Crypto/NFT Accounting & Tax 101: It’s Time to Comply. Interview with Damien Jones, Partner & Head of Accounting Advisory Team, EY and Greg Reinhardt, Partner and Head of Tax, Norton Rose Fullbright

Transcript

Nick Abrahams:
Hello everyone and welcome to this episode of Web3: From Mystery to Main Street, where we try to make the current moves with Web3 crypto, NFTs, DeFi, make it accessible to everyone because it does seem like it’s a bit of a mystery but it is very quickly moving to the main street. And often we talk about truly exciting topics like prices paid for incredible NFTs and virtual properties and the metaverse. And today we are going to talk about a subject, which I’m sure is very exciting for us all and that is the tax and accounting treatment of cryptocurrency. Now I know many people who are involved in the crypto world have a belief that you don’t need to worry about tax or indeed accounting issues with crypto. And I can assure you that nothing could be further from the truth because the revenue authorities, they may move slightly slowly but they will get there in the end, they are like the glacier.

Nick Abrahams:
The revenue authorities will catch up with crypto and crypto trading and so forth. So, today what I’m going to talk about is really a couple of things. With our experts from EY, talk about accounting and also from my firm, Norton Rose Fulbright to talk about tax and really to dispel a couple of myths. So, the first is that you are anonymous when you are dealing in crypto and so forth. And people do live with this idea that they have a virtual wallet and that conveys anonymity. It conveys a degree of anonymity, but I can assure you that in my experience, wallets can be traceable. So, I think the anonymity argument is somewhat flimsy. I would be concerned if you were relying on that. I think there’s this idea of what is happening with organizations? So, we’re seeing a lot more organizations who are embracing cryptocurrencies and we’re going to talk today about what to do if you’re an organization and you want to invest in some crypto to put on the balance sheet that’s part of a corporate treasury strategy.

Nick Abrahams:
Going to talk about if you’re an organization that wants to accept Bitcoin or other cryptocurrencies in return for your goods and services. We know that Gen Z loves crypto. And so, many organizations are starting to seriously consider how they can start accepting crypto payments, what the tax issues with that, what are the accounting issues? And they’re surprisingly relatively straightforward, but you do need to be across them. And then of course, what to do with employees and where employees are being paid in cryptocurrency? And we’re starting to see that happen and then give a little case study on a wonderful project that I worked on together with the Norton Rose Fulbright team where we were setting up a token option plan. So, rather than an employee share option plan, a token option plan where the employees actually got tokens rather than shares. And I’ve got to say the employees were very keen on those token. So, a token option plan may be something for your organization down the track. So with that, let us move to our first discussion and that is in relation to tax and cryptocurrencies.

Nick Abrahams:
Today I’m delighted to be joined by Greg Reinhardt, who is a partner and also the head of the tax team for Norton Rose Fulbright Australia. So, Greg, thanks very much for joining us.

Greg Reinhardt:
Nick Abrahams, thank you for having me.

Nick Abrahams:
So, what we’re going to talk about today is tax and crypto, which is really sort of the fun police, because I think a lot of people in the crypto world have a bit of a view that it’s anonymous. I can … Tax isn’t probably highest on their minds. So what we’re trying to do today is understand a little bit more about what is the actual tax treatment of crypto, particularly for organizations that are looking to embrace it more into their particular operation. So it’s really looking at it more from the corporation’s point of view, not the individual holders of crypto. So Greg, I guess the first question is what is the Australian tax officer’s view on crypto?

Greg Reinhardt:
Yeah. It’s an interesting one because this is by its nature disruptive technology, and tax rules by their nature tend to always lag a little bit behind. So there’s two real aspects. One is what is the technical treatment. And also in terms of an enforcement perspective, what is the ATO doing here? The ATO has taken quite a pragmatic view. They just treat crypto as any other form of asset. In this case, it’s digital, but they apply all the same capital gains; tax trading, stock rules, employee withholding rules to crypto transactions as if you were paying with any other asset. Importantly, though, what they haven’t done is they don’t treat it as currency. So there are special rules, some of which are quite conceptual about transactions with foreign currencies where you might be able to defer realization times and things like that. They don’t apply. They only apply to state endorsed currencies. And the ATO has been very specific that that doesn’t include crypto assets. So if you are holding crypto and you sell it at the base case, you’ll make a capital gain hopefully. And-

Nick Abrahams:
Depending on when you bought it.

