Profit motive puts crypto trades on revenue account

Cryptocurrency and tax are a big issue and when people start to lodge their tax returns for the current financial year, there are likely to be some sizeable disputes with the ATO.

The ATO has, correctly, been warning the community that gains and losses from the use of cryptocurrency have a tax implication, except in some limited circumstances where the cryptocurrency is a personal use asset.

On the assumption your cryptocurrency holdings are not a personal use asset, the ATO is asking taxpayers to put their cryptocurrency transactions in one of two categories: as an investor or as a trader conducting a business.

For example, ATO Assistant Commissioner Tim Loh said: “It’s really going to depend on whether someone is actually carrying on a business of trading in cryptocurrency.”

If a taxpayer wants to offset crypto losses against ordinary income, they will have to persuade the ATO that their gains and losses resulted from a cryptocurrency trading business.

The view of the ATO gives the best outcome for revenue collection. This is because capital losses may only be deducted against capital gains. Further, because many people acquire and dispose of cryptocurrency within short periods, the general 50 per cent CGT discount is often unavailable because the cryptocurrency has been held for less than 12 months.

But the ATO’s position is not the complete story.

There is a third alternative that the ATO acknowledges only briefly in its website advice. This is where gains and losses from cryptocurrency are on “revenue account” but are not from the conduct of a business. Gains and losses on revenue account are not treated as capital gains and losses under the tax law. These gains and losses are motivated by profit-making and not from holding cryptocurrency for a long period and selling at a profit (investment).

This third category of gains and losses arises from what is, in my view, the most important Australian tax decision ever. This decision is the Myer Emporium case that was made by the High Court in 1987. This established the principle that even if a taxpayer was not conducting a business, gains and losses from a “business operation” or “commercial transaction” are on revenue account provided the transaction was entered into with the purpose of profit-making.

The ATO has released two important rulings on the Myer decision. These are Taxation Ruling 92/3 and Taxation Ruling 92/4. These rulings provide a good explanation of the above point.

This principle was applied in the Federal Court decision of Greig v Commissioner of Taxation (March 2020). In this case a taxpayer was (by majority) permitted to claim a tax deduction of nearly $12 million resulting from losses on the disposal of shares in one company. The taxpayer acquired shares in the company on 64 different occasions over about a two-year period but was forced to sell them for nothing through a court order.

Having established that the taxpayer was not conducting a business and had acquired the shares for the purpose of making a profit, the key question was whether the taxpayer had engaged in a “commercial transaction”. The court decided that the taxpayer had engaged in a commercial transaction and, therefore, the loss was on revenue account and deductible against ordinary income. The reasons for the decision in this case are very important to understand in relation to the tax implications of gains and losses from cryptocurrency.

Simon Steward (who has since been elevated to the High Court) delivered the main judgement. He decided that the taxpayer had entered into a commercial transaction due to “an elusive factor”. This was a reference to what Professor Parsons said in his celebrated book on income tax principles. Professor Parsons said that determining whether a person was engaging in a business transaction may be nothing more than simply asking whether the transaction is something a businessperson would do.

When referring to the term “investment” Mr Steward said: “An investment connotes something to be held over time, which might then be sold ‘long afterwards’…”.

Regarding whether a transaction is a “business deal” or “commercial transaction”, Mr Steward said this “involves only a low threshold”. In other words, in his view, it would not take much for a transaction to be treated as a business deal or a commercial transaction.

In my view, this is significant when referring to dealing with cryptocurrency. This is because the vast majority of people who acquire cryptocurrency do so with the intention of making profit from its disposal. If that is the case and it is (per Mr Steward) relatively easy to have a commercial transaction, both of the tests in the Myer Emporium principle are satisfied and the gains and losses are on revenue account – that is, the gains and losses are not treated as capital gains and losses.

Based on what my clients (accounting firms) are telling me, there are considerable numbers of taxpayers that are either conducting a business of trading in cryptocurrency or are making gains and losses on revenue account in line with the Myer Emporium principle.

I also refer to a footnote (21) from Taxation Determination 2014/26 that responds to the question “is bitcoin a CGT asset?” This footnote said (in part):

“…if the property has no other use other than as the subject of trade, a conclusion that the property was acquired for the purpose of trade and, therefore, the transaction was commercial in nature, would be readily drawn.”

So, according to the ATO, if an item of property (e.g. cryptocurrency) has no other use than as the subject of trade, the conclusion will readily be drawn those transactions involving that property will be commercial in nature. I think it is reasonable to say that most cryptocurrency, currently, is acquired with the sole purpose of trade.

The ATO’s efforts to reduce gains and losses from transacting in cryptocurrency to a dichotomy of trading v investing are probably done with the view of making decisions easier for taxpayers. However, in my view, it is not a dichotomy. It is a trichotomy and accountants need to have proper regard to the Myer Emporium principle.

The value of many cryptocurrencies has plunged in recent times. Come 30 June 2022 I expect there will be thousands of taxpayers visiting their accountants and seeing what tax relief can be obtained for the losses. No doubt, the ATO is concerned about this and is trying to direct “tax traffic” down the road of (mostly) gains and losses being of a capital nature.

My recommendation to accountants who have the task of completing tax returns for their clients is they should also seriously consider whether the Myer Emporium principle applies to the client’s facts.

Please note that this article is not intended to deal with the tax position of superannuation funds.

John Jeffreys is director of John Jeffreys Tax Pty Ltd.