Chapter 3 – Cryptocurrencies

• Crypto-assets are a fast-growing sector
• Should different types of crypto-assets have different GST treatments?
• Issues with applying GST to crypto-assets
• Issues from applying financial arrangement rules to crypto-assets
• How should a crypto-asset be defined?
• How should GST be removed from supplies of crypto-assets?
• Other services related to crypto-assets
• Other tax rules will continue to apply to crypto-assets
• Application date
• Other tax issues with crypto-assets

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3.1 This chapter discusses proposals to exclude cryptocurrencies (crypto-assets) from GST and the financial arrangement rules to ensure these rules do not impose barriers to developing new products, raising capital or investing through crypto-assets. The tax system strives for neutrality and to minimise distortions.

3.2 Income tax will still apply to any profits made when cryptocurrencies are sold or traded (this is further discussed in paragraphs 3.60–3.62).

3.3 The proposed GST changes would only apply to supplies of crypto-assets. Other services related to crypto-assets, that are not in themselves supplies of crypto-assets such as mining, providing crypto-asset exchange services or providing advice, general business services or computer services will continue to be subject to the existing GST rules.

3.4 GST will continue to apply to supplies of goods and services which are bought using a crypto-asset (the same as if those goods or services had been purchased using money or swapped for another good or service).

Crypto-assets are a fast-growing sector

3.5 Crypto-assets are digital assets (commonly known as coins or tokens) that use cryptography to secure transactions and verify the transfer of the coins or tokens. Instead of relying on a financial institution to verify transactions, crypto-asset transactions are confirmed by computers operating on the currency's network.

3.6 At the time of writing, there are currently over 5,000 crypto-assets and the total global market value of all crypto-assets exceeds US$300 billion.

3.7 The use and development of crypto-assets are growing in New Zealand, including investors, exchanges and start-ups.

Should different types of crypto-assets have different GST treatments?

3.8 Tax rules in New Zealand and overseas do not contemplate crypto-assets and can be difficult to apply as crypto-assets will often not fit into existing definitions that were designed for other investment products such as currency, shares, debt or equity securities. Because of their innovative nature, they will often also have different features to these other investment products.

3.9 This means that some existing tax rules can be difficult to apply, involve very high compliance costs or may provide policy outcomes for some crypto-assets that lead to over-taxation compared to other alternative investment products.

3.10 More simple and certain tax rules could contribute to the further growth and development of the crypto-asset sector in New Zealand by:

• Ensuring New Zealand businesses, investors and crypto-asset users 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).
• Making it more attractive for businesses to issue their initial coin offerings or other token generating events from New Zealand, which could facilitate increased investment, business growth and technology development in New Zealand.
• Making it easier to buy or sell crypto-assets with New Zealand dollars as opposed to having to exchange New Zealand dollars into foreign currencies and incur foreign exchange fees.

3.11 It is intended that crypto-assets should have a similar tax treatment to other investment products or asset classes which are close substitutes for the crypto-asset. It is not intended that crypto-assets would receive a concessionary tax treatment.

3.12 A key question is whether the same tax treatments should be applied to most types of crypto-assets or apply different tax treatments depending on the key features of the particular crypto-asset, such as whether it is a payment token, a utility token, security token, an asset token or a hybrid token with a mix of features.

3.13 Two potential approaches to this issue are discussed.

Token classification framework and deeming rules

3.14 One option would be to develop a framework for categorising different types of crypto-assets and use this to create some deeming provisions that apply across all Revenue Acts. For example, rules that deem certain types of crypto-assets to be included in the Revenue Act definitions of securities, or currency, depending on whether the crypto-asset has some particular features.

3.15 This approach could mean:

• 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, supplies of currency are not subject to GST and the exchange of currency is an exempt financial service for GST purposes.
• Crypto-assets deemed to be shares would not be financial arrangements for income tax purposes (so would generally be taxed on a realised basis) and would be exempt financial services for GST purposes.
• Other types of crypto-assets could be deemed to have a different GST or income tax treatment.

3.16 An advantage of this approach is that it should provide a neutral tax treatment for those crypto-assets which are close substitutes for existing financial products such as currency or shares.

3.17 However, this approach assumes that crypto-assets generally have similar uses or features to existing financial products (which may not be the case), and that the existing tax rules for these other financial products are practical to apply and provide sensible policy outcomes when applied to crypto-assets.

