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Cryptocurrency: when can you claim tax losses in a falling market? –



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Over the past year, the world has seen the prices of many
cryptocurrencies fall sharply. This has resulted in investors,
traders and businesses crystallising losses or having unrealised
losses on their books.

From a tax perspective, the question is whether these losses are
deductible.

What is crypto for tax purposes?

Crypto has been defined as:

a digital currency in which transactions are verified and
records maintained by a decentralized system using cryptography,
rather than by a centralized authority.

Relevantly for tax purposes, crypto is not a currency; however
it is a CGT asset.

What is the correct tax treatment?

In tax world, there are three possible ways for crypto to be
characterised. Crypto can be:

  1. an investment asset – meaning that it is generally held on
    capital account and losses can only potentially apply to reduce
    future capital gains

  2. an asset purchased as part of a profit-making scheme – meaning
    any loss will only be accounted for once the crypto has been
    disposed

  3. an asset purchased as trading stock of a business – meaning
    that the trading stock provisions operate to determine when
    deductions for losses can be applied.

Case study

Bessie the sheepdog, operates a business through her company
Bessie Pty Ltd. It creates and trades in Non-Fungible Tokens
(NFTs). Bessie uses the crypto, DoggyCoin, to purchase NFTs and
receives DoggyCoin when she sells her NFTs.

Bessie’s company usually has significant reserves of
DoggyCoin that she uses to acquire NFTs and pay expenses in
relation to the business. During the 2022 income year, DoggyCoin
experienced a significant fall in price.

Bessie needs to work out how these unrealised losses are treated
for income tax purposes. If the DoggyCoin is a capital asset or
purchased as part of a profit-making scheme, any losses will only
be available once the DoggyCoin has been sold and the losses are
realised.

In this case however, provided that the company is operating a
business trading NFTs, its DoggyCoin is likely to be trading stock.
This is also the ATO view. The issue is likely to be whether Bessie
Pty Ltd meets the threshold for carrying on a business.

What does this mean for Bessie Pty Ltd?

If DoggyCoin is trading stock, then Bessie’s company:

  1. accounts for the cost of acquiring DoggyCoin as a
    deduction

  2. accounts for the sale of any DoggyCoin as assessable
    income

  3. must, at the end of each income year, determine the difference
    between the value of the trading stock at the beginning of the year
    and at the end of the year, and:.

    • if the value is higher at the end of the year, the difference
      will be assessable income

    • if the value is lower at the end of the year, the difference
      will be a deduction.

Importantly, Bessie can choose to value DoggyCoin at the end of
the year at its market selling value. This may
mean that Bessie’s company can access the company’s
unrealised losses on the decrease in value of its DoggyCoin and
claim this as a deduction.

Conclusion

Income tax loss rules can be complicated, particularly in the
context of share trading and cryptocurrency.

If you would like to look in greater detail at issues relating
to losses, click here to join us on 30 August
2022, for the third webinar in our 2022 tax masterclass series -
The loss of losses – considering whether losses are on capital
or revenue account and traps with the non-commercial loss
rules.

©
Cooper Grace Ward Lawyers

Cooper Grace Ward is a leading Australian law firm based in
Brisbane.

This publication is for information only and is not legal
advice. You should obtain advice that is specific to your
circumstances and not rely on this publication as legal advice. If
there are any issues you would like us to advise you on arising
from this publication, please contact Cooper Grace Ward
Lawyers.

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