No Doge-ing the tax bill on crypto-currency transactions
SARS is tightening tax collection on crypto-currency transactions, which makes it important to distinguish between events that will trigger income tax rates or CGT rates, say Joon Chong, Partner and Lumen Moolman, Senior Tax Manager Webber Wentzel.
Have you (i) sold your crypto-currencies (crypto); (ii) exchanged one crypto for another crypto; (iii) purchased goods and services using crypto; (iv) mined or forked for crypto; (v) received staking rewards in crypto; (vi) then sold your staking rewards; (vii) received air-drops of crypto; or (viii) used crypto as collateral for loans? If you answered yes to any of these questions, remember your taxes!
The South African Revenue Service (SARS) is increasingly auditing taxpayers’ crypto holdings and trading activities. It has also requested information from certain South African crypto exchanges, including Luno, about users on the platform and their transactions.
SARS has not issued an interpretation note on the tax implications of crypto assets. Crypto is defined as a "financial instrument" in the Income Tax Act 58 of 1962 (ITA), as opposed to "currency" which would have excluded crypto gains from the ambit of capital gains tax (CGT). This means the intention of the taxpayer, supported by objective factors such as length of holding and frequency of trades, would determine whether the crypto gains are revenue (taxed at a maximum of 45%) or capital in nature (taxed at a maximum of 18%).
Disposal of crypto
The disposal of crypto as a financial instrument is a taxable event. It may, however, be hard for taxpayers to prove that their crypto investment gains fall within the CGT net, as there are no capital deeming rules in the ITA for crypto, such as the three-year rule for equity shares.
In determining the intention of the disposal, SARS may be guided by cases involving the disposal of Krugerrands. In ITC 1525, the taxpayer held Krugerrands for 12 years and the purchase was made with the intention to provide funds for a rainy day. The Krugerrands were sold to inject capital into a new business. In ITC 1526, the taxpayer held Krugerrands from eight months to nine years. They were purchased to provide a store of wealth for the taxpayer's children and protection from inflation. They were sold for various reasons, including to make improvements on and purchase properties. The Tax Court held in both these cases that the Krugerrands were held on revenue account and subject to income tax rates.
It may thus be practical to use different wallets for trading cryptos and holding cryptos for long-term gains.
The gain when one crypto (A) is exchanged for another (B) is the difference between the market value of B and the acquisition cost of A. If A was held or acquired on revenue account, the difference will be taxed as income (45%). Otherwise, if held on capital account, the difference will be subject to CGT (18%).
It can be difficult to determine the market value and acquisition cost of crypto in ZAR. We suggest that the spot rate should be used for the transactions. Schedules of rates and transactions should be compiled on the calculated gains or losses on the tax return.
The same principles would apply where the taxpayer has purchased goods or services with crypto. The difference between the market value of the goods or services and the acquisition cost of the crypto would be subject to income tax (45%) or CGT (18%), depending on whether the crypto was held on revenue or capital account.
Assessed losses from trading in crypto may be ring-fenced. It might not be possible to offset these losses against any other income of the taxpayer if the taxable income and losses of that taxpayer (adding back assessed losses from the current and prior year) are more than ZAR 1 577 300 for the 2021 tax year. There are, however, exceptions to this rule. (Section 20A (2)(b)(ix))
If a taxpayer derived crypto from mining or forking, then the gains would be subject to income tax (45%), since they are derived from conducting a trade. If the taxpayer's intention was to hold the crypto as a long-term investment, then they will be subject to CGT (18%) on any gains.
Staking rewards are also taxed at income tax rates and are, for now, unlikely to meet the definition of "interest" in the ITA. This means the annual interest exemption for individuals cannot be set off against staking rewards.
Further complexities arise when staking rewards are sold. For example, assume a taxpayer received staking rewards with a market value of 80 at the time of receipt. That 80 would be subject to income tax as it is akin to interest (without the annual interest exemption). Assume next that the staking reward is sold for 450 after five years. The difference between 450 and 80 is the gain on the disposal. This gain may be taxed at CGT rates (18%), not income tax rates (45%), again depending on the intention of the taxpayer at disposal.
If the taxpayer receives new crypto through airdrops on existing crypto held, this is akin to a distribution of new financial instruments based on existing financial instruments held. Once again, the taxpayer’s intention in holding the existing crypto, frequency of trading, how long they were held, etc, would be taken into account to determine whether the new airdropped crypto would be held on revenue or capital account. If held on revenue account, the market value of the new airdropped crypto would be subject to income tax (45%), and if on capital account, CGT (18%). It is irrelevant that the value of the crypto airdropped was not converted to ZAR. Income is subject to tax when received or accrued, and there is accrual when there is an unconditional entitlement to the crypto/income.
Crypto used as collateral
In our view, when crypto is used as collateral for a loan, there is no disposal of the crypto and no taxing event. Where the taxpayer is the lender and receives interest in crypto, then the market value of the crypto would be subject to income tax (45%). In this situation, we would argue that the annual interest exemption should apply.
We recommend that taxpayers seek advice to ensure that their crypto gains are reported correctly in their tax returns. The volatility and high-risk nature of this asset class should not be compounded by an unexpected tax bill.