The Finance and Expenditure Committee of New Zealand has prepared a report from their cryptocurrency enquiry. It focuses on recommending and advising the government to prepare for regulatory policies and find a legal stance on cryptocurrencies.
There was a recommendation regarding the taxation of cryptocurrency (quoted below).
“We recommend that Inland Revenue explore, in consultation with the digital assets industry in New Zealand, whether tax incentives for digital asset service providers are necessary or appropriate, in addition to continuing work to provide clarity around the treatment of digital assets within the tax system, to encourage investment of capital in New Zealand, as well as enhance the competitiveness of the New Zealand tax system.”
We agree with this recommendation and have commented further below. Before our comments, below are other taxation comments highlighted in the report.
Other taxation comments highlighted in the report
The report also outlines further information as follows (from paragraph 316 on the report, page 86).
316. We see two broad approaches that New Zealand could adopt towards the taxation of cryptoassets:
(a) Continue with the ad hoc and belated approach New Zealand has taken to date, seeking to address technical issues in sporadic amendments to the Tax Acts as they come;
or (b) Take a more “hands off” approach to this sector, introducing broader tax concessions (e.g. rollover relief until cryptoassets are converted to fiat) to let the New Zealand blockchain sector flourish.
317. We consider the first approach, ad hoc and belated, would likely jeopardise New Zealand’s opportunity to become a leading jurisdiction for blockchain development and investment. We are already seeing blockchain entrepreneurs seriously consider taking their ventures offshore to jurisdictions where they would not face these issues.
318. The second, more “hands off” approach is more daring. It would involve risking some tax, in exchange for making New Zealand a more attractive blockchain destination, and potential a hub for innovation in this space.
319. Ultimately this is a decision for policy makers. The first approach is certainly more in keeping with New Zealand’s general approach to tax. But, in our view, there would be merit in considering the second approach in more detail
Our view is that the current income tax legislation does not fit well with cryptocurrency. We often describe this as a square peg trying to fit into a round hole because of the following reasons.
- Significant volatile price fluctuations
Significant volatile price fluctuations can occur rapidly in cryptocurrency markets. Some cryptocurrency tokens have increased (and decreased) by more than 500% in a month.
There are not many other businesses or investing activities where you can be in a significant profit one day and then a large loss the next. These profitability swings could be in a single financial year or from one year to the next. A standard commercial business generally has the same profitable flow, subject to forecasted seasonal fluctuations.
The volatility makes tax planning and managing trading capital difficult. Taxpayers don’t know where they are going to be at the end of the year, so why should they be penalised if they don’t pay tax now when in a loss-making position?
- The nature of trading and cryptocurrency tokens
Taxpayers want to keep their tax funds invested in cryptocurrency. From their perspective, the gains are not real until they are withdrawn back to fiat ($NZD). Therefore, why should they have to sell cryptocurrency to pay tax when they haven’t withdrawn any $NZD and all their investments are still in cryptocurrency?
This is one of the biggest surprises and learning experiences for our new clients. Once known, it significantly changes the client’s activity. Rather than searching for opportunities to make money, they are sometimes scared of the unintended tax consequences.
- Lack of current record-keeping systems
It’s very easy to trade cryptocurrency on multiple exchanges and use multiple defi protocols and wallets. However, it’s extremely complicated to keep track of all the individual transactions. Traditional businesses have centralised accounting processes, been around for centuries, and more recently, Xero or MYOB enables live business financial statements through software. Cryptocurrency doesn’t have these digital processes yet. Instead, it is a manual process to pull together all transaction data from each exchange and wallet into a centralised system to reconcile the portfolio. Think of this as creating your own bank statements to calculate the closing balance each day.
You would think that with the tech innovation in the space, reliable software would have been created. We have seen Koinly, Cointracking.info, and others create their own versions, but they currently haven’t been able to keep up with the rapid developments in multiple areas (NFT, liquidity pools, new blockchains created, etc.).
We find that if a client only uses one fiat onramp and one exchange, we can reconcile their portfolio in a suitable timeframe. However, as soon as any DEFI transactions are involved, the increase in complexity is significant.
This makes compliance costs expensive, difficult, and onerous for cryptocurrency taxpayers.
- General understanding of income tax legislation and cryptocurrency tax complexity
Most of our clients’ investment into cryptocurrency is their first exposure to the NZ tax system outside of PAYE wages. While it is arguable that New Zealanders should have an understanding of the tax system, the complexities of cryptocurrency tax make this difficult. This is evident in Evans Doyle being approached by multiple other accounting firms for cryptocurrency tax advice.
As we have mentioned to Inland Revenue several times, we recommend a de minimus threshold for cryptocurrency tax.
This would result in cryptocurrency transactions not being taxed until being sold back into fiat provided that the taxpayer had less than (say) $100 – $500k of cryptocurrency. This is consistent with the Finance and Expenditure Committee of New Zealand’s recommendation for rollover relief until cryptoassets are converted to fiat.
For the majority of cryptocurrency investors, this would significantly simplify their tax obligations, removing the red tape of compliance, and IRD would not be out of pocket (it is only a timing deferral). Recently, we’ve had clients pay significant tax for the record 2022 financial year, only to get significant tax refunds for their losses in the 2023 financial year.
It would also make New Zealand an inviting and attractive option for this new and exciting space.
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.