Nowhere to hide… Advice for your crypto-clients

Financial advisers and planners must make sure they understand their client’s total income picture before advising them on the tax implications of their crypto asset investing or trading activities. “It also makes sense for advisers or advice practices to partner with a registered tax practitioner with a proven track record to help with complex tax advice,” said Francois du Toit, CFP® and owner of Propulsion Learning & Technology. Crypto assets have become mainstream over the past couple of years; but there is still widespread confusion over how individual taxpayers should declare their cryptocurrency investing or trading activities to SARS.

Allow your intention to guide you

There are two main ways in which tax could be liable on an individual’s cryptocurrency transactions, with the applicable method depending on his or her intention. “It comes down to the behaviour and intent of the taxpayer,” said Du Toit. “If the cryptocurrency is held for a long period of time, probably three years or longer, and is then sold, SARS should agree it to be an investment, to which Capital Gains Tax (CGT) applies; if the cryptocurrency is bought and sold on a regular basis, even once a year, then it could be treated and taxed as part of income”. 

Dale Irvine, an executive director at Sentinel International, expanded on the concept, saying that cryptocurrency is defined as an asset or bundle of rights, meaning that the normal rules in determining capital versus revenue apply: “The indicative factors to consider include what your client’s intention was when purchasing the asset, whether there was a change of intention, how frequently transactions took place, the length of time the asset was held, the nature of your client’s business and the reason for the sale”. 

In either case, the sale of the cryptocurrency is seen as the tax ‘trigger’ event, with an important caveat. “Switching between cryptocurrencies is equivalent to a sale and would also trigger a tax event,” said Hedley Lamarque CFP®, a Wealth Adviser at BDO Wealth Advisers. And the argument that you merely moved one cryptocurrency into another will not hold water. “Using one cryptocurrency to buy another is no different to any barter transaction which is taxable and treated the same way SARS would normally treat it,” agreed Irvine. 

Why all the uncertainty?

This writer wondered why there was so much uncertainty around the appropriate tax approach for this emerging asset class. Du Toit said that the wording of current tax law is old fashioned and silent on recent investment vehicles such as crypto assets and even ETFs. Section 9C of the Income Tax Act narrowly defines an equity share, with the result that crypto assets do not clearly fall into the ‘exact and certain’ section 9C rules. Section 9C removed the subjective test and brought clarity around the way defined equity shares, including unit trusts, are taxed in year four, and it is probably time for National Treasury to expand its objective three year test to accommodate newer investment vehicles. 

Irvine commented that 9C was not a good ‘fit’ for cryptocurrency, since the asset class was neither similar to equity shares nor held in SA-resident companies. “What might help the taxpayer, however, is the argument of holding their crypto assets for more than three years … although the asset is not deemed, it would assist in the argument as to why the crypto is held as capital instead of income,” he said. Commentators agree that the taxation of this investment class will either be a capital gain tax, for investors, or a revenue or income tax for the rest. 

Investors, CGT applies: If you buy and hold cryptocurrency for a period exceeding three years, with the view to accumulating value over time, then you will be considered an investor. Investors will trigger a CGT event when they sell or switch all or part of their holdings, which event incurs a tax liability in the tax year in which the sale or switch was made. You pay tax on your capital gains per the current SARS rules. In other words, you calculate your capital gain, reduce the gain by the R40000 annual allowance, and then add 40% of this amount to your total taxable income. “Your cryptocurrency capital gain will be added to the gains and losses from the sale or disposal of any other assets during the tax year. The R40000 is an overall deduction for the year, not per CGT event,” explained Du Toit. 

Traders, income tax applies:  If you actively trade cryptocurrencies, then the profit you make from all sales or switching transactions carried out in a given tax year is considered as profit from an ‘income generating activity’ and must be added to your gross income amount. You would therefore pay tax on your cryptocurrency income at up to your maximum marginal tax rate of 45%. Although some commentators have suggested that SARS will view all cryptocurrency transactions as ‘income generating activity’ it is unlikely that those who invest with a genuine long-term view will be assessed in this way. It should be noted, however, that the onus of proof insofar his or her intention vests with the taxpayer. Du Toit said that traders aim to increase their annual income or revenue by buying and selling assets and that the tax treatment of cryptocurrency traders would be the same as that for taxpayers who buy and sell forex, houses, shares or other goods to produce revenue. 