Greg Reinhardt:
Yes, there is some important timing caveats there, but if you’ve made a capital gain, you will be expected to account for tax on it. And if you’ve held that crypto for more than 12 months, you may get access to the CGT discount. But the ATO does treat that sale as a taxing event. Importantly, also, if you switch between cryptos, each crypto is a separate asset. So if you’re trading between them, every time you go in and out, any gains you realize are taxable. The same with losses, but you know, it is actually a taxing event and you are meant to be reporting it. You can’t say, “Oh, well, this is in the crypto world. I only pay tax when it becomes connected to the real world.” So, their approach there is to treat it just as another asset. As I said, it’s not currency. It’s also not considered subject to some sort of equity treatment. It’s not like a share or something like that. So all the rollovers and things like that that might apply for shareholders or employee share schemes, they’re not going to apply here either. This is just a digital asset, and every time you transact, the ATO would like to see some of that in your tax return.

Nick Abrahams:
So, I think the takeaway from that is that we’ve got a robust set of regulations. The ATO has been very good with setting that up. And so really, there is a framework. It’s interesting, the trading between crypto that you mentioned, I think many individual holders are probably not super across that. And particularly in the world of DeFi, there’s a lot of sort of trading happening between cryptos and there’s some interesting business models actually that have come up with organizations that can help track your crypto trading and so forth. So it’d be interesting to see as those traders mature, how they interface with the ATO.

Nick Abrahams:
Now, we’ve seen some interesting things with crypto and corporates. So, Tesla very famously bought Bitcoin to put on the balance sheet, and we’ve got other companies such as Micro Strategies and also Block, formerly Square, now owner of Afterpay. So, they’ve got crypto on the balance sheet. And then remarkably, I think KPMG Canada announced that they have bought some Bitcoin and some Ethereum or Ether to put on their balance sheet as part of corporate treasury strategy. So for those organizations, Greg, out there who might be thinking, what are the tax implications of holding crypto on the balance sheet?

Greg Reinhardt:
Well, I mean, for them and particularly those sorts of organizations which are going to be held to a high level of scrutiny and more investigative resources, that’s going to be treated like all other assets. They will need to account for the gains and losses that they make in those transaction and treasury events like they would with bonds, shares or any other currency asset. But as I said before, they’re not going to get the benefit of any retranslation exemptions and things like that. So when they buy and sell, that gain inherent will need to be reported to the tax officers. For most people who hold cryptos a kind of longer term hold, you might access capital gains. But if you’re actually in the business of trading and selling it, you’d probably actually account for it as trading stock, which means that whatever, there’s no CGT discount. You’re just paying tax on any gains as they arise, and you’d account for it as trading stock at the end of each year.

Nick Abrahams:
Oh, fantastic. Okay, that’s interesting. I hadn’t thought through the trading stock idea, but yeah, that makes sense. We’ve also seen organizations starting to open up to the idea that they may need to start accepting payment for their good or service in Bitcoin or others. And we’ve seen in the US, particularly folks like AT&T have been allowing people to pay their phone bills in crypto. What are the tax considerations if you’re going to start accepting crypto?

Greg Reinhardt:
You know, in Australia, the interesting one here is really around GST in that it is a different means of payment. In about 2017, the ATO actually realized that this was a possibility, and what they did is they practically exempted cryptocurrencies from GST. So buying and selling crypto does not attract the 10% GST if you’re registered, but what you buy and sell with that crypto, that’s still subject to GST. So there is a translation question here is that if I sell something for $110 and I accept payment in Bitcoin, I still have to account to the ATO for $10 of GST on that, the 111th. And you would need to be able to convert that transaction quite quickly, to lock in your position to then be able to pay the ATO, because they’re not going to accept payment in Bitcoin.

