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The tax treatment of gains – or losses – from digital assets comes down to what motivated the trade.
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Are my crypto trades on a wash cycle?
29 July 2022
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The ATO is concerned with “wash sale” arrangements in relation to the acquisition and disposal of cryptocurrency, and the focus of its attention is the potential application of part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) to such arrangements falling on capital account.
However, how do wash sale arrangements apply where the taxpayer holds assets on “revenue” account? And where so, does the outcome result in the same treatment for the taxpayer?
In a late June media release, the ATO said it was focusing resources on taxpayers disposing of assets such as cryptocurrency and shares just before the end of the financial year, and then reacquiring the same or similar assets shortly after their sale.
On the basis of statements made by Assistant Commissioner Tim Loh, the ATO considers the sale of such assets for the purposes of deriving a loss as an offset against capital gains or assessable income, as meeting the criteria of a wash sale.
A transaction that is considered as such, will have the loss denied.¹
“Wash sale” is not a defined term in income tax legislation. Generally, the term refers to the disposal of an asset and the reacquisition of that asset, or a similar asset, within a short amount of time.
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Much of the ATO’s position in relation to wash sale arrangements is considered in Taxation Ruling TR 2008/1. However, the ruling in general refers to assets held by taxpayers that have characteristics other than cryptocurrency (shares, and so on).
The ATO’s concerns are with regard to the motivation of these arrangements, namely that they are driven overwhelmingly by tax considerations (i.e. the resultant loss reduces any gain or assessable income that may apply for that year). Having regard to the manner, substance and timing of the transaction, the loss-making event in the words of the ATO is “mainly to be explained by reference to the purpose of obtaining a tax benefit from the loss”.²
That is, the ATO is concerned with:
“Arrangements under which a taxpayer disposes of, or otherwise deals with, an … asset where in substance there is no significant change in the taxpayer’s economic exposure to, or interest in, the asset, or where that exposure or interest may be reinstated by the taxpayer (a wash sale), in order to apply a resulting capital loss or allowable deduction against a capital gain or assessable income already derived or expected to be derived.”³
A concern for tax professionals is that the ATO has further stated that those promoting such arrangements may face the scrutiny of the Tax Practitioners Board.⁴
Notwithstanding the focus of the ATO pronouncements in relation to taxpayers holding assets on capital account, part IVA may also apply to a wash sale where the holding of the asset is on revenue account.⁵
Where the asset is held on revenue account, what is the potential application of part IVA to a taxpayer’s circumstances?
The trader v the isolated transaction
The trader
Part of the current debate in relation to the capital/revenue dichotomy is the consideration of the factors under which taxpayers enter the cryptocurrency market and the purposes for which they enter.⁶
In particular, the revenue side of the debate can be characterised as falling into two streams.
One stream of debate is whether the taxpayer can be said to be conducting their trading activities as a business.
The consideration of such requires reference to the long list of factors held in case law and the relevant ATO guidelines.⁷
Where a taxpayer can be considered to be trading as a business in cryptocurrency, and thereby meeting the factors and requirements necessary, the application of part IVA to a wash sale arrangement may be more problematic.
For example, where a trader has undertaken a wash sale arrangement a counterargument in respect of a trader, where the asset has continued to be held by the individual, is that an allowable deduction could have been obtained by the trader by choosing to apply the trading stock provisions. For instance, the trader may choose the market selling value for trading stock at the close of the financial year to determine its value.
The trader’s economic position in relation to the asset has not altered from continuing to hold it. It is the same or similar economic position had the trader sold the asset, realised the loss, and then reacquired it shortly after. In such matters, the taxpayer would appear to have a substantial hypothetical alternative arrangement to that of the determination of a wash sale transaction that may cause the ATO some difficulty in applying part IVA.
The isolated transaction
The second stream of argument in relation to the holding of an asset on revenue account (and one that is more likely closer to the factual situation faced by many tax professionals, particularly those with clients in the small to medium market) is where a taxpayer enters transactions as an individual on a regular basis or even on an ad hoc basis, but not to the extent that trading activities constitute a business.
The general question in determining a profit or loss from an isolated transaction is whether:
(a) In entering into the transaction, the taxpayer intended or expected to derive a profit that would have been assessable income.
(b) The transaction was entered into, and the loss was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction.
For taxpayers not able to substantiate that they are in the business of trading, they may be able to argue they have conducted such activities as a commercial transaction and therefore hold the asset on revenue consistent with the principles in Myer Emporium.⁹
The ATO accepts that in respect of bitcoin an isolated transaction that is not carried out as part of a business operation will generally be ordinary income where the intention or purpose of entering the transaction was to gain profit and it was carried out in a commercial manner.¹⁰
Where such taxpayers have traded cryptocurrency to realise losses, particularly in the final weeks of June 2022, because of the fall in the market the ATO is likely to perceive such arrangements as tax-driven. If part IVA is applied, the loss will be denied by the ATO.
It is therefore necessary for advisers to consider and document the factors that may have triggered the reasoning of the taxpayer in reacquiring the asset, or similar assets, post-sale. In particular, the time between disposal and reacquisition of the asset and the factors leading to the reasons for the reacquisition may be critical to the question.¹¹
Careful examination of market-based factors may also be indicative of the true motivation and intent of a taxpayer re-entering the market. For example, whilst there was a material fall in bitcoin from mid-March to mid-June 2022, the exchange value of the commodity stabilised within a US$19,000-22,000 range from mid-June until the close of the financial year. This raises the question that taxpayers seeing a floor in the market may have reacquired the asset for the purposes of future gain and value from the change in market conditions. The timing of the transaction is referable to the change in market sentiment and the performance of the asset, rather than the motivation to recover capital gains for taxation purposes.
Phillip London is head of tax at Tax & Super Australia.
The Melbourne-based not-for-profit organisation is offering a webinar on Wash sales and crypto on August 10.
¹ Section 177F (1) of the ITAA 1936 (Part IVA) (Taxation Ruling TR 2008/1 (paragraph 14)).
² Taxation Ruling TR 2008/1 paragraph 2.
³ Ibid paragraph 3
⁴ See Accountants Daily, 29 June 2022, interview with Assistant Commissioner by Philip King.
⁵ Taxation Ruling TR 2008/1 paragraph 7 and 8
⁶ See John Jeffreys Accountants Daily https://www.accountantsdaily.com.au/tax-compliance/17228-profit-motive-puts-crypto-trades-on-revenue-account
⁷ Taxation Ruling TR 2019/1. Taxation Ruling TR97/11.
⁸ Section 70-45(1) of the Income Tax Assessment Act 1997 (ITAA 1997
⁹ FC of T v The Myer Emporium Ltd (1987) 163 CLR 199
¹⁰ See Taxation determination TD 2014/26 paragraphs 22-24.
¹¹ See TR 2008/1 Example 6.
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