Longingly eyeing its share of bitcoin super-profits

SARS has been licking its lips as the price of bitcoin and other cryptocurrencies go through the roof. Bitcoin, for example, jumped from around R50k in January 2019, to R105k in January 2020, to R550k in January this year; but the digital currency has been incredibly volatile, peaking at R900k in May 2021 and currently changing hands at around R490k. The point is that those trading the currency could as easily have posted a loss as a profit in recent months. So, let us consider a taxpayer who buys and sells bitcoin throughout the year, ending up with a R150000 loss from trading activities. Can this amount be offset against other income generating activities? 

“This becomes more complicated,” opined Du Toit. “The crypto trading will be treated as a separate trade from other income generating activities, such as earning a salary, and SARS may allow a deduction against other income in the first three years”. He added that each case would have to be assessed on its own merits and that SARS was likely to ring-fence losses from cryptocurrency trading activities if they persisted for more than three tax years. In such cases, losses will have to be carried forward and be offset against future profits from the same cryptocurrency trading activity. Lamarque suggested keeping a close eye on SARS’ interpretation notes and reading up on ‘suspect trades’ and ring-fencing of assessed losses as per section 20A of the Income Tax Act, before offsetting cryptocurrency trading losses against taxable income, even in the first year of such activity. Capital losses can be offset against future capital gains from any source. 

One of the difficulties that a taxpayer may have on his or her various cryptocurrency transactions is the need to convert values into different cryptocurrencies as well as dealing with the fiat currency rand / dollar exchange rate. Consider the following example: On 1 July 2021 the taxpayer sells 1 Bitcoin (at $33771 per coin) in exchange for 15,84 Ethereum (at $2132 per coin). His purchase price was $16082 on 14 November 2020. In this case the taxpayer will have to convert each stage of the transaction to an acceptable rand / dollar exchange rate when completing his or her tax return. SARS publishes relevant average exchange rates for each month; but taxpayers could also rely on the daily forex crosses from one of the country’s banking institutions if necessary. 

SARS will get wind of your crypto asset activities

Many taxpayers are dabbling in cryptocurrency trading and investing in the mistaken belief that SARS will never get wind of their activities. This is an incredibly naïve stance given that SARS and other financial sector regulators have crypto assets firmly in their sites. “SARS has made it clear that they will be focusing on cryptocurrency investments and doing lifestyle audits on potential big investors; the magnifying glass is on crypto,” said Irvine. Financial advisers and planners should remind clients that a failure to declare purchases and sales on trading assets in this year’s tax return could result in crypto profits being eroded by tax penalties and interest in the future. 

It is nigh impossible to hide capital, income or profits in the digital age. Du Toit pointed out that there is already automatic exchange of financial information between over 100 countries and that SARS recently ordered local crypto exchanges to provide them details of certain account holders. “It was also announced in the 2021/2022 Budget that SARS would receive an additional R3 billion to modernise its technology and infrastructure systems, as well as its artificial intelligence capabilities. You can be sure that much of this cash will be applied to boost tax collections, including by more intensive enforcement and monitoring of taxpayers’ crypto asset activities. 

Taking aim at the most obvious target

Most commentators agree that SARS sees cryptocurrency investors and traders as an easy target, having already taken early steps to extract their pound of flesh from crypto trading profits. And the private sector will assist in their endeavours. “You will probably find over the next year or two that cryptocurrency platforms will have to up their tax reporting functionality,” said Lamarque, adding that financial advisers would do well to seek independent tax advice for clients that were heavily involved in cryptocurrencies. 

“SARS has already included questions about whether or not you are investing in crypto assets in their online tax return forms,” he concluded. “If they pick up an undeclared capital gain or trading profit two years down the line they can reissue your assessments and charge interest and penalties”. 

Writer’s thoughts:
Our brief interaction with three financial and tax advice professionals showed up a reasonable level of uncertainty with regards the tax treatment of crypto asset gains or profits. Much of this uncertainty stems from the lack of comprehensive guidance from SARS, and it is hoped the authority will soon issue an updated interpretation note on the matter. In the meantime… What approach are you taking when advising your clients on their crypto asset tax liabilities? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts editor@fanews.co.za.

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