Although the devil will be in the detail, the final report of the ‘Australia as a Technology and Financial Centre’ committee (tabled on the 20th October 2021) details 12 recommendations covering a range of regulatory issues, such as taxation, decentralised autonomous organisations and debanking. This report promises significant economic reform to push Australia towards becoming a leader in the twenty-first century crypto economy. In particular, the committee’s recommendation to reform the capital gains tax (CGT) regime is a welcome announcement to enable taxpayers dabbling in the crypto space to have the confidence and certainty to comply with their tax obligations.
According to the committee’s report (also known as the Bragg report), 25 per cent of Australians have, or have held, cryptocurrencies, thus describing Australia as one of the biggest per capita adopters. Within growing blockchain communities, uncertainty and disquiet have been brewing (sometimes unexpectedly) about the tax implications of crypto activities. The words by Adam Smith can aptly capture the sentiment,
The uncertainty of taxation encourages the insolence and favours the corruption of an order of men who are naturally unpopular, even where they are neither insolent nor corrupt.
This is particularly so as the technology continues to experience dynamic experimentation and evolution. From what may be seen narrowly by some as merely a means of payment, blockchain technology has unlocked an ever-expanding metaverse (as reflected in the increasing number of acronyms associated with this space – initial coin offerings (ICOs), central bank digital currencies (CBDCs), non-fungible tokens (NFTs), decentralised finance (DeFi), decentralised autonomous organisations (DAOs)).
For the tax system, experimentation that results in new forms of assets, new forms of business and new forms of financing, create practical challenges for taxpayers, tax practitioners and the regulatory frameworks that compliance relies upon.
What does the committee highlight about the complexities with respect to the tax system and CGT?
There are a number of key takeaways from the report with respect to CGT. The committee make it abundantly clear that there is now a formal recognition of the rapid uptake and innovation in this space, particularly with respect to DeFi (at 6.42) and that Australia’s tax regime is falling behind other jurisdictions, such as Singapore (at 6.43). (DeFi, or decentralised finance, refers to the emerging system of financial products available on blockchain that remove traditional intermediaries such as financial institutions. In other words, it is the decentralised alternative to centralised finance.)
The committee is clearly concerned that if Australia does not act now, then innovators will look elsewhere, quoting witness Scott Chamberlain, Entrepreneurial Fellow at the ANU School of Law,
[O]ur tax laws ‘[u]navoidably complicate the establishment of Digital Asset Projects compared to competing jurisdictions like Singapore that have favourable income tax laws and do not have CGT or GST [goods and services tax]’. – at 6.43
Although a further recommendation was raised in regards to offering a tax discount with respect to sourcing renewable energy for mining activities (see Recommendation 7 at 6.56), CGT was the clear focus of the committee.
One of the key issues that the committee agrees taxpayers face in dabbling in digital asset investment activities, is that often digital asset transactions occur several layers away from the Australian dollar. The committee concluded that due to this, there is difficulty in taxpayers correctly assessing their tax liabilities (at 6.46).
Looking closer at the committee’s analysis of submissions, the joint submission from a selection of RMIT University academics (including the author of this piece) was quoted in describing this issue insofar as non-compliance is concerned:
Operating in what is treated as a barter economy, where transactions can occur multiple levels beyond fiat currency, means the compliance burden for taxpayers is increasingly complex and uncertain. Taxpayers’ compliance becomes increasingly abstract and therefore increases the risk of inadvertent non-compliance. – at 3.132
The challenges for the CGT regime and broader are further pronounced when DeFi activities are involved (at 6.47). Submitters in this regard were noted to raise a number of issues, for example:
- the interaction of crypto assets with the DeFi protocol, whether swapped, accessed, burned, staked or exchanged triggers multiple taxable events and resets acquisition dates thereby impacting the 50% CGT discount (Submitter: Fintech Australia at 126); or
- depositing or lending crypto assets into what is akin to an interest bearing account being considered a disposal (Submitter: Ms Razwina Raihman at 130).
