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14 September 2018
Taxation of cryptocurrencies before draft TLAB
Cryptocurrencies in draft TLAB
Inclusion in definition of 'financial instrument'
Ring-fencing provisions now apply
National Treasury's stance on cryptocurrencies
On 16 July 2018 the National Treasury's draft Taxation Laws Amendment Bill (TLAB) was published for public comment. The draft TLAB represents a first for South African taxpayers as it introduces legislative provisions regarding cryptocurrencies.
On 6 April 2018 the South African Revenue Service (SARS) announced that normal tax rules would apply to cryptocurrencies in South Africa. Despite the continued popularity of cryptocurrency trading, until the publication of the 2018 draft TLAB, South African legislation had been silent on the taxation and regulation of cryptocurrencies (for further details please see "SARS speaks up: clarity provided on taxation of cryptocurrencies").
In their operations within the cryptocurrency sphere, taxpayers have thus far simply been required to declare any cryptocurrency gains or losses as part of their taxable income. Further, in accordance with SARS's April 2018 announcement, in order to determine whether cryptocurrencies and cryptocurrency transactions have been of a capital or revenue nature, the taxpayer's intention when acquiring the cryptocurrency has been considered. For example, if the taxpayer obtained a cryptocurrency in order to pursue profit making, the cryptocurrency would be considered trading stock and any transactions would be of a revenue nature. This test has been applied to the facts and circumstances of each individual case.
The draft TLAB includes cryptocurrencies in three separate sections and with effect in both the Value Added Tax Act (89/1991) and the Income Tax Act (58/1962). However, this article focuses solely on the impact of the proposed amendments to the Income Tax Act.
The draft TLAB proposes to amend the definitions section of the Income Tax Act to include "any cryptocurrency" in the definition of a 'financial instrument'. Further, it is proposed that Section 20A be amended to include "the acquisition or disposal of any cryptocurrency" under the trades covered by the ring-fencing provisions thereof.
Under the proposed amendments set out in the draft TLAB, cryptocurrencies will be included in the definition of a 'financial instrument' set out in Section 1 of the act, alongside, for example:
The inclusion of cryptocurrencies in the Income Tax Act's definition of a 'financial instrument' is relevant is in the context of, among other things, Section 22's trading stock provisions. Section 22 sets out the amounts to be considered for trading stock values in relation to the determination of taxable income, and financial instruments are excluded from the considerations of Section 22(1)(a).
Further, there may be capital gains tax implications for including cryptocurrencies in the definition of a 'financial instrument'. One example of where this impact may be felt is in the context of Paragraph 42 of the Eighth Schedule to the Income Tax Act, which provides for the taxation of short-term disposals and acquisitions of identical financial instruments. Paragraph 42 applies only where a person makes a capital loss on the disposal of financial instruments, subsequent to which the same person or any of its connected persons acquires a financial instrument that is of the same or equivalent quality within a 91-day period (beginning 45 days before the date of disposal and ending 45 days after that date). In these instances, according to Paragraph 42, the capital loss cannot be considered at the time of disposal and must instead be carried forward and added to the base cost of the replacement instrument.
According to the Comprehensive Guide to Capital Gains Tax, Paragraph 42 essentially encompasses an anti-avoidance rule which governs instances that are informally referred to as 'wash sales', where financial instruments are disposed of towards the end of an assessment year in order to realise losses. Considering the nature of cryptocurrency trading, it is conceivable that short-term disposals and acquisitions are common and that Paragraph 42 will therefore seek to ensure that traders which hold a cryptocurrency as capital in these circumstances will be treated as having disposed of the asset for proceeds equal to base cost, with the capital loss being 'held over'. The exclusions in Paragraphs 42(3) and 42(4) will still apply.
Should the proposed amendments take effect, the acquisition or disposal of any cryptocurrency will be considered a specified trade under Section 20A of the Income Tax Act. As such, Section 20A will be relevant to cryptocurrency traders, as it ring-fences assessed losses associated with the acquisition or disposal of a cryptocurrency. This section applies to natural persons only and effectively prevents taxpayers from offsetting assessed losses incurred from the kinds of trade contemplated in the section against the income derived from carrying on other trades. In other words, assessed losses derived from a trade listed in Section 20A may be set-off only against income derived from that trade in future assessment years.
Colloquially, Section 20A has been said to ring-fence the offsetting of assessed losses associated with 'suspect trades'. Among such trades listed in Section 20A(2)(b) are:
In this way, Section 20A differentiates between losses resulting from the actual trading activities of taxpayers and the losses resulting from what could be perceived as their hobbies or lifestyle activities.
As a result of this proposed amendment, taxpayers who trade in cryptocurrencies may face potential restrictions in netting-off their assessed losses incurred in trading cryptocurrencies against their taxable income. The inclusion of "acquisition or disposal of any cryptocurrency" certainly limits taxpayers who do not hold a cryptocurrency as a capital asset; however, cryptocurrency traders are not prevented from offsetting losses from their cryptocurrency trade specifically against the income from that trade.
In a volatile market such as cryptocurrency trading, losses are to be expected. The proposed amendment to Section 20A of the Income Tax Act appears to be an attempt to limit the effect of these losses on SARS's revenue collection prospects. This is further evident in the proposed effective inclusion of cryptocurrencies in the anti-avoidance provisions of Paragraph 42 of the Eighth Schedule to the act.
The draft TLAB is indicative of the National Treasury's approach to the tax treatment of cryptocurrencies, with the proposed amendments demonstrating an identifiable impact on cryptocurrency traders at the outset. While taxpayers may welcome the further clarifications in the ever-expanding cryptocurrency environment, SARS and the National Treasury have invited written public comment in respect of the suggested amendments and are engaging in a full consultation process.
For further information on this topic please contact Jessica Carr at Cliffe Dekker Hofmeyr by telephone (+27 115 621 000) or email (firstname.lastname@example.org). The Cliffe Dekker Hofmeyr website can be accessed at www.cliffedekkerhofmeyr.com.
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