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Bitcoin, cryptocurrency and tax: how does it work?

Bitcoin is a form of digital currency, created and held electronically. No one controls it, writes H&R Block's Mark Chapman.

Bitcoins aren’t printed, like dollars or euros – they’re produced by people, and increasingly businesses, running computers all around the world, using software that solves mathematical problems.

It’s the biggest example of a growing category of money known as cryptocurrency.

There are three ways to get bitcoin – by mining them, buying them or providing goods and services to earn them through payment. Mining refers to the process by which bitcoins are created – a computer crunches through a set of difficult mathematical problems and success is rewarded with a bitcoin.

The alternative is to create an ‘online wallet’, visit a bitcoin exchange system that puts sellers in touch with buyers and the buyers pay for bitcoins purchased by transferring money via online banking.

The third way is possible because bitcoin is becoming an increasingly accepted virtual currency used by businesses and individuals around the world, including in Australia.

As of February 2015, over 100,000 merchants and vendors accepted bitcoin as payment. According to research produced by Cambridge University in 2017, there are 2.9 to 5.8 million unique users using a cryptocurrency wallet, most of them using bitcoin.

How is bitcoin taxed?

Using bitcoin to pay for personal transactions

Generally, there are no income tax or GST implications to clients who are not in business or carrying on an enterprise and who simply pay for goods or services in bitcoin (for example, acquiring personal goods or services on the internet using bitcoin).

Bitcoin is a capital gains tax asset which potentially applies whenever an Australian resident sends a bitcoin to another person. However, transactions are exempt from capital gains tax if:

·         bitcoins are used to pay for goods or services for personal use – e.g. Expedia hotel bookings, or at a café which accepts bitcoins, and

·         the cost of the bitcoins used to pay for the transaction is less than $10,000 (this is the exemption for personal use assets).

If the cost of the bitcoins used in the transaction exceeds $10,000, the personal use exemption will not be available and CGT will apply. The capital gain is calculated as the increase in value of the bitcoins between the time they were acquired and the time they were disposed of.

Using bitcoin to buy and sell goods and services in a business

If the client receives bitcoin for goods or services provided as part of a business, they will need to record the value of the bitcoins in Australian dollars as part of ordinary income. The value in Australian dollars will be the fair market value which can be obtained from a reputable bitcoin exchange, for example.

Where the client carries on a business and purchases business items (including trading stock) using bitcoin, the client is entitled to a deduction based on the arm’s length value of the item acquired.

There may also be capital gains tax consequences where a client disposes of bitcoin as part of carrying on a business. However, any capital gain is reduced by the amount that is included in assessable income as ordinary income.

Mining bitcoin

Where a client is in the business of mining bitcoin, any income that derived from the transfer of the mined bitcoin to a third party is included in assessable income.

Any expenses incurred in respect of the mining activity are allowed as a deduction.

Losses made from the mining activity may also be subject to the non-commercial loss provisions.

Bitcoin held by a client carrying on a business of mining and selling bitcoin is considered to be trading stock. The trader should bring to account any bitcoin on hand at the end of each income year.

Taxpayers conducting a bitcoin exchange (including bitcoin ATMs)

Where the client is carrying on a business of buying and selling bitcoin as an exchange service, the proceeds derived from the sale of bitcoin are included in assessable income.

Any expenses incurred in respect of the exchange service, including the acquisition of bitcoin for sale, are deductible.

Bitcoin held by a client carrying on a bitcoin exchange is considered to be trading stock and the client is required to bring to account any bitcoin on hand at the end of each income year.

Disposing of bitcoin acquired for investment

If a client acquires bitcoin as an investment, but is not carrying on a business of bitcoin investment, any profits resulting from the sale are not assessable income and no deductions can be claimed.

Capital Gains Tax may apply although where the cost of the bitcoin does not exceed $10,000 the personal use asset exemption applies.

Where the cost of the bitcoin exceeds $10,000, the personal use exemption will not be available and CGT will apply. The capital gain is calculated as the increase in value of the bitcoins between the time they were acquired and the time they were disposed of.

If the transactions amount to a profit-making undertaking or plan then the profits on disposal of the bitcoin will be assessable income.

Note: the rules around trading bitcoin for business or profit versus buying and selling bitcoin as an investment are essentially the same as those applying to share traders versus investors.

Record keeping

Every person dealing with bitcoins needs to keep the following records:

·         the date of each transaction

·         the amount in Australian dollars at the time of the transaction (which can be taken from a reputable online exchange)

·         what the transaction was for, and

·         details of the other party (the bitcoin public address is enough).

Mark Chapman, is director of tax communications at H&R Block

Bitcoin, cryptocurrency and tax: how does it work?
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