The committee concluded that the number of taxable events created by the interactions with the DeFi protocol was the most significant barrier to entry (at 6.47). Overall, there is confusion and differing interpretations on how tax principles apply to DeFi activities, and in particular whether there are material changes to ownership that ought to result in CGT events (at 6.47).
What does the committee propose?
There was a strong conclusion in the committee’s examination of the CGT regime for digital assets: reform is needed to ensure taxpayers have the confidence in undertaking digital asset transactions and that the tax regime does not undermine new technology applications (at 6.48). However, the committee disagreed that taxing points should be removed entirely for crypto-to-crypto transactions (the on and off ramping) as advocated by some—although this may simplify compliance, it is a risk to tax revenue leakage (at 6.49).
The committee recommends targeted tax reform;
The committee recommends that the Capital Gains Tax (CGT) regime be amended so that digital asset transactions only create a CGT event when they genuinely result in a clearly definable capital gain or loss.
This proposal may result in a new category of CGT asset (to complement personal use assets and collectibles), or a new CGT event class.
The committee also agreed with concerns as to guidance and clarity within the crypto space, stating that both the Treasury and the Australian Taxation Office (ATO) need to be proactive and work with industry. The committee suggests that the ATO guidance needs to be updated at least every six months just to keep pace (at 6.50).
What don’t we know?
The committee’s recommendations are certainly a step in the right direction to reflect this increasingly complex digital ecosystem. However, we are yet to see what the reform will actually look like. Without contemplating too deeply,
- What will be considered ‘genuinely’ to be a ‘clearly definable capital gain or loss’?
- When will that capital gain or loss be recognised and how will it be calculated?
- If a new category of CGT asset is created, what will be captured (or fall outside of) this category? In other words, how will ‘digital asset transactions’ be defined?
- What will be the special rules for this new category of CGT asset? For example, could losses be quarantined or even disregarded? Will there be a certain threshold in cost to disregard the gain (loss) on disposal and will certain elements of cost be specifically excluded?
- How will this category interact with the existing categories and/or tax provisions?
The targeted nature of this proposal may mean that related income issues that can arise from the same crypto activities (such as within the DeFi space), may continue to pose certainty and complexity issues.
Similarly, unless there are encompassing provisions as to what is captured by the reform, cryptocurrencies such as Bitcoin may (unintentionally?) fall outside of the scope. This stems from existing arguments that Bitcoin may fall within the definition of foreign currency following international developments in 2021.
Moreover, important other practical issues need to be considered apart from ‘when will this happen?’, including whether the reform will be retrospective, and what grandfathering provisions will be included to cater for those with existing crypto holdings.
As with any tax reform consideration, the devil will be in the detail.
Final thoughts
The Bragg report signals the beginning of a major shift in Australia for the crypto economy and the approach to its taxation.
This may well lead to critical innovative reform for the tax system, which could go much further. Perhaps we can begin to imagine upheaval of the tax collection system itself, such as automated tax collection, final taxing points or wallet-centric taxing regimes (as raised by the RMIT University academics at 3.151).
As Adam Smith describes,
Every tax ought to be levied at the time, or in the manner, in which it is most likely to be convenient for the contributor to pay it….
Targeted reform can create confidence and certainty for taxpayers about compliance with their tax obligations. No doubt that there is a need to balance the government’s revenue targets and reduce the risk of revenue leakage. Moreover, any such reform should ensure taxpayer rights are protected. However, there is a need for simplicity and robustness for our increasingly digitally driven economy.
The Government has a chance now to improve the tax system so that it is more supportive and encouraging towards taxpayer compliance for the digital ecosystem. The creation of adequate frameworks formally recognising what activities are occurring on blockchain enables a raft of benefits, not only in legitimising the activities but establishing capabilities to respond to emerging economic activity, establish concessions for advancing society, and allowing the digital ecosystem to flourish.
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