You can see my original post in the BitPrime blog
Since cryptocurrencies began to gain popularity around the world, different entities and regulators started to look into how to regulate and fit these new asset types into existing tax structures. No easy job, current tax structures around the world have been designed without the capabilities of cryptocurrencies in mind.
In addition, governments and financial institutions are beginning to understand and see the real value behind crypto; therefore, they don’t want to make it harder for businesses to innovate in this new industry.
This article explores the proposal that the New Zealand Tax Agency, Inland Revenue (IRD), has made available to the public. The proposal looks at excluding cryptocurrencies from GST and the financial arrangement rules, to ensure these rules do not impose barriers to develop new products and services, or raise capital or invest in New Zealand. This article assesses the three questions for submitters who want to share their thoughts on the proposal by IRD:
- Should different types of crypto-assets have different GST treatments, or should a broad definition of crypto-asset be developed to exclude all types from GST?
- How should a crypto asset be defined?
- How should GST be removed from supplies of crypto-assets? Should the same GST treatment apply to supplies to residents and non-residents?
Cryptocurrencies
Cryptocurrencies are digital tokens that use cryptography and the power of blockchain technology to ensure security and decentralisation. These tokens can be used as a form of digital cash, but they are not restricted to only one specific use case. There’s usually no central authority responsible for validating the legitimacy of transactions, all is done in decentralised systems, through the power of blockchain technology.
Since the launch of Bitcoin in 2009, the cryptocurrency industry has been growing at a rapid pace, and as of today in 2020, there are over 5000 crypto-assets, and the total market capitalisation of all crypto-assets exceeds US$300 billion.
Furthermore, the expected Compound Annual Growth Rate (CAGR) of this industry between 2019 and 2024 is 6.18%, making it a 1.4 billion USD industry by 2024. This means that the cryptocurrency industry is a fast-growing and innovative space that is transforming one of the oldest, most established industries: finance.
The use and development of cryptocurrencies are following the global trend and are also growing in New Zealand, including but not limited to investors, exchanges and startups.
1. Should different types of crypto-assets have different GST treatments?
This is a hard question to answer, as the current tax structure in New Zealand never accounted for cryptocurrencies and their innovative nature. They often don’t fit into existing definitions of investments such as currency, shares, debt or equity securities. The cost of trying to apply existing tax rules to these new assets is simply too high, and it could become detrimental to New Zealand investments, and the attempt at trying to avoid putting barriers to crypto-investors and business in New Zealand.
The IRD’s proposal suggests that more simple and certain tax rules could contribute to further growth and development of crypto-assets in New Zealand, which is a fair assumption. The main concern about crypto-asset taxation for the IRD is that investors and startups are not disadvantaged from issuing or selling tokens in New Zealand (relative to selling the tokens outside New Zealand or raising capital through other means).
We live in a globalised world, and as crypto-assets are borderless, they can be traded or created from everywhere, so it’s in each country’s best interest to make it easier to launch and manage crypto tokens inside their territory. If not, companies would choose other countries for their crypto-assets due to the ease of use and benefits it can offer. Countries such as Japan, Switzerland or Malta are already following a “crypto-friendly” regulatory frame to entice companies to launch their products there.
IRD proposes to provide crypto-assets with a similar tax treatment as other investments or asset classes which are close substitutes for the specific crypto-asset. It doesn’t want to give a concessionary tax treatment for these types of tokens. This leads to an important question:
Does IRD apply the same tax treatments to most crypto assets or apply different tax treatments depending on the key features of a particular crypto-asset?
In order to answer the above question, IR has evaluated two potential approaches:
- Create a token classification framework and deeming rules.
- Create a broad definition of crypto-assets to exclude them from GST and financial arrangements.
Let’s see each one in more detail.
Create a token classification framework and deeming rules
This approach proposes the creation of a framework to categorise different types of crypto-assets, and then use this framework to create some deeming provisions that would apply across all Revenue Acts.
This would mean, for example, that crypto-assets deemed to be currency would be subject to income tax on disposal for those who are cash-basis persons, and on an accrual basis for those who are not. Currently, currency is not subject to GST, and the exchange of currency is an exempt financial service for GST purposes. Also, crypto-assets deemed to be shares would not be financial arrangements for income tax purposes.
The advantage of this approach is that it would provide a neutral tax treatment for those crypto-assets which are close substitutes for existing financial products such as currency or shares.
Nevertheless, this approach assumes that crypto-assets have similar features to existing financial products, which might be true in some cases, but not in most. Also, the creation of such a framework would be impractical, as it would need to be adaptable to new types of tokens, and use cases, to be suitable for the high level of innovation in the crypto industry.
Take, for example, the DeFi space; a stablecoin can be minted and used as currency, but it can also be used as a financial product in another DeFi platform. How can a crypto-asset like DAI or MKR fit into a tax category, knowing most probably in the near future, there will be another DeFi platform that is built on top of it with another different use case?
