As the public’s and the Australian Taxation Office’s (ATO) interest in cryptocurrency continues to increase further guidance has been released by the ATO in relation to the tax treatment of staking rewards and airdrops. As we previously reported here, the ATO has increased its access to information regarding cryptocurrency asset holdings, exchanges and disposals. It is therefore important that tax advisors and investors understand the appropriate tax treatment that applies to all cryptocurrency transactions.
In our previous articles on cryptocurrency, we discussed the capital gains tax (CGT) implications of cryptocurrency disposals as well as the circumstances when a disposal or receipt may be taxed as ordinary income and subject to marginal tax rates. In this article, we will consider “staking rewards” and “airdrops”, which are two instances where the receipt as well as the disposal of cryptocurrency triggers tax liabilities.
What are “Staking Rewards”?
The blockchain technology underpinning cryptocurrencies is decentralised meaning that decision making is distributed. Given this decentralised structure, a consensus mechanism is required to confirm and validate transactions.
For bitcoin and many other cryptocurrencies the consensus mechanism utilised is a “proof of work” (PoW) system. Under a PoW system transactions are authenticated by using computer resources to solve complex mathematical equations. This authentication process is referred to as “mining”, and “miners” are those that contribute their computer resources to validating the transactions. By doing so, miners order transactions and create new blocks in the chain of transactions. Miners who successfully solve the relevant mathematical equation receive coins from the network as a reward.
An alternative consensus method that has been developed is “proof of stake” (PoS). Under the PoS model, users who meet minimum balance requirements can “stake” their existing coins by depositing and locking them in the relevant network as a stake. In contrast to a PoW there is no complex mathematical challenge (known as a hash) in a PoS.
The PoS process gives validators, also known as “forgers”, the chance of being selected to validate the next block. Forgers generally receive additional coins as a reward for staking their existing coins (similar to how a miner is rewarded in a proof-of-work chain). Neo (PoS cryptocurrency with support for smart contracts) is an example of a cryptocurrency that utilises a PoS consensus mechanism. Additionally the Ethereum network is moving to a PoS consensus mechanism.
How are Staking Rewards Taxed?
The ATO has indicated that the monetary value (in equivalent Australian dollars) of the rewards forgers receive by staking rewards will be taxed as ordinary income at the time of receipt. The same treatment will also apply to any other form of coin reward that is derived by a taxpayer as a result of contributing to a consensus mechanism, as well as rewards received from staking by proxy or allowing a third party service to stake an individual’s coins on their behalf.
This approach aligns with long standing principles of tax law in respect of the derivation of ordinary income, i.e. the receipt of a reward for the provision of services. In the context of cryptocurrencies, validators (forgers) are essentially receiving a reward for their services to the relevant network.
Taxpayers who derive income as a result of participating in a PoS consensus mechanism must report that income in their tax return in the income year the staking reward is received. Taxpayers should consider and document the monetary value of any coins at the time they are received, as well as keeping track of any expenditure that may be deductible. Taxpayers should consult their tax adviser if they are unsure about the tax treatment of any cryptocurrency holdings or the deductibility of any incurred expenditure.
Although coins are generally taxed as ordinary income on receipt their nature may change when disposed. Whether the coins are taxed as income or capital on their disposal will ultimately depend on how the coins were used and the holder’s intention at that time of the acquisition and throughout the period the coins were held.
What are Airdrops?
An additional way a cryptocurrency holder may come to own a coin is by an “airdrop”. An airdrop occurs when the network increases coin supply by increasing the balance of coins held by existing coin holders for nil consideration.
Airdrops differ from chain splits (which we considered here). A chain split occurs when a blockchain is replicated to form a new chain, often as a result of a disagreement between users managing the technology. As a result of the split a new currency will be created and holders of the existing currency will be entitled to an equivalent amount of the new currency. The creation of Bitcoin Cash in August 2017 is a notable example of a chain split. In airdrops a new chain is not created, rather the coins are duplicated.
How are Airdrops Taxed?
The ATO takes the view that the monetary value of coins received via an airdrop is to be taxed as ordinary income similar to the receipt of paid-up bonus shares. As bonus shares are additional shares a shareholder receives for an existing holding of shares in a company, airdrops are additional coins a coin holder receives for an existing holding of coins on a chain.
In addition to being taxed on receipt, a disposal of the coin received via an airdrop may also trigger a tax liability on disposal.
What should you do?
Both cryptocurrency holders and tax advisors need to ascertain how existing coins were acquired. Where coins were received from an airdrop or as a reward for participating in a consensus mechanism then a tax liability may have been created at the time a coin was received and appropriate disclosures must be made for tax purposes.
As outlined in our previous cryptocurrency article (here) the ATO has access to data about cryptocurrency activities from Australian designated service providers and other Federal Government institutions such as the Australian Transaction Reports and Analysis Centre and the Australian Securities and Investment Commission. In light of the ATO’s sophisticated data collection capabilities, advisors and investors should act with the expectation that the ATO is already aware of their cryptocurrency activities and that their anonymity is no more.
For more information on the taxation of cryptocurrencies or for general tax advice, please contact:
Laura Spencer
Senior Associate
M 0436 436 718 | T +61 3 9611 0110
E: lspencer@sladen.com.au
Daniel Smedley
Principal | Accredited Specialist in Tax Law
M +61 411 319 327| T +61 3 9611 0105
E: dsmedley@sladen.com.au
