After being recently appointed the Minister for Taxation for Team Australia, I thought it was high time I got off my backside and wrote the third of my posts on bitcoin and tax in Australia. Today's post deals with tax minimisation. Unfortunately this is less of an issue today than it was at this time last week, but it is still very relevant for most crypto currency investors.
You can find my first two posts shown here:
Crypto Investing Basics - Bitcoin and Tax in Australia (Part One)
Crypto Investing Basics - Bitcoin and Tax in Australia (Part Two - Capital Gains Tax)
Today’s post will deal with two key issues. The first one will be general strategies to minimise the tax that you may pay on your crypto currency trading portfolios. The second will deal with the personal use exemption, which is always a source of animated discussion whenever bitcoin and tax is mentioned.
Basic Tax Minimisation
The simplest way to minimise tax when it comes to any form of investment is to HODL. This strategy has two key benefits.
The first is the 50% discount applied to any capital gains on assets that have been held for more than 12 months. The ATO reference relating to this can be found here:
Working out your Capital Gain or Loss
Under Australian tax law, if you purchase an asset and hold it for longer than 12 months, then you are able to halve the reportable gain on any subsequent disposal. In layman’s terms this means that if you have held an asset for longer than 12 months, when you sell it, you only pay half as much tax. A simple example will be sufficient to explain.
Imagine you purchased a house as an investment of $500,000 and subsequently sold it six months later for $600,000. As you have held the asset for less than 12 months, the full capital gain of $100,000, ($600,000 $-500,000 equals $100,000) would be assessable and would be added to your taxable income for the financial year in question.
Using the same scenario, if you had held the house for greater than 12 months, then your taxable gain would be reduced by 50%. So, in our example above, we would still have made a gain of $100,000 on our investment. As we had held the house for longer than 12 months, however we would be able to apply a discount of 50% to the gain of $100,000, which would result in a net assessable gain of $50,000 that we would be required to report to the ATO for that financial year.
The same rulings apply to bitcoin and other crypto currency investments.
So even though you may be sitting on some substantial capital gains in some of your portfolios, if you have held these assets for more than 12 months, then only half of the capital gain that you have made will be assessable for tax purposes.
This is very simple in principle, but has the potential to become quite complex if you are trading regularly. If you are not trading regularly however, and have simply bought a quantity of crypto currency over the preceding year or two and are now sitting on a substantial capital gain then it is possible that your tax situation could be significantly better than you originally thought, as any tax which you are required to pay will be reduced by 50% if you have held those assets for greater than 12 months.
The second advantage to HODLing as a strategy is not related to tax, but more to investor behaviour. Countless studies have shown that the more often an investor trades the less profitable their trading becomes. There’s a number of different schools of thought as to why this is so. Firstly, and most simply, every time you trade you pay brokerage fees and accrue a tax liability. Therefore, the more often you trade the greater your fees and the greater your tax expenses. This has the effect of reducing the total profitability of your trading strategy. If you buy and hold however, you minimise the brokerage that you pay, and are only liable for taxation upon eventual disposal of the asset. Thus trading less frequently can significantly reduce your costs, which comes with a corresponding increase in your profits. More information on this topic can be found at the following link.
The Psychology of Investors Who Trade Too Much
There is also an argument that can be made that if you trade too frequently you are over trading and therefore artificially suppressing your profits by entering and exiting positions to frequently. Over trading is generally a sign of a poorly developed trading plan, and is something which amateur investors frequently fall victim to. For many amateur traders, their trading more closely resembles gambling than investing. In general, your aim should be to trade as infrequently as possible.
The Personal Use Exemption
As outlined in previous articles, the ATO has released guidance which states that crypto currency assets which have a cost base of less than $10,000, and are used purely for personal purposes, are exempt from paying capital gains tax. In this instance the ATO is referring to situations where crypto currencies are used as currencies (i.e. a medium of exchange) not as investment assets. I will reproduce an example from one of my previous articles to illustrate this concept.
Imagine I was to travel to Europe on vacation, and was to convert Australian dollars into British pounds prior to leaving on my holiday. If upon return from holidays I had not spent all of my money, I would be able to re-convert those British pounds into Australian dollars. If whilst I was on holidays, the value of the British pound had risen and I had made a gain on the exchange rate, then this gain is exempted by the tax office, and I’m not required to pay tax on. This is how to view personal use transactions in relation to crypto currencies. The key here is that I bought British pounds in order to use them for personal use, not with the expectation that I would make a profit on the exchange rate.
