1.1 Overview of the income-tax system
From an Australian income-tax perspective, a taxpayer’s country of residence and the source of income are important. This is because an Australian resident may be subject to tax in Australia on all income whatever its source (Australia or overseas), whereas a foreign resident can only be taxed in Australia on income that has an Australian source.
A taxpayer’s liability to income tax for an income year is based on their assessable income for that year. Taxable income is assessable income less allowable deductions. Assessable income consists of ordinary income and statutory income.[1] Ordinary income is income according to ordinary concepts[2], and statutory income is income that is assessable by virtue of a specific provision in the income-tax legislation[3], namely the Tax Acts (e.g. net capital gains under Division 102 of the ITAA 1997).
Income according to ordinary concepts can essentially be divided into 3 categories, namely:
- income from rendering personal services, including employment income;
- income from carrying on a business; and
- income from property such as rent, interest, and dividends.
Income-tax rules applicable to specific entity types are not discussed. For the purposes of the discussion below, only the tax treatment of Bitcoin for Australian resident taxpayers is considered.
1.2 Mining bitcoin
Before considering the income-tax consequences of mining bitcoin, it is necessary to firstly consider whether the activities related to mining bitcoins constitute the carrying on of a business by the miner. This analysis is similar to that undertaken in 4.2(a)for GST, albeit it deals with whether such activities constitute the carrying on an enterprise for GST purposes.
Even though the meaning of “enterprise” in the context of GST is broader than the meaning of “business” for income-tax purposes, it is still possible that the activities related to mining bitcoin constitute the carrying on of a business for income-tax purposes. Whether in fact a miner is carrying on a business is a question of fact to be determined according to the circumstances of each particular case. As indicated in 4.2(a), it very much depends upon the nature, extent, and manner of the activities undertaken by the miner, e.g. the level of investment in the activities, whether or not there is an intention to make a profit from the activities, the size and scale of the operations, etc. But, it is likely that a miner that carries on an enterprise for GST purposes would also be carrying on a business for income-tax purposes.
(a) Carrying on a hobby
Where the mining activities are not carried on as a business but rather as a hobby, any bitcoins that are awarded to the miner as a result of its mining activities will not be income under ordinary concepts and thus, not assessable income.[4]
(b) Carrying on a business and trading stock
Where a miner is carrying on a business, it is likely that the scope of the business would encompass both the mining and trading of bitcoins. In such a case, the bitcoins generated from mining and acquired from trading will be treated as trading stock of the business.
“Trading stock” is broadly defined in section 70–10(1) of the ITAA 1997 to include:
(a) anything produced, manufactured or acquired that is held for the purposes of manufacture, sale or exchange in the ordinary course of a *business; and
(b) *livestock.
The term “anything” is not defined in the ITAA 1936 or ITAA 1997, and therefore takes its ordinary meaning taking into account the legislative context in which the term is used. According to the Macquarie Dictionary, the term “anything” is defined as:
a pronoun 1; anything whatever; something, no matter what.
a noun 2; a thing of any kind.
an adverb 3; in any degree; to any extent. […]
Notwithstanding the above, it is understood that the Commissioner may be of the view that the ordinary meaning of the term “anything” when considered in its legislative context has a narrower meaning that the dictionary definition of the term. That is, throughout Division 70, trading stock is referred to as something that a taxpayer “holds” or has “on hand”. From this, the Commissioner considers that the legislative context is one which is referring to a thing that is capable of ownership, being some form of property. In this case, Bitcoin is money (in the form of intangible property) and thus capable of ownership (refer discussion at 1.4).
Bitcoins that are mined and traded are held for the purpose of sale or exchange in the ordinary course of the miner’s business. On the basis that none of the exclusions in section 70–10(2) apply to bitcoins, there does not appear to be any reason why bitcoins cannot fall within the scope of “trading stock” as defined in section 70–10(1).
The implications of treating bitcoins as trading stock for income-tax purposes are as follows:
- the cost of mining and acquiring bitcoins is deductible under section 8–1 of the ITAA 1997;
- the value of all bitcoins on hand at the beginning of the income year, and all bitcoins on hand at the end of the income year must be taken into account in ascertaining the taxable income of the taxpayer if any business is carried on by the taxpayer. The tax effect of taking bitcoins on hand into account is as follows:
(i) If the value of all Bitcoins on hand at the end of the income year exceeds the value of all Bitcoins on hand at the beginning of that year, the assessable income of the taxpayer includes the amount of the excess;[5]
(ii) if the value of all Bitcoins on hand at the beginning of the income year exceeds the value of all bitcoins on hand at the end of that year, the amount of the excess is deductible;[6] and
(iii) the value of bitcoins on hand at the end of the income year becomes the value of Bitcoins on hand at the beginning of the next income year.[7] If an item’s closing value in the previous year was not taken into account at all, the item’s opening value is nil.[8]
At the end of an income year, a taxpayer will be required under section 70–45(1) of the ITAA 1997 to value each bitcoin on hand at either cost value, market selling value, or replacement value.
