username and login details to FTX/Celsius accounts and any legal entitlement to any cryptocurrency refunded.
Example:
James is unable to access 1 Bitcoin that he bought for $50,000 on a crypto platform and is a creditor in the bankruptcy proceeding. James decides to sell his rights as a creditor (an independent third party) for $1,000 before 31 March 2023. The contract is documented, and James will receive payment before 31 March 2023.
On execution of the contract, James has made a disposal and can recognize a loss of $49,000 ($50,000 less $1,000) in the 2023 Tax Year. However, if funds become available after the bankruptcy proceeding, James would have no right to receive them, as he sold his entitlement.
In this example, the sale value of $1,000 is only used as an example.
Summary
In summary, if you are expecting to claim a tax-deductible loss on inaccessible FTX or Celsius tokens in the 2023 financial year, you will need clear and compelling evidence that the tokens are worthless. Based on the available information right now, it is unclear, and therefore, IRD’s position today is that they will not likely allow the deduction.
Taxpayers can choose to sell their right to the tokens and any future claims in the bankruptcy claim if they want to dispose of all interests in those tokens. This sale/contract would be a disposal for tax purposes. Taxpayers need to ensure that the contract is with an independent third party and that all other terms and conditions of the contract are commercial and documented.
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.
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