Crypto and digital assets have emerged as a lucrative investment avenue in recent years, captivating the attention of institutional investors, crypto enthusiasts and everyday individuals worldwide. “To the Moon!” or “When lambo (Lamborghini)?” is a common expression used by those looking to make a quick profit. But you need to be careful.

While most people are familiar with the capital gains tax (CGT) provisions and the concept of carrying on a business, there’s a sleeper provision that can catch unsuspecting individuals venturing into the crypto space, where they are neither clearly running a business (like a mining operation) nor simply acting as investors.

 A trip down history lane

 Prior to the introduction of the capital gains tax regime in 1985, the Australian Taxation Office (ATO) had no way to tax the capital appreciation when an asset was realised. Accordingly, to account for isolated once-off events where there is enough to treat a transaction as a profit-making scheme but not enough to be a business, they introduced a Section 15-15 of the Income Tax Assessment Act 1997 which states:

Your income (which is taxed) includes profit arising from the carrying on or carrying out of a profit-making undertaking or plan.

 It doesn’t sound hard, does it? 

Now whether rightly or wrongly, this provision unfortunately still exists today for which we consider it to be a sleeper clause because it can surprise unsuspecting investors.

Whilst it was initially introduced to catch mum and dad property developers where they ‘flip property’ on a once off basis, this has broad application and can also apply to cryptocurrency and digital assets.

In Practice

Let’s delve deeper into the details, shall we?

Unfortunately, the provision is quite broadly defined and really does come down to the individual facts and circumstances of each case.

 Taxation Ruling: TR 92/3 income tax: whether profits on isolated transactions are income is the relevant authority here. Profit from an isolated transaction is generally taxed under Section 15-15, if both of these elements must be present: 

1. The intention or purpose of the person entering into the transaction was to make a profit or gain; and
2. The transaction was entered into, and the profit was made, in carrying out a business operation or commercial transaction.

The relevant intention is both a subjective and objective look at the person’s facts and circumstances. It not necessary that the profit-making purpose or intention is the sole or dominant purpose. It just has to be significant. 

For there to be a commercial purpose, the following factors are typically considered: 

•          nature and scale of activities 
•          nature of the entity undertaking the operation
•          complexity of the transaction
•          manner in which the operation was entered into 
•          timing and various steps involved in that transaction

 
In summary, the criteria not actually that hard to prove so it would be quite easy for the ATO to argue for this circumstance. 

 Did you do something for the purposes of making a profit?

The question arises, do you know anyone (in particular in the crypto space) that does something solely for the purpose of not making a profit? 

 The caveat here is that the ‘profit making scheme’ provisions are unlikely to apply if you are truly in this space for the longer term but remember you may have to be able to demonstrate this to the ATO.

Example 1 – Bitcoin trader   Mr Digital Gold purchased 2 Bitcoin (BTC) for $100,000 and, following a sharp rise in the price of BTC, sold the digital assets one week later for $150,000. Mr Digital Gold did not carry on a business and had no previous dealings in BTC.   The profit of $50,000 is income and assessable under section 15-15. It can be inferred from the objective circumstances (especially the quick sale following a rise in price and the fact that the asset had no immediate use other than as an object of trade) that profit-making was a significant purpose of Mr Digital Gold in acquiring the BTC.   Furthermore, the substantial amounts of money involved and the nature of the asset traded lead to the conclusion that the transaction was commercial in nature.

 *the above example was taken directly from TR 92/3 and modified for crypto related assets

Tax Implications

The tax implications is that income/profits made from the sale of assets subject to a profit-making undertaking is treated not as a capital gain but rather “normal income” e.g., like your salary and wage.  These need to be reported in the assessable income label 24 under “other income”.

Accordingly, because it is not on capital account, no CGT 50% discount can apply here even if you hold the asset for more than 12 months. It also means that the income derived from the sale of crypto/digital assets cannot be offset against any capital losses that you have made during the year or have carried forward. 

However, on the flipside, any losses make under a profit making scheme is deductible and can be offset against other income (unlike CGT losses). These deductions need to be reported in the deduction label 15 under ‘other deductions’.

Practical Tips

Now if you are involved in the crypto space, there are varying type of products/scenarios which you need to be cautious about:

1. Crypto trading – if you have read the guide on carrying on a business and you don’t think you would meet the requirements to be in business, you would still need to be careful if you are crypto trading under these rules as it can have the effect of undesired tax outcomes
2. Derivatives & profit like activities – options trading, contracts for difference (CFD), arbitrage trading, maximal extractable value & front running are all activities which can be caught here.
3. Non-fungible tokens (NFT) – if you are an artist or trading NFTs in enough size, volume, and scale such that it is a commercial transaction, then the profit derived can be ordinary income and not subject to CGT

WARNING: if you are an NFT trader/artist and you think you may fall within these provisions, please be warned of the potential GST impact on your sales. Professional advice should be sought here as the ATO have expressed their position on GST on NFTs.

Of course, this is not an exhaustive list, as new products are being developed daily in this rapidly innovating space. However, it provides an idea of the features that maybe prevalent in a profit making scheme.

Conclusion

"Clear as crypto" when you first got into it? I’ll bet! It is certainly prudent to really familiarise yourself with these provisions before you put on a trade or get into other activities to ensure that you fully understand the tax consequences of your activities.

Whether you are a seasoned crypto adventurer or have began dappling in this revolutionary world, feel free to reach out to your team of crypto tax specialist to decrypt your tax and accounting affairs today on (07) 3569 3701 or via email at: david@consensuslayer.com.au.