It can be seen that where a currency is genuinely purchased with the intent of being used as a medium of exchange it can be exempted from capital gains tax, provided that the cost base of the currency in question was less than $10,000.
To use a an example more relevant to crypto currency let’s imagine that an investor had purchased $9000 worth of Ether in January 2017. Ether was worth just under $10 per coin at this time. Ether is now worth upwards of $850 US per coin meaning that an investor would have made a profit of approximately $755,000. Normally the capital gains tax on this would be significant and most likely approach 25% of the total capital gain. Thus the investor would be liable for a tax bill of approximately $189,000.
As the original purchase price of this ether was below $10,000 however, this investor could claim the personal use exemption for these assets. Provided that the full $755,000 was used to purchase goods and services them potentially this investor may have to pay no tax on these assets whatsoever. He or she may well have a problem finding $755,000 worth of goods and services that they can purchase in crypto, but in theory it’s possible that the entire amount could be tax exempt.
If you wish to make use of the personal use exemption for a portion of your crypto currency holdings than I would recommend the following:
Establish a new wallet for the purpose of holding your personal use assets.
Identify a portion of your crypto currency holdings that have a cost base of less than $10,000 and have undergone a significant capital gain since you have purchased them.
Transfer these assets to your new personal use wallet.
Commence using these assets to pay for goods and services as appropriate
The key here is record keeping. By maintaining a clearly separate wallet for these assets there can be no confusion that they are part of your broader investment portfolio, which you may hold in a variety of other wallets. You would also need to ensure that any transactions that went in and out of this wallet was solely for the purpose of paying for goods and services, and were not in any way investment related.
To give a really simple example of how this would work I will use my own personal circumstances.
I have chosen to use a holding of Ether as the portion of my crypto currency portfolio that I have designated for personal use. I have created a new desktop login on my laptop and installed a new Exodus wallet under that login. Note that the type of the wallet is irrelevant, I simply find Exodus a convenient wallet to use. I then use this either to pay for goods and services as appropriate. Please note that I was not fortunate enough to purchase ether at $10 so my capital gains are unfortunately significantly less then the investor in our example above.
I’ve chosen Ether simply because it is easy to administer, and commonly accepted by most organisations that accept crypto currencies as payment. It would be pointless to identify a more obscure crypto currency such as Tron or Lisk, as you will have great difficulty finding merchants who will accept these crypto currencies as payments.
It is not necessary to simply identify a one currency as I’ve done. You can identify $4,999 worth of ether, and $4,999 worth of bitcoin and still satisfy the requirements of the ATO. The most important things are that the total cost base of the portfolio that you designate as personal use is below AU$10,000, and that this portfolio is solely used for the purposes of buying goods and services.
I would recommend you don’t try to get too cute with this and overly manipulate the system in order to avoid paying taxes. The simpler the recordkeeping, the easier it is to justify to the ATO that you have done the right thing should you ever be audited. I would also highlight that the personal use exemption can only be claimed once. By this I mean that you can only claim a total cost base of $10,000 of crypto currencies. You can’t identify $10,000 worth of bitcoin, $10,000 worth of Ether, $10,000 worth of Steem, $10,000 worth of Bitcoin Cash etc, and attempt to claim that each of those holdings are individual personal use assets. You only get one $10,000 limit.
In my previous articles I spent some significant time discussing what would and wouldn’t count as using crypto currency as a medium of exchange. I used the example of the purchase of a BMW to illustrate this point. After a lengthy conversation with my accountant, I’ve come to the conclusion that services such as the Living Room of Satoshi (LROS), and Bitcoin debit cards would satisfy the requirements of the personal use exemption. Therefore, if you established your personal use wallet and transferred assets from this wallet to LROS to pay your rent or credit card bills, then you would meet the ATO’s requirements. Please note that this is a personal opinion only and that should you ever be questioned by the ATO in relation to this, you would need to be able to justify to them why your personal use portfolio met their requirements.
The clearer your record keeping is and the simpler transactions you try to undertake, the easier it will be for you to demonstrate that you have tried to adhere to the spirit of the law. As this area of taxation is so new, there are no hard and fast rules. Therefore your best defence against the ATO is simply to understand the intention behind what they are trying to achieve, and do the best that you can to operate within these guidelines. For my own purposes I’m comfortable that doing what I have outlined above satisfy these requirements and should the ATO ever audit me then I will be comfortable to defend my position.
As always I am happy to answer any questions to the nest of my ability in the comments section below.
Photo by Bench Accounting on Unsplash