If a bitcoin is purchased in a foreign currency, that amount must be translated into Australian dollars in accordance with the rules in Division 960 of the ITAA 1997. If a bitcoin on hand at the end of an income year is valued at cost, the value is translated at the exchange rate prevailing at the time when the bitcoin became stock on hand.[9] If a Bitcoin is valued at market selling value or replacement value, the value is translated at the exchange rate prevailing at the end of the income year.[10]
Furthermore, any expenditure incurred in relation to mining activities (that is not of a capital nature) may be an allowable deduction under section 8–1 of the ITAA 1997. If such expenditure is of a capital nature, then the capital allowance provisions in Division 40 of the ITAA 1997 may apply.
1.3 Holding bitcoin
The income tax implications of holding Bitcoin are considered in the context of the activities and specific tax provisions discussed.
1.4 Using bitcoin
(a) Using bitcoin for payment of goods and services
Where bitcoins are used for the payment of goods and services, an amount on account of the bitcoins received would be included in assessable income of the party receiving payment.
Conversely, a general deduction may be allowable for the party providing the bitcoins as consideration under section 8–1 of the ITAA 1997. More specifically, section 8–1 provides that a taxpayer can deduct from assessable income any loss and outgoing to the extent that:
- it is incurred in gaining or producing assessable income; or
- it is necessarily incurred in carrying on a business for the purposes of gaining or producing assessable income.
However, a taxpayer cannot deduct a loss or outgoing under section 8–1 to the extent that:
- it is a loss or outgoing of capital or of a capital nature;
- it is a loss or outgoing of a private or domestic nature;
- it is incurred in relation to gaining or producing exempt income or non-assessable non-exempt income; or
- a provision of the ITAA97 prevents it from being deductible.
Whether or not a taxpayer is entitled to claim a deduction for the bitcoins used in the acquisition of goods and/or services will therefore depend upon the nature of the goods and/or services acquired and whether they have a sufficient nexus to the production of assessable income.
As the use of bitcoins to acquire goods and/or services involves the disposal of a CGT asset, there may be CGT consequences. These are discussed in further detail below.
(b) Buying and selling bitcoin
The income tax and CGT implications associated with trading bitcoins depend upon whether the activities of buying and selling Bitcoin undertaken by the taxpayer constitute a business, and the nature of the business.
Where the buying and selling of bitcoins is carried on as a business of a bitcoin trader:
- the bitcoins generated from mining and acquired from trading will be treated as trading stock of the business. The income tax consequences of treating bitcoin as trading stock were previously addressed in 5.2(b);
- any gains made in trading would be included as ordinary income of the business. Further, any losses made in trading would be generally be allowable as a deduction.
However, where of bitcoins are acquired as a capital investment (e.g. as a speculative investment), outside the course of a business (e.g. as a hobby) or as part of an isolated transaction, the disposal of the Bitcoins may also give to a CGT event, in particular CGT event A1.
Pursuant to section 104–10(1) of the ITAA 1997, CGT event A1 occurs if a taxpayer “disposes” of a CGT asset.
The term “CGT asset” is widely defined in section 108–5(1) of the ITAA 1997 to mean:
(a) any kind of property; or
(b) a legal or equitable right that is not property.
The term “property” takes its ordinary meaning, but the essential legal characteristic of property is something that can be owned or possessed, or of which an interest can be held. Accordingly, the ownership of “property” can be transferred, assigned, or alienated. The term can include real and personal property, as well as intangible property in the form of choses in action. Being money, Bitcoin is intangible property that is capable of being owned. As Bitcoin does not fall within any of the exclusion in section 108–5(2) of the ITAA 1997, it qualifies as a CGT asset, as defined in section 108–5(1).
For the purposes of CGT event A1, a disposal occurs if there is a change of ownership from the taxpayer to another entity, whether the change of ownership occurs because of the happening of a specific act or event, or by operation of law.[11] The event is taken to occur when any contract for the disposal is entered into or, if there is no contract, when the change of ownership occurs.[12]
A capital gain arises of the capital proceeds from the disposal are more than the asset’s cost base.[13] A capital loss arises if the capital proceeds from the disposal are less than the asset’s reduced cost base.[14]
Thus, to the extent that a net capital gain or loss arises from buying and selling Bitcoin, such gain or loss would need to be taken into account in the taxpayer’s assessable income.
Furthermore, section 118–20 generally provides that capital gains will be reduced or eliminated to the extent to which other taxing provisions also include an amount in the taxpayer’s assessable income (e.g. sections 6–5 or 15–15 of the ITAA 1997) or exempt income as a result of a CGT event occurring.
1.5 Foreign exchange issues
(a) Conversion / translation of bitcoin amounts
Section 960–50 of the ITAA 1997 states that an amount in “foreign currency” is to be translated into Australian currency.
As discussed, “foreign currency” is simply defined as “a currency other than Australian currency”, and Bitcoin arguably already meets that definition (being arguably a “currency” other than the Australian dollar).
