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Bitcoins – what are they, how the ATO’s Rulings will affect them, and why you need to know about them

Posted on August 22, 2014

Bitcoins are a hot topic at the moment, and the ATO has just released rulings on how they will treat them for taxation purposes. However, we need to put Bitcoins in context to make use of the ATO’s rulings.

What are Bitcoins?

Bitcoins are a digital currency. They exist solely online. There are a number of other digital currencies, including Dogecoin and Litecoin, but Bitcoin is by far the most popular. Bitcoins have the following features:

  1. the transactions of Bitcoins are stored in an online accounting ledger called a “Blockchain”. The Blockchain is copied on to every computer that uses Bitcoin;
  2. the Blockchain records every transaction that has ever happened;
  3. to effect a transaction with Bitcoins the transaction is entered into the Blockchain. Once entered it is final and cannot be undone;
  4. recording and maintaining this extremely large Blockchain requires a lot of computing power. Users who allow their computers to be used to maintain the Blockchain get rewarded with new Bitcoins in a process called “mining”;
  5. the programs that run Bitcoin are “open source” which means that the code itself can be seen or edited by anyone. Changes become official when they are accepted by the majority of users. In this way there is complete transparency as to the system that manages Bitcoins; and
  6. the Blockchain is highly encrypted - the transactions and the people behind them are essentially anonymous to everyone else.

Where are Bitcoins used now?

The Bitcoin system was created in 2009 by a programmer called Satoshi Nakamoto. For the first few years Bitcoins have been the purview of geeks and hackers, and also a small number of criminals who have used it for its anonymity. More recently there has been much interest from speculators who have invested large amounts of money in an attempt to make profit from the wild fluctuations in its price. There are also a growing number of ordinary users who use the coin as an alternative to currency. In Australia it is currently estimated that there are 50,000 Bitcoin users and about 1,000 businesses that accept them. There are even Bitcoin ATMs.

An analogy for where Bitcoin is at the moment is the Internet during the dot-com bubble. At that time the Internet had left the domain (no pun intended) of the geeks and hackers and there was a large amount of speculative capital that distorted the market. The Internet was used only tentatively by traditional businesses. But once the surfeit of speculative capital was cleared out when the dot-com bubble burst, the Internet has been able to normalise and become an important part of our life including with companies such as Amazon and Google (Google famously had a business model that was so unviable that even the riskiest venture capitalists wouldn’t touch it).

This is not to say that there is any certainty that Bitcoin will even survive. However because it is open source there are no copyright reasons why other currencies – such as Dogecoin or Litecoin couldn’t take its place. At the moment we cannot know for sure which of these will become the next Google and which will be the next Altavista or Lycos – consigned to a footnote in Wikipedia.

Why Bitcoins will be useful

In my view, Bitcoin needs to clear the hurdle of the currency fluctuation that is caused by the large amount of speculative investment. However once the value of Bitcoin stabilises it is likely that it will find a number of niche uses that complement our currency. Possible examples are:

  1. as a costless transaction system. Although we can pay many things online with our credit cards, we may not always wish to pay the accompanying credit card fee. Bitcoin transactions are free;
  2. as an undisputable and final payment system. Just as retailers no longer accept cheques because of the risk they might bounce, so too retailers (or financial institutions) in certain circumstances might not wish to bear the cost of disputed transactions. Receiving Bitcoins is the equivalent of receiving cash: you either have it or you don’t. I note that the same legal remedies exist for Bitcoins as for cash. For example, you can sue someone for fraud or theft;
  3. as a secure form of holding money. This is because Bitcoins:
    1. can only be stolen if you reveal to someone your password;
    2. are not a financial institution and therefore can never collapse in that way;
    3. have a predictable and mathematically set expansion of the supply of Bitcoins; and
    4. will never be subject to a government printing money (as many around the world are doing); and should the US dollar ever lose its place as the world’s reserve currency then Bitcoin would be an ideal model for international exchange.

How Bitcoins are Taxed in Australia

The ATO has released five draft Taxation Determinations for Bitcoins:

  1. TD 2014/D11 – is Bitcoin a foreign currency (no);
  2. TD 2014/D12 – Is Bitcoin a CGT asset (yes);
  3. TD 2014/D13 – is Bitcoin trading stock (yes – when held for sale or exchange in the ordinary course of business);
  4. TD 2014/D14 – is the provision of Bitcoins by an employer to an employee a property fringe benefit (yes); and
  5. GSTR 2014/D3 – GST implications of Bitcoin (a transfer of Bitcoin is a ‘supply’).

I will now explain the rulings on CGT, trading stock and GST in more detail:

Bitcoin as a CGT Asset

The Commissioner considers Bitcoin to be a CGT asset as it falls within the meaning of ‘any kind of property’. This means a disposal of a Bitcoin to a third party gives rise to CGT event A1. A gain is made if the capital proceeds are more than the cost base.

The Commissioner then acknowledges that Bitcoin may be a personal use asset but declines to provide detailed circumstances in which that will be the case.

Bitcoin as trading stock

The Commissioner considers Bitcoin to be trading stock as its falls within the meaning of ‘anything produced, manufactured or acquired that is held for the purposes of manufacture, sale of exchange in the ordinary course of a business’.

Bitcoin as trading stock will mostly be of relevance to banks and investment firms that are beginning to invest and trade in Bitcoin as they do in other ‘traditional’ currencies.

Bitcoin and GST

A supply, for GST purposes, is defined to exclude money. The Commissioner considers that Bitcoin does not fall within the definition of ‘money’ as defined in the GST Act. One of the reasons is because the use of Bitcoin is not sufficiently widespread. Because it is not money, a transfer of Bitcoin is a taxable supply for GST purposes. This means there will be GST implications for transactions involving Bitcoins where the parties are registered or required to be registered for GST.

What does this matter to me if I don’t use Bitcoins at the moment?

Electronic commerce is advancing at an ever increasing pace. There will be ever more challenges for the laws that regulate commerce. Fortunately, a rigorous understanding of the law enables one to see how the law will evolve to meet the new demands upon it.

For example, an old rule relating to the formation of contracts called the “postal acceptance rule” has evolved to take in contracts sent by fax machines, then emails, and now other types of electronic communication. Technical programming issues can have a determinative effect on how these longstanding laws apply. A few lines of code or changing where the hosting server is located can completely change transactions. The impact can be significant: the simple formation of a contract can determine which tax laws, privacy law, employment law, intellectual property law and jurisdiction for dispute apply.

Many general understandings of how the law may apply to new technology are based on presumptions. For example many people assume that money in the bank is akin to cash. However a bank does not hold a bag of cash for you. Instead you have a contract of banker and customer that gives you a right to demand cash. This is an important distinction that can determine:

  1. Whether trust resolutions over a bank account are effective;
  2. Whether a cheque, promissory note or bill of exchange is money;
  3. Whether and when an electronic transaction to transfer money from that account is effective; and
  4. The tax implications of dealing with rights in relation to that bank account.

If you are dealing with electronic commerce or a new technology you should not assume that the laws that apply to a bricks and mortar operation will apply in the same way to you. Although you face the same set of rules, it may be possible for you to alter how they affect you. Indeed, it is not difficult to conceive a modified online currency that is treated, for Australian tax purposes, entirely differently.

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