Nick Abrahams:
I mean, that’s quite a challenge, isn’t it? And your point there, given that you don’t have like for like if you’re accepting the payment in Bitcoin, but you’ve got to pay the GST in Fiat and Aussie dollars, you’re making that translation very swiftly so you’re not left with an exchange issue. Fascinating. Makes the idea of the the vast return become even more complicated. So something to look forward to.

Greg Reinhardt:
It’s the same issue we’d have if you accepted payment in US dollars or British pounds, but generally the movement between those currencies and the Aussie dollar are not as extreme day to day. So, your effective rate becomes a easier to hedge.

Nick Abrahams:
Yeah, right. Right. Then what we’ve seen recently is companies like Finder in Australia, very successful technology company, quite a young workforce, they’re offering to pay people partly in cryptocurrencies. So we’re starting to see a little bit more of this, and particularly with Gen Z who see crypto as more of a native aspect to it. If you are going to start paying your employees in cryptocurrency, what are the tax tricks there?

Greg Reinhardt:
This is the one area that the ATO hasn’t been quite as clear on, because they actually released two comments about it which kind of cut across each other. The basic rule is, crypto’s not currency, so it’s an asset. And if you provide an asset to an employee, subject to fringe benefits tax. And with fringe benefits tax, it’s the employer that pays the tax, not the employee. So a company doing that’s really got to be careful that the tax expectations are being managed right, because they’re going to be paying tax at a corporate level on the highest marginal rate and the employee’s not paying tax. So the amount you pay, however you translate that, you need to manage quite carefully.

Greg Reinhardt:
But they have also put out a … So, that was in the tax determination. I’m just trying to think. It was 2014 they said, “No, if you give your employees digital assets, we’re going to treat that as fringe benefits.” And that makes a lot of sense when it’s in addition to your wages. And that was really the context back in 2014 that they were looking at is you’re still getting your normal wages, but perhaps your bonus is in crypto. And that’s when the FBT treatment. They’ve also put out on their website that if you actually pay your employees completely in crypto, we expect PAYG to be withheld and it’s just treated like wages. So, those two things don’t sit quite comfortably. But I think as a sort of rough guide we’re starting and you know, this is still a bit of a brave new world for the tax office, if all your salary is coming out as crypto, there’s no Aussie dollar component, I think as a employer, you’d be saying you should withhold tax, do a conversion, treat it as if you paid them in currency and make sure that you’re meeting the withholding tax obligations. If you’re doing it as in addition to wages, it’s a bonus, it’s maybe a discretionary element or a piece on top, then the FBT treatment might apply, in which case the employer is primarily liable for that tax.

Nick Abrahams:
Right. Sounds like that’s quite a nuanced issue. So I suspect-

Greg Reinhardt:
[crosstalk 00:12:04].

Nick Abrahams:
… folks who are listening to that, please do get some very solid tax advice on how you’re doing it if you are going to be paying folks. Because it does seem … Obviously the treatment between FBT and PAYG is significantly different. We’ve also got I guess the superannuation guarantee, et cetera. So …

Greg Reinhardt:
Yeah, because that would count as part of their salary and then you would be expected to account for it. And the interesting thing particularly with Super, there’s no statute of limitations on that one. The ATO can come back to an employer 20 years down the track. So getting it right and getting clarity, including engaging with the ATO upfront becomes really important, because whilst everyone is happy now and things are going well, you just need one disgruntled employee down the track to look back and go, “Ah, you didn’t properly compensate me,” and a claim can be made. And you’re really on the back foot as the employer because the rules are set up to protect employees going forward. So, you really do need to get that clarity as to how these things should be treated.

