Cryptocurrency, and specifically Bitcoin, has taken the financial world by storm over the last year. Bitcoin, now valued at approximately US$13,500 (28 December 2017 at 13:17 – it fluctuates violently from moment to moment) increased in value by 1,388% over the last 12 months, 465.05% over the last 6 months, 237.19% over the last 3 months and 43.5% over the last month. Some of the other leading cryptocurrencies showed similar growth in value over the last year with Ethereum up 9,632.84%, Ripple 20,981.72%, Litecoin 5,307.27%, Iota 426.58% and Dash 10,813.56% (These figures were all obtained from CoinCap on 28 December 2017 and would have fluctuated dramatically by the time I finished typing this sentence.)
However, it is not only one-way traffic. Bitcoin came down to its current value from a high of almost US$20,000 a few weeks ago. The other currencies follow a similar pattern of volatility.
Financial commentators did not miss the remarkable growth in the value of the currency, and combining the volatility, have been predicting a burst in the bubble for some time now. Enthusiasts of the phenomenon on the other hand sees the growth as a natural consequence of a concept that the world desperately needs and predicting further phenomenal growth, with volatile movements in value as short-term blimps on the graphs. What everyone agrees on though is that no-one can say for sure what will happen next – it is a new concept with new rules that are made up as the industry matures and governments, banks and the existing financial infrastructure all over the world struggling to get to grips with this.
The purpose of these articles is not to try and explain exactly how cryptocurrency works (I do not understand blockchain technology well enough to even try to do that in any event), nor is it an attempt to make any prediction regarding the future of these currencies. What I rather want to do is to take what we do know and apply principles related to fiat money (government issued legal tender, not backed by commodities) and other tangible or intangible assets that may or may not be used for trading purposes.
The first principal that needs to be established when dealing with the issue of cryptocurrency and tax, is whether cryptocurrency is viewed as “money” in terms of the Income Tax Act (or other acts administrated by SARS such as the Value-added Tax Act).
Section 1 of the Income Tax Act defines “gross income” as follows:
“in relation to any year or period of assessment, means,
(i) in the case of any resident, the total amount, in cash or otherwise, received by or accrued to or in favour of such resident, or …
during such year or period of assessment, excluding receipts or accruals of a capital nature …”
The key terms that should be explored are: “total amount”, “cash”, “otherwise” and “received by or accrued to”, with “amount” being the first and most important hurdle to cross as all the other concepts hang on that.
None of the terms are further defined in the Income Tax Act, even though the courts have provided clarity to a certain degree.
For tax to be levied on any income, there must be an amount on which the tax is based.
In CIR v People Stores (Walvis Bay) (Pty) Ltd (1990 AD) the following statement made by Watermeyer J in Lategan v CIR (1926 CPD) was adopted – “In my opinion, the word ‘amount’ must be given a wider meaning and must include not only money, but the value of every form of property earned by the taxpayer, whether corporeal or incorporeal, which has a money value …”
Haupt (2017, 18) interprets this by stating that “the term ‘property’ includes any asset … The term ‘incorporeal’ means an intangible asset, such as a ‘right’. Therefore, if the taxpayer receives something, which is an asset, and this asset has a value, then there is an amount for the purposes of the gross income definition.”
An intangible asset can therefore be considered an amount, and therefore included in gross income, if it (1) conforms to the definition of an intangible asset and (2) has value. It is important to note that both these criteria must be met.
Since neither of the terms are defined in the Income Tax Act, one must look at other definitions that may be relevant. IAS 38 defines an intangible asset as follows:
“an identifiable non-monetary asset without physical substance. An asset is a resource that is controlled by the entity as a result of past events (for example, purchase or self-creation) and from which future economic benefits (inflows of cash or other assets) are expected. [IAS 38.8] Thus, the three critical attributes of an intangible asset are:
- Control (power to obtain benefits from the asset)
- Future economic benefits (such as revenues or reduced future costs)
Identifiability: an intangible asset is identifiable when it: [IAS 38.12 is separable (capable of being separated and sold, transferred, licensed, rented, or exchanged, either individually or together with a related contract) or arises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.”
(International Accounting Standards Board 2004)
Inherent to this definition is the concept of a “right”. This is one of the key components in the concept of identifiability, and an inherent part of the “control” requirement. If you therefore receive something that has no physical substance and it conforms to all the components within the definition of an intangible asset, but there are no rights associated with the asset, it cannot properly be considered as an intangible asset and consequently not an amount and therefore not included in gross income.
Applying these principles to cryptocurrency should be relatively easy. Since cryptocurrencies are not regulated in South Africa, the only point of reference is the terms and conditions on which it is traded in South Africa.
Luno, the largest cryptocurrency exchange in South Africa, provides the following risk warning under its terms and conditions page:
Bitcoin is a new technology that often works differently to your prior experience. It therefore entails various risks that you should understand. We have highlighted some of these risks below.
Bitcoin transactions sent from your Luno wallet are irreversible. If you send Bitcoins to an incorrect address, or send the wrong amount of Bitcoins, you cannot get them back. Luno cannot be held liable for executing a transaction if the instruction relates to an incorrect Bitcoin address.
Before buying or selling Bitcoin, educate yourself about Bitcoin. Buying and selling Bitcoin entails risks and could result in a complete loss of your funds. Please ensure that you fully understand the risks involved and do not invest money that you cannot afford to lose.
Bitcoin is not backed by any entity. Neither Luno nor anyone else has an obligation to buy back your Bitcoins in the future.
Additionally it is very important to note the following risks:
Bitcoin is not legal tender and it is not backed by the government. Accounts and value balances are not subject to any Government backed deposit insurance or any other Government protections;
Legislative and regulatory changes or actions at the state or international level may adversely affect the use, transfer, exchange, and value of Bitcoin;
Transactions in Bitcoin are generally irreversible, and, accordingly, losses due to fraudulent or accidental transactions may not be recoverable;
Bitcoin transactions shall be deemed to be made when recorded on a “block chain” ledger, which is not necessarily the date or time that you initiate the transaction;
Bitcoin is derived from the continued willingness of market participants to exchange fiat currency for Bitcoin, which may result in the potential for permanent and total loss of value of Bitcoin, should the market for Bitcoin disappear;
There is no assurance that a person who accepts a Bitcoin as payment today will continue to do so in the future;
The volatility and unpredictability of the price of Bitcoin relative to fiat currency may result in significant loss or tax liability over a short period of time;
The nature of Bitcoin may lead to an increased risk of fraud or cyber attack;
The nature of Bitcoin means that any technological difficulties experienced by a service provider may prevent the access or use of your Bitcoin.
(Luno South Africa n.d.)
From the Luno terms and conditions it is clear that there are no legally enforceable rights associated with the ownership of Bitcoin (or any other cryptocurrency for that matter). The value is entirely based on the voluntary exchange of goods and services for cryptocurrency.
From a purely South African Income Tax perspective therefore, owning cryptocurrency amounts to nothing, as it fails at the first hurdle of the definition of gross income.
However, this does not mean that any transaction involving cryptocurrency will be free from income tax as there are several other sections in the Income Tax Act that regulates the transfer of assets at a value (or amount) different to market value.
In the next article the concept of “value” relating to cryptocurrencies will be explored, and the correct tax treatment under certain scenarios will be suggested.
Note: This article should not be used as a substitute for detailed tax advice and is intended for general background information regarding the tax treatment of cryptocurrency. Every transaction is unique, and it is impossible to provide information on every eventuality in an article such as this. For detailed advice, make an appointment with your tax advisor.
Charl du Plessis