3.18 In addition, because of the specific definitions that apply for different tax rules, this approach could still lead to different tax treatments between a crypto-asset and the financial product they are deemed to be for the purposes of the Revenue Acts. For example, a particular crypto-asset could be deemed to be a share, but if it does not provide an interest in a foreign company or partnership, it would still be taxed very differently to other foreign equity investments which will often be foreign companies subject to the FIF rules or partnerships subject to flow-through tax treatment.

3.19 There may also be practical limitations from trying to accurately classify tokens and apply differing tax treatments to different types of token.

3.20 There are over 5,000 crypto-assets – many which have different rights or features. In contrast other investment products, such as a portfolio consisting of shares in listed companies, are much more standardised. There is no universal standard for classifying tokens. This means an investor who buys a lot of different crypto-assets may find it difficult to identify whether a deeming rule in the New Zealand tax legislation applies or not. Some tokens will be hard to classify as they are hybrid. The legal or economic features of a crypto-asset may change as it is developed, leading to a change in tax treatment. For example, some of the proposed features of a particular crypto-asset will not exist yet at the time of investment and may change as the underlying software is developed.

Broad definition

3.21 An alternative approach would be to prioritise specific changes to those tax rules and provisions which are identified as creating the most significant policy issues when applied to crypto-assets.

3.22 For example, it appears that the GST and financial arrangement rules lead to significant policy and practical issues when applied to crypto-assets. Some of these issues are explained in the next section. Therefore, there appears to be a case to exclude most types of crypto-asset from the GST and financial arrangement rules by developing a broad definition of crypto-assets for this purpose.

Issues with applying GST to crypto-assets

3.23 New Zealand has a broad-based GST system that applies to nearly all goods and services. A service is broadly defined to mean anything which is not goods or money.

3.24 GST does not apply to money or financial services, but the existing definitions of money and financial services were not designed with crypto-assets in mind. It is likely that many crypto-assets have a different GST treatment to money or financial services.

3.25 When a crypto-asset is traded or sold, the GST treatment may vary depending on the specific facts and features of the crypto-asset and the residency of the buyer and seller. The supply of a crypto-asset could be an exempt financial service, subject to 15% GST, or a zero-rated supply to a non-resident.

3.26 In this regard, the current GST rules provide an uncertain and variable GST treatment making, using or investing in crypto-assets less attractive than using money or investing in other financial assets. The variable GST treatment may distort decisions around the type of crypto-assets a business may choose to develop and issue, whether they issue the token in New Zealand or offshore, and what type of tokens New Zealand investors choose to buy or sell.

3.27 The final issue is that, because of the complexity of the GST treatment and the limited information available about the specific features of a crypto-asset and the residency of the seller or purchaser, the current GST rules can be difficult to apply or impractical to comply with.

Issues from applying financial arrangement rules to crypto-assets

3.28 Financial arrangements are broadly defined, and this broad definition means that some types of crypto-assets are likely to be financial arrangements under the current rules.

3.29 Many security, asset, or utility tokens could be considered financial arrangements between the holder who provides money and another person who provides money or money’s worth in the future. Payment tokens such as bitcoin are unlikely to be financial arrangements as they do not involve an arrangement between two persons.

3.30 Requiring the financial arrangement rules to be applied to some crypto-assets would lead to accrual-based taxation on large unrealised gains and losses from crypto-asset values, which can be very volatile. It could also bias investment decisions about which types of crypto-assets New Zealand investors may prefer to invest in, if some tokens are only taxed on realised gains or losses when they are sold or exchanged for other tokens, and others that are subject to tax on accrued gains or losses.

3.31 If they apply to a crypto-asset, the financial arrangements rules would require the person to convert the value of their crypto-asset into NZD, spread income and expenditure over the term of the arrangement and undertake a base price adjustment on maturity.

3.32 From an income tax policy perspective, it seems more appropriate and practical to tax crypto-assets at the time they are sold (or exchanged for other tokens) rather than on accrued gains or losses.

3.33 Traders who have a business of dealing in crypto-assets should be taxed under the trading stock rules the same way that share traders are.

3.34 Some crypto-assets may have features that make them economically equivalent to debt arrangements – for example a token that is issued at $1 of value (in money, other tokens or services) and can be redeemed for $1.20 of value in two years’ time. Such tokens should continue to be taxed under the financial arrangement rules. This could be achieved by excluding such tokens from the definition of crypto-assets which qualify as excepted financial arrangements.