All in all, this approach lacks practicality (a characteristic not to be taken lightly in this scenario) and would be extremely difficult to implement.
Create a broad definition of crypto-assets to exclude them from GST and financial arrangements.
Applying GST and financial arrangement rules to crypto-assets leads to significant policy and practical issues when applied to these types of tokens. Therefore, there exists a case for creating a broad definition of crypto-assets to exclude them from GST and financial arrangements.
The main issue applying GST to crypto-assets is the complexity of the GST treatment and the limited information available about the specific features of a crypto-asset. Also, because crypto-assets can be traded internationally, is very impractical to comply with the tax rules.
As financial arrangements are broadly defined, it may very well be the case that some types of crypto-assets fit that definition, although there is of course issues in applying financial arrangements rules to crypto-assets.
For example, payment tokens like Bitcoin are unlikely to be financial arrangements as they do not involve an arrangement between two persons.
Also, applying financial arrangement rules would mean that IRD would have to apply taxes on accrual basis on large unrealised gains, and losses on crypto-assets which can be very volatile. This might also create bias in investment decisions about which types of crypto-assets investors want to invest in New Zealand.
There are some crypto-assets that have characteristics that make them similar to debt arrangements. For example, a token that is issued at $1 of value, and can be redeemed for $1.20 of value in two years time. There’s a case for taxing these types of tokens under financial arrangements, by excluding them from the broad definition of crypto assets. This, again, can be very tricky, as many of these types of tokens can also be used as currency.
This approach leads to the big question IRD needs to answer, which is:
2. How should a crypto-asset be defined?
This is one of the root questions that IRD, and other tax agencies around the world, have to come up with an answer to. This is because it’s legal definition will imply how the asset should be treated in regards to tax exemptions.
Inland Revenue proposes a broad definition of crypto-assets in order to capture nearly all possible use cases of tokens.
The most basic requirement of a crypto-assets would be that it uses cryptography and blockchain technology. Of course, this is a very broad definition, but the intent of IRD is to use this definition to remove crypto-assets from both GST rules (by making crypto-assets an exempt supply) and the financial arrangement rules (by making a crypto-asset a new type of exempted financial arrangement).
It is also important to understand the different classifications of crypto tokens that the US Securities and Exchange Commission (SEC) has put in place, which has been widely accepted by the crypto community and institutions.
There are two main classifications for crypto-assets worldwide:
Utility Tokens
Utility tokens are crypto-assets in which their value is directly linked to their native platform; they have no use outside. They enable future access to the products or services offered by a company. Generally, they are not intended to be created as investments. Another example of this is the Golem Token used in the Golem network, which is intended to be used as payment for computational power inside the network. Another example can be the Filecoin token, which raised $257M through the sale of tokens. These tokens will allow user access to its decentralised cloud storage platform.
Security Tokens
Security tokens are crypto-assets whose value is not linked with the context of their native environment. These tokens can be used as a medium of exchange everywhere, and most people recognise their value. They are intended to be used as investments. They usually represent ownership of a physical or digital asset (like real estate, for example) that has been verified in the blockchain and has legal meaning. Security tokens can be traded for fiat money or other cryptocurrencies, used as collateral in loans, or even fractionalised to store in different digital wallets.
Another classification of tokens that is tightly related to the above classification is between fungible and non-fungible:
Fungible Tokens
A fungible token is a crypto-asset that is interchangeable, and all instances of the token type are the same, meaning they have identical specifications. If we make an analogy with a fiat currency, a dollar coin can be exchanged for any other dollar coin, and that makes no difference to the holder. A fungible token is also divisible in smaller units, the same as 1 dollar can be divided into two 50 cents coins or five 20 cents coins. Most of the fungible tokens created in the Ethereum platform follow the ERC20 standard.
Non-fungible Tokens
A non-fungible token cannot be exchanged for any other non-fungible token of the same type. Each token is different and unique to all other tokens of the same type. Also, they cannot be divided like in the case of the fungible tokens. The most common example of these tokens are the CryptoKitties tokens in the Ethereum network, where each token represents a unique “crypto kitty”. The ERC721 is the Ethereum platform standard for this sort of token.
How similar countries are treating crypto
New Zealand’s neighbouring country Australia has taken a different approach, they have created a more narrow definition for “digital currency” which they then voted to remove from GST tax.
Singapore’s and Australia’s definitions of crypto-assets exclude the stablecoins (cryptos that are pegged 1:1 to fiat currency), as well as tokens that give a right or entitlement to receive something else. This means they exclude Utility tokens which can be redeemed for specific goods and services and asset-backed coins which can be redeemed for gold or other specific assets. Furthermore, tokens issued in private blockchains, and currency that can only be redeemed within an online game and loyalty points are also excluded.
Is it possible to create a definition?
