(This article is written by Manager of Taxation, Charles Yuan)
Did your crypto portfolio plummet in the last few months?
Did you get caught up in the USDT/Luna saga?
Are you forecasting a recession and looking to sell out?
If you’ve realised significant losses on your cryptocurrency portfolio, did you know it may be possible to claim the losses as a tax deduction against your other taxable income? What could this mean for your crypto investments?
Read on to find out.
Tell me more about it.
The default taxing position by the ATO on cryptocurrency held as a speculative investment is that it’s a CGT asset – this means your gains and losses derived are taxed as capital gains or allowable as capital losses. For many taxpayers, this unfortunately means you will not get a “tax deduction” for losses suffered unless you had other capital gains in the same year.
You will instead “carry forward” the capital loss until you derive a capital gain in the future (e.g. sale of shares, sale of property, etc).
However, for serious crypto enthusiasts, it may be possible to carry on a business as a trader of cryptocurrency, in the same way someone could be a trader in shares. This means that your trading activities are treated as a business for tax purposes, with all of your cryptocurrencies treated as if they were “trading stock” that you buy and sell.
As a business, your gains would be ordinary assessable income and losses would therefore be ordinary deductible expenses. The catch however is that there is a very high bar to reach in order to qualify as a trader in the eyes of the ATO – you must have sufficient level of activity, evidence of a business plan and demonstrate that you are operating in a business-like manner.
Importantly you can demonstrate that you intend to buy and sell cryptocurrencies for short term profits and can evidence that you are trading repeatedly and in volume. On top of all this, you may also be subject to the non-commercial loss rules to prevent you from deducting the loss against your other income such as salaries, dividends and distributions unless you meet one of the four tests.
What are the four tests?
The tests largely aim to deny deductions unless the taxpayer had generated assessable income, made profits in three of the last five years, or holds sufficient amount of assets that are required for the operation of the business. These tests may be difficult to pass for a taxpayer who only buys and sells shares or cryptocurrencies.
But what if we told you there may be a third option – that you didn’t need to qualify as a trader, but still able to treat your crypto gains and losses as revenue?
Is it too good to be true?
While this third option may seem like a fantasy conjured up by a lawyer specialising in tax wizardry, it is in fact based on the very well-known Myer Emporium case, which the High Court decided in 1987 that an investment with a profit-making motive would be taxable on revenue account even if a taxpayer was not conducting a business.
This is because gains and losses from a “business operation” or “commercial transaction” are taxed as revenue provided the transaction was entered into with the purpose of profit-making.
This argument was successfully used recently in the case Greig v Commissioner of Taxation (March 2020) to which the taxpayer won and was allowed a revenue deduction to the tune of $12 million relating to losses incurred on shares he had bought for speculative profit-making purposes.
“So how would this apply to me?” You ask. Here are our thoughts on this.
Do I need to spend $80 million like Myer Emporium?
Don’t let the big numbers in the court cases dissuade you. While it is true spending a large sum of money on an investment asset is more likely to be a “business operation” or “commercial transaction”, as compared to spending $500 on the latest cryptocurrency hype, but the principles in the case law precedents remains the same regardless of the amount of money invested.
Quoting a Federal Court judge who said in reference to Myer Emporium case:
"If the intention or purpose of the relevant entity in entering into a transaction or upon acquiring an asset was to make a profit or gain, that profit or gain will be income, even if the transaction was extraordinary by reference to the ordinary course of that entity’s business.”
“Similarly, if the intention or purpose was to make a profit or gain but a loss was ultimately in fact sustained, then a deduction in the amount of that loss would be permitted.”
Using this principle, it could mean that if you had a profit-making motive, the buying and selling of cryptocurrency could be considered a commercial transaction to which you should be assessed on revenue account. By extension, this also means losses could be deductible on revenue account.
There ought to be a catch!
Yes, there is a catch, and in my opinion a very big one at that – that is how would you be able to prove your case in a court of law and whether the value of deductions sought would outweigh the cost of going to court? Let’s look at this objectively.
Consider that you did have sufficiently strong proof that you have a profit-making motive and undertook the transaction “in a commercial manner”, however it would all become an academic point if you are unable (or unwilling) to fund litigation costs in court. Given the ATO’s numerous Tax Determinations published on the matter relating to cryptocurrencies, it’d be extremely unlikely the Commissioner of Taxation will allow a deduction for losses stemming from cryptocurrency investments simply based on a taxpayer’s word for it, meaning any such claims would almost certainly be disallowed in the first instance, requiring the taxpayer at a minimum to apply to AAT to have a chance in successfully objecting to the decision.
With this catch in mind, the adviser part of my role as a tax adviser asks whether commercial reality has been considered when you look to argue for treating cryptocurrency losses on revenue account. Would the financial cost of potential tax audit and litigation (as well as time and effort) be worth the potential tax deduction you are looking for? In other words, are you seeking a $500 deduction, or are you seeking a $5 million deduction? After all, you probably invested in cryptocurrency to make profit, so it would not make commercial sense to incur more costs on top of losses you had already suffered unless you are chasing a very large tax deduction.
If you do want to go down the litigation route, evidence that could support your case includes: if you have records that the investment was a targeted transaction with a specific profit-making motive; or that you do not ordinarily put money into investments and the cryptocurrency purchase was made solely with the expectation to make a short-term trading profit.
Did you know?
The current sitting ALP government has made legislating cryptocurrency one of its priorities, following announcements as recently as June 2022 reaffirming that Bitcoin along with all other cryptocurrencies will not be treated as foreign currencies, despite some countries moving to make it legal tender. Whether legislations will further regulate or liberalise cryptocurrencies remains to be seen.
What are your thoughts?
Do you agree with the Myer Emporium view? Are you currently sitting on large losses that you wish to make use of? Whatever your personal circumstances, come and have a confidential chat with one of Prosperity’s team members so you understand your tax options and have time to set out a proper plan on your investment roadmap.
Read our article here on considerations of how cryptocurrency would be taxed or tune in to our recent podcast here on the topic of Tax on Cryptocurrency.
To discuss any taxation matters please contact Manager of Taxation, Charles Yuan at cyuan@prosperity.com.au or Director of Taxation, Paula Tallon at ptallon@prosperity.com.au.