How should a crypto-asset be defined?

3.35 It is proposed that a broad definition of crypto-assets be developed which captures nearly all the crypto-assets that are used or invested in.

3.36 This broad definition would then be used to remove crypto-asset from both the GST rules (by making crypto-assets an exempt supply) and the financial arrangement rules (by making a “crypto-asset” a new type of excepted financial arrangement).

3.37 A crypto-asset could be defined based on a requirement that the token use cryptography and a block chain.

3.38 The proposed definition is broader than the definition of “digital currency” which Australia has legislated to remove GST on certain types of crypto-assets as well as the proposed definition of “digital payment token” which Singapore has developed for the same purpose.

3.39 Australia’s and Singapore’s definitions exclude crypto-assets whose value is pegged to or dependent on a fiat currency (for example, stable coins) as well as tokens that give a right or entitlement to receive something else. This means their definitions 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.

3.40 Singapore’s draft guidelines clarify that some “hybrid” utility tokens may still qualify as digital payment tokens so long as they can still potentially be used as a medium of exchange even after they have been used to obtain a product or service.

3.41 Australia’s and Singapore’s definitions are not explicitly limited to crypto-assets as they do not require cryptography or block chain. However, they do exclude tokens that are not generally available to be used without substantial restrictions. This requirement excludes tokens issued on private block chains, currency that can only be redeemed within an online game, or loyalty points that can only be redeemed at certain merchants.

3.42 We consider it could be complex to require a crypto-asset to be generally available without restriction. For example, initial coin offerings are often made to a select group of investors before they later become available on an exchange. In this context a requirement that the coins be “generally available” could lead to the tax treatment for particular crypto-asset changing over time or being uncertain at a particular point in time.

3.43 We welcome submissions on how a crypto-asset should be defined including whether there are other distinguishing features of a crypto-asset which should be included in the definition.

How should GST be removed from supplies of crypto-assets?

3.44 There are two main options for removing GST on crypto-assets:

• Making all supplies of crypto-assets not subject to GST. Under this option supplies of crypto-assets would have the same GST treatment as supplies of money, which are not subject to GST.
• Making supplies of crypto-assets to New Zealand residents exempt from GST and supplies to non-residents zero-rated supplies (subject to GST at 0%). Under this option supplies of crypto-assets would have the same GST treatment as financial services.

3.45 The key difference between these two options is the GST treatment of supplies of crypto-assets to non-residents. To the extent that a GST-registered person makes zero-rated supplies of crypto-assets to non-residents, they would be able to claim GST input credits (a refund on the GST charged on goods and services) in relation to inputs that they use to make these zero-rated supplies.

3.46 Zero-rating of supplies to non-residents could therefore make it more attractive for GST-registered persons to sell crypto-asset to non-residents than New Zealand residents or discourage New Zealanders from using New Zealand-based exchanges. This could hinder the development of the New Zealand dollar market for crypto-assets which would make it more difficult and costly for New Zealand businesses and investors to convert crypto-assets to New Zealand dollars.

3.47 In addition, zero-rating supplies of crypto-assets to non-residents would mean that New Zealand investors who traded more than $60,000 of crypto-assets in a 12-month period on international exchanges would typically be required to register for GST (assuming most of their trades were with non-resident persons), and incur the compliance costs of filing GST returns and returning GST on any other taxable supplies they may make.

3.48 Furthermore, the global nature of crypto-asset markets means that businesses and investors who trade crypto-assets could potentially have a mix of supplies to non-residents and supplies to New Zealand residents. In many cases, it will be impractical to identify if the supply of a crypto-asset is to a resident or a non-resident.

3.49 It is therefore proposed that all supplies of crypto-assets be made not subject to GST, including supplies to non-residents.

3.50 This would ensure New Zealand businesses and investors are not disadvantaged when they sell crypto-assets to other New Zealand residents, which should facilitate the exchange of crypto-assets for New Zealand dollars. It would also reduce compliance costs and would be consistent with the GST treatment of money. In addition, making crypto-assets not subject to GST would be consistent with existing market practices.