The crypto space is so young and growing so fast that it is extremely difficult to fit it into an existing tax category or create a proper definition.
There is so much room to innovate, and we are in a very early stage with most of the biggest projects still in an “experimental” mode. But because it affects a deeply rooted and established industry such as finance and tax, there’s a need to enclose it somewhere inside our traditional parameters of what it should be. It needs to make sense for lawyers and lawmakers.
Mature industries are easier as the level of innovation goes down when the industry establishes itself, but as mentioned before, the current structures cannot cope with the level of innovation of crypto.
For example, a few of the latest projects in DeFi that will impose a tremendous challenge for categorising tokens are “Side Chains”, “IEOs (Initial Exchange Offering)”, “Decentralised Exchanges” and “Flash loans”.
Ideally, Inland Revenue would need a flexible definition that is subject to changes over time as the space progresses. It would have to be very open and acquire a deeper understanding of the protocols and technologies behind crypto projects in order to provide a fair environment to investors and startups. It should be adaptable to the fundamentals of its workflow and how it sees laws.
We are in an era of constant change and innovation, laws and taxes are made to be static, and with little modifications, that would have to change to create a flexible and dynamic definition of what a crypto-asset should be.
3. How should GST be removed from supplies of crypto-assets? Should the same GST treatment apply to supplies to residents and non-residents?
The proposal analyses two main options for removing GST on crypto-assets:
- Making all supplies of crypto-assets not subject to GST: this would mean that supply of crypto-assets would have the same treatment as the supply of money, which is not subject to GST.
- Making supplies of crypto-assets to New Zealand residents exempt from GST and supplies to non-residents zero-rated: Under this option, the crypto-assets supplies would have the same treatment as financial services.
The main difference between these two options is the GST treatment of supplies of crypto-assets to non-residents. This would mean that a GST registered person making zero-rated supplies of crypto-assets to non-residents would be able to claim GST input credits in relation to inputs that they use to make these zero-rated supplies. This could mean that a GST-registered person would want to sell a crypto-asset to non-residents as they can claim back GST input credits, therefore discouraging the use of New Zealand exchanges from New Zealanders.
Another very important aspect to take into account is the global nature of cryptocurrencies and the internationalisation of trading with borderless exchanges. Even when most cryptocurrency exchanges have KYC (“Know Your Customer”) rules in place, and users have to provide their identification, it would still be impractical to identify if the supply of a crypto-asset is a resident or a non-resident. And on top of all this, there are decentralised exchanges in which there’s no need for KYC, and it is impossible to know where the participants of the trade are.
Therefore, IRD proposes that all supplies of crypto-assets be made not subject to GST, including supplies to non-residents.
A good move by IRD, as this will ensure New Zealand business and investors are not disadvantaged when they sell crypto to other New Zealanders or non-residents. This will also drive more innovation to the crypto space, as there are fewer obstacles for New Zealand businesses to grow and produce more value.
What happens with other services related to crypto-assets?
It is intended that the proposed changes would only apply to supplies of crypto-assets. This would mean that other services that are not supplies, like mining, consulting, exchanges, general business and computer services will still be subject to GST. Under the existing GST rules, these services could be taxable to 15% for New Zealand residents and zero-rated for non-residents.
Standard GST rules will continue to apply to other services not mentioned above; the intention of IRD is not to modify any existing GST treatment outside the supply of crypto-assets.
To make it clear, this means that if a person has received a crypto-asset as payment for goods or service, they will be able to exchange the crypto-asset for money or another crypto-asset with no GST consequences, which makes sense as the person already paid the GST for the provided services.
Application date
The proposed date for excluding crypto-assets from GST and financial arrangements rules is retrospectively from 1st January 2009, the date the first crypto-asset, Bitcoin, was launched. This would mean that New Zealand crypto traders are not subject to GST regardless of when their purchases or disposals of crypto assets took place.
The application date for any change to the capital raising deduction rules would be from 1st April 2017, as this was the date that the capital raising deduction rule took effect.
Crypto GST Tax: Conclusion
As mentioned, the crypto-industry is very young, with a lot of space to grow and innovate. Trying to fit a fast-growing industry into a small category for tax purposes will be detrimental to the development of the industry in New Zealand. As the industry matures and establishes itself, there will be a time where it will be easier to understand and fit types of crypto-assets into defined categories. Now does not seem like the right time if New Zealand wants to be at the forefront of crypto-innovation.
Although a broad definition of a crypto-asset is welcomed, it is highly unlikely that it will fit all use cases and serve as a framework for evaluating tax compliances.
Crypto-assets were born into an interconnected, borderless world, in the world of the Internet, so any intent to bring crypto to physical world rules by differentiating supplies between residents and non-residents of a country would lead to a dead end.
All in all, New Zealand is doing the right thing by asking these questions, and the sooner we ask, the sooner we’ll find those answers, and we’ll be more prepared for the world that’s coming.