In any case, an amount expressed in bitcoin would not meet the requirement in section 960–50 as it is not expressed in Australian dollars, and in order to calculate any Australian income tax liability (e.g. arising from the transactions considered above) in respect of bitcoin it is necessary to undertake translation.
As such, in order to satisfy this requirement and be consistent with the position proposed on the issue from a GST perspective, it is proposed that an amount expressed in bitcoin may be converted into Australian currency based upon the rules in Subdivision 960-C of the ITAA 1997.
There is no reason why the rates quoted by Bitcoin Exchanges or foreign exchange service providers such as XE and Oanda cannot be used to convert Bitcoin to Australian currency for this purpose (whether as a commercial exchange rate or a rate agreed between the transacting parties). Further, as discussed, it is likely that a transaction in bitcoin will already reflect a pre-determined rate against the Australian currency.
(b) “Foreign currency” gains and losses
Division 775 of the ITAA 1997 provides that a taxpayer’s assessable income includes “forex realisation gains” and “forex realisation losses” arising from “forex realisation events”. Forex realisation events include CGT event A1 in the context of “foreign currency” (forex realisation event 1) and cessation of rights and obligations to pay or receive “foreign currency” (forex realisation events 2 to 5).
The relevant forex realisation gain or forex realisation loss is described in the applicable forex realisation event. But such gain or loss is only made to the extent that it is attributable to a “currency exchange rate effect.” [15] Further, Division 775 does not provide for double taxation or double deductions.[16]
If bitcoin is “foreign currency”, then “realised” gains and losses would need to be included in assessable income of the taxpayer under Division 775 (or perhaps Division 230 of the ITAA 1997 — refer discussion below).
Prima facie, the forex realisation events in Division 775 would seem to have general application to all taxpayers using bitcoin or accepting bitcoin as payment — irrespective of whether or not they trade bitcoin on a bitcoin exchange. However, the mere holding of bitcoin in isolation of any transaction would not fall within a forex realisation event.
Given the volatility of bitcoin rates against the Australian dollar (as a real world currency), there is potential for significant forex realisation gains or losses arising in respect of transactions undertaken using bitcoin.
1.6 Taxation of Financial Arrangements (TOFA)
The TOFA rules in Division 230 of the ITAA 1997 provide for the tax treatment of gains and losses arising from “financial arrangements” in priority to other provisions of the Tax Acts (e.g. the trading stock provisions in Division 70 of the ITAA 1997). In summary, the TOFA rules have the effect of bringing gains or losses (including unrealised gains or losses) from a financial arrangement to revenue account.
As a general proposition, the TOFA rules only have mandatory application to large taxpayers (e.g. taxpayers with “aggregated turnover” exceeding $100 m) and not to individuals.[17] But, a taxpayer can elect that the TOFA rules apply to all its financial arrangements.
In and of itself, bitcoin would not be a financial arrangement within the general meaning in TOFA rules[18], as it is not an “arrangement” — although the underlying transactions in respect of which bitcoin is utilised may involve a financial arrangement. It is beyond the scope of this paper to consider any such underlying transactions from a TOFA perspective.
However, section 230–530 of the ITAA 1997 provides that the TOFA rules also apply to “foreign currency” as if the currency “were a right that constituted a financial arrangement.”
This means that if Bitcoin falls within the meaning of “foreign currency” in section 995–1 of the ITAA 1997, bitcoin will be deemed to be a “financial arrangement” and potentially subject to the TOFA rules, depending upon the circumstances of the taxpayer.
Where applicable to a taxpayer, gains or losses from Bitcoin (i.e. as “foreign currency”) would need to be calculated and included in assessable income in accordance with the TOFA rules (rather than the rules in Division 775 of the ITAA 1997) — this would be the case irrespective of whether or not the taxpayer is trading bitcoin on a bitcoin exchange, and would include any unrealised gains or losses from holding bitcoin.
Notes:
[1] section 6–1(1) of the ITAA 1997.
[2] section 6–5 of the ITAA 1997.
[3] section 6–10 of the ITAA 1997.
[4] Evans v FC of T (1989) 20 ATR 922, which held that the taxpayer was not a professional punter as his gambling lacked the essential element of system or organisation.
[5] section 70–35(2) of the ITAA 1997.
[6] section 70–35(3) of the ITAA 1997.
[7] section 70–40(1) of the ITAA 1997.
[8] section 70–40(2) of the ITAA 1997.
[9] item 3, section 960–50(6) of the ITAA 1997.
[10] item 4, section 960–50(6) of the ITAA 1997.
[11] section 104–10(2) of the ITAA 1997.
[12] section 104–10(3) of the ITAA 1997.
[13] section 104–10(4) of the ITAA 1997.
[14] section 104–10(4) of the ITAA 1997.
[15] As defined in section 775–105 of the ITAA 1997 — in short, being exchange rate fluctuations or differences between agreed or applicable exchange rates.
[16] Sections 775–15(4) and 775–30(4) of the ITAA 1997.
[17] Section 230–5 of the ITAA 1997.
[18] Section 230–45 of the ITAA 1997.