Input credits for capital raising

3.51 The GST rules were amended in 2017 to allow GST-registered persons to claim input credits for inputs such as legal or advisory services used to raise capital using equity or debt securities (see section 20H of the GST Act). It is proposed that GST-registered businesses that raise funds through issuing security tokens which have features that are similar to debt or equity securities (such as a right to a share of the profits of a project) should also be able to claim input credits on their capital raising costs.

3.52 This would ensure that businesses are not disadvantaged if they choose to raise capital through issuing crypto-assets which are close substitutes for debt or equity securities. These input credits for inputs related to capital raising costs could be claimed regardless of whether the GST-registered person issued the qualifying securities tokens to residents or non-residents.

Other services related to crypto-assets

3.53 The proposed changes would only apply to supplies of crypto-assets.

3.54 Although the simple fact of owning a crypto-asset is not itself a financial arrangement, crypto-asset can still be used as part of a financial arrangement (in the same way that money or money’s worth can form part of a financial arrangement). For example, lending funds in the form of crypto-assets and derivatives based on the value of crypto-assets will still be treated as financial arrangements.

3.55 Similarly, for GST purposes, other services related to crypto-assets, that are not in themselves supplies of crypto-assets such as mining, providing crypto-asset exchange services or providing advice, general business services or computer services will continue to be subject to the existing GST rules.

3.56 Under the existing GST rules these services could be either taxable supplies to New Zealand residents subject to 15% GST or zero-rated supplies to non-residents. Because of the global nature of crypto-asset markets, many of these services are likely to be zero-rated supplies to non-residents.

3.57 The intention is that the change in the GST treatment of the supply of crypto-assets should not change the GST treatment of the supply of these other services, even though the service provider may receive crypto-assets as consideration for performing these services. This is consistent with the fact that supplies of goods and services have the same GST treatment regardless of whether the consideration was paid in money or another form of payment (such as barter or crypto-assets). If the GST treatment changed depending on the type of payment received it could create a tax bias for preferring some payment types over others.

3.58 The standard GST rules will therefore continue to apply to supplies of goods and services which are bought using a crypto-asset (the same as if those goods or services had been purchased using money or swapped for another good or service).

3.59 However, the changes proposed above will mean that if a person has received a crypto-asset as a payment for goods or services, they will be able to exchange the crypto-asset for money or another crypto-asset with no GST consequences.

Other tax rules will continue to apply to crypto-assets

3.60 Under the proposed changes, crypto-assets would only be excluded from the GST and financial arrangement rules – they would still be subject to other tax rules.

3.61 In particular, a crypto-asset is considered property for income tax purposes. When a person acquires crypto-assets for the purpose of disposal (selling or exchanging it) the proceeds made from selling it are subject to income tax (see section CB 4 of Income Tax Act). Disposal includes swapping one type of crypto-asset for another or exchanging a crypto-asset for New Zealand dollars or another fiat currency such as US dollars or Euro.

3.62 Investors who have a business of dealing in crypto-assets (see section CB 5 of the Income Tax Act 2007) will be subject to income tax each year under the trading stock rules.

Application date

3.63 It is proposed that the relevant law changes to exclude crypto-assets from the GST and financial arrangement rules should apply retrospectively from 1 January 2009, the date the first crypto-asset, bitcoin, was launched.

3.64 The proposed application date should ensure all New Zealand traders of crypto-assets are not subject to GST or the financial arrangement rules, regardless of when their purchases or disposals took place.

3.65 It should also mean the proposed new rules would generally align with current and previous tax positions where we understand most of the affected New Zealand taxpayers have generally not applied GST or the financial arrangement rules to determine their tax positions.

3.66 The application date for any changes to the capital raising deduction rules would be from 1 April 2017 as this was the date that the capital raising deduction rule took effect.

3.67 Submissions are sought on whether any variations or savings provisions to the proposed application dates should be provided. For example, a savings provision could be included to preserve tax positions taken based on the GST Act provisions or financial arrangement rules that applied prior to the new amendments.

Other tax issues with crypto-assets

3.68 Officials appreciate that some other aspects of the tax rules may also be difficult to apply to investments and transactions involving crypto-assets. While we welcome submissions identifying these issues, this issues paper only proposes excluding crypto-assets from the GST and financial arrangement rules.

3.69 Inland Revenue intends to continue to publish guidance such as answers to commonly asked questions in respect of how other tax rules may apply to crypto-assets.