Digital assets have become a rapidly growing phenomenon over the past decade. With this new growth comes the question of how to tax these assets.
Guidance on how to account for the vast array of digital assets is currently lacking, as is an international consensus on how to tax digital assets.
To understand more about what digital assets are and how they are spreading globally, we recommend reading our blog and downloading the paper on Digital Assets: A window into the new economy.
Some countries currently regard digital assets as being currency for tax purposes. This includes Belgium, Italy, and Poland. This means that realised gains and losses would be taxable.
Many others, including Australia, view Digital Assets as a form of intangible assets, with gains and losses being treated under the capital gains regime. For countries such as Singapore and Hong Kong, classifying digital assets as property means that individuals avoid taxation, as there are no capital gains taxes applicable for individuals.
Virtual currencies can be created through what is known as the mining process. This is where rewards are generated via a proof of work protocol, rather than through purchasing the digital assets. The question arises as to whether we should be taxing the digital currencies at this point of creation, or not until they are actually disposed of and there is a measurable flow of revenue.
One potential taxation point for digital assets is at the point of creation.
Many major companies including Finland, New Zealand, Japan, Norway, the United Kingdom, and the United States, consider such creation events to be taxable as ordinary income, with the costs of production allowed as a deduction. When the digital assets are later sold, this is treated as a capital gains event and taxed under the relevant capital gains regime.
Some countries, including Australia, Canada and Singapore, only tax the creation of digital assets through mining activities if the activity takes place as a business activity (as opposed to a hobby).
Many countries ignore the creation of digital assets through mining as a taxation point. Instead, the first taxation point is the disposal of the digital currency. In these countries the total disposal value is included as assessable income (less allowable costs incurred to mine the digital asset).
Usually countries that tax digital assets this way treat the income as a capital gain.
In some taxation jurisdictions the mining activities are taxed on a receipts basis when those activities are carried on as a business. This means that all mined digital assets are treated like stock and included in business income as income, losses or sales revenue. Deductions are treated in the same manner as any other business deduction.
Regardless of the different taxation options, most countries agree that disposal of a digital asset is a taxation event. Disposals can occur through loss, exchange, or sale of the digital asset.
Most major economies regard the disposal of digital assets for fiat currency to be a taxable event. Although there are notable exceptions, such as Italy, where such transactions are not taxed unless they are treated as speculative trading.
In most countries the exchange of one digital asset for another digital asset is considered to be a taxable exchange. Other countries however, do not consider such exchanges to be taxable. This is possibly due to the difficulty in accurately valuing the realised gains or losses on such exchanges.
Other countries, such as Australia, Belgium, and Japan, vary their treatment of these type of exchanges depending on the type of owner and how the virtual currency is expected to be used.
With virtual currencies becoming more acceptable globally, it is becoming common for these digital assets to be used to purchase goods and services. This typically means that the person using the virtual currency to make a purchase has realised a taxable event. The person receiving the virtual currency as payment, likewise is in receipt of taxable income at that same value. The tax treatment then depends on that country’s personal income tax rules.
Other situations of disposal may include gifting the digital asset, loss or theft. In these situations the owner of the digital asset has disposed of their holding but not received anything in exchange.
Some countries tax the recipient of gifts, others tax the disposal at the deemed value of the asset being disposed.
When it comes to theft or loss, this is typically deductible if the individual is running a business and the digital assets are trading stock, but not if they are holding the assets as private individuals.
Creating a cohesive treatment for digital assets, let alone a consensus on how to tax these assets, is a long way from being realised. This will require a lot of research and collaboration to come to fruition as the world continues to embrace the use of virtual currencies on an ever increasing scale.
Our Founder, John Marcarian, goes into further detail in the International Taxation of Digital Asset Transactions paper.
John is an Australian Chartered Accountant with over 25 years of experience.
He has a deep understanding of digital assets and the Fourth Industrial Revolution presently underway around the world in the area of blockchain and digital assets.
John’s passion for digital assets has led him to co-found, NeoFlow Asset Management Limited, (with Joshua Boles and Richard Stromback), a funds management business that seeks alpha for its investors in all classes of digital assets and decentralised finance.
A recognised tax specialist in digital assets, John has a qualification from the MIT Sloan School of Management in BlockChain technologies.
John regularly works with companies issuing tokens and other forms of digital assets, and is one of the very few global tax specialists that has founded a funds management business in digital assets.
This unique blend of skills gives John a practical day to day knowledge of the business challenges faced by entrepreneurs in the digital asset market.