Nick Abrahams:
Yeah. Terrific. Now, you and I had had an interesting project just recently where we had a client that had its own token and was offering that token as part of a token option plan. And so we had the very interesting situation where we had a standard ESOP, so an equity share option plan, and then a token option plan. And I have to say my sense was the enthusiasm of the employees was far more around the token than it was around the equity, which was a real flip if you think people are driven by the equity opportunity. And I think in this case, because you know, if you’re taking equity in an unlisted company as an employee, you’ve got to wait around for a while before you can monetize that, whereas a token, once vested, you can actually sell into the market quite quickly. So, important new tool for incentivizing employees. Can you talk a little bit about some of the tax issues we found along the way there?

Greg Reinhardt:
No, this was really interesting because employee share schemes, they’re old school. They’ve been around forever and the ATO has got quite detailed rules that look to tax and give concessions to employees who are participating in the equity arrangements. Digital assets, even when they’re granted in the same way, don’t enjoy those concessions. So there was the startup concessions introduced really targeting the IT industry and looking to create new ways of rewarding employees in startups, they don’t extend beyond traditional equity models. So even though they’re targeted at the same industries, the concessions just don’t extend beyond for the token option plan. And so you’re really back into that whole issue of if we give out tokens and they have value at the time we give them, then you’re really dealing with FBT challenges and potential tax for the employer that needs to be managed.

Nick Abrahams:
Right. Thank you for that. I think for those people that are listening, that piece of advice should be worth the cost of listing, because it’s actually quite a difficult analysis, but thanks, Greg, for making that so clear. Just finally … So, the Australian government has made a pledge that it will regulate crypto this year. And so I guess what does that mean, do you think, from the tax point of view? Are we going to see a lot of changes in the tax laws?

Greg Reinhardt:
You know, I think there’s definitely going to have to be some changes because this is new [inaudible 00:16:03]. But actually what these are … Going in October 2021, so last year, Senator Bragg’s committee put out a paper that said, “Oh, we need to amend the CGT rules to deal with these assets.” But the actual changes they’ve proposed don’t seem to be … It’s certainly not wholesale reform from the existing rules. They are very concerned when you’re looking at sort of DeFi protocols and how crypto assets might interact with our tax system in that sort of distributed space, but they’ve definitely … They’ve talked about perhaps having new sort of CGT events so that you only have … That translation taxing point might only be when you move it out of one class into another, but they haven’t … Someone had suggested they would move to taxing crypto assets so that you basically only tax at an on ramp and off ramp point. They’ve said, “No, we’re not doing that. We’re still taxing. We’re still treating these as digital assets.” So actually, how this will move out is still a little bit unclear. I think the bigger challenge for the ATO is really going to be about enforcement. And you know, I think a lot of people underestimate the data gathering power of the ATO. It’s certainly not quick, but it’s pretty thorough.

Nick Abrahams:
It gets there in the end.

Greg Reinhardt:
You know, the way they’ve been tackling crypto transactions up until now is to really look at where it interacts with the rest of the economy. You’ve got to move money into the system and out of the system. You’ve got to pay for things. At some point, that will create enough of a record that the ATO can then come and start to ask you difficult questions about how you’ve afforded or paid for different things. And the ATO gets a lot of information from the banking sector at the moment. They’re also look at sort of DSPs within the crypto world to sort of go, if you’ve got a presence in Australia, we can request information from you. So I think a lot of the anonymity that is currently enjoyed, certainly within perhaps the digital environment, it keeps having to interact with the traditional economy, and the ATO is definitely at the moment targeting those interactions.

Nick Abrahams:
Yeah. Yeah.

Greg Reinhardt:
But it is going to be interesting as to at what point does it become too difficult for them to get visibility there? And if they feel that they’re not capturing enough tax, I think then we will see a vastly different set of regulations being introduced.

Nick Abrahams:
Yeah. Yeah, no, I agree entirely. I think there’s a world out there that believes that your persona in the virtual world is a only sort of virtual wallet, and that that’s not traceable. But we’ve that it has been. So look, Greg, thank you very much for your time. A lot of amazing information. A lot of work has gone into those answers. I know they are not simple. Thank you very much for making it so easy to understand, and thanks for joining us. Greg Reinhardt.

Greg Reinhardt:
Absolute pleasure. Thank you.