Taxation of cryptocurrency prior to the draft TLAB
The South African Revenue Service (SARS) announced on 6 April 2018 that normal tax rules would apply to cryptocurrency in South Africa. As noted in our Tax and Exchange Control Alert of 20 April 2018 in this respect, despite the continued popularity of cryptocurrency trade, South African legislation has, until the 2018 draft TLAB, been silent on the taxation and regulation of cryptocurrency.
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. Moreover, in accordance with SARS’s April announcement, in order to determine whether cryptocurrency and cryptocurrency transactions are of a capital or revenue nature, the taxpayer’s intention when acquiring the cryptocurrency would be considered. For example, if the taxpayer obtained cryptocurrency so as to pursue profit-making, the cryptocurrency would be considered trading stock and any transactions would be of a revenue nature. This test is applied to the facts and circumstances of each individual case.
Cryptocurrency in the draft TLAB
Though the draft TLAB has included cryptocurrency in three separate sections and with effect in both the Value Added Tax Act, No 89 of 1991 and in the Income Tax Act, No 58 of 1962 (Act), this alert will focus solely on the impact of the proposed amendments in the Act.
The definitions section of the Act may be amended by the draft TLAB to include “any cryptocurrency” in the definition of “financial instrument”, whilst s20A of the Act may be amended by the draft TLAB to include “the acquisition or disposal of any cryptocurrency” under the contemplated trades within the ring-fencing provisions thereof.
Cryptocurrency forms part of the definition of “financial instrument”
Per the proposed amendments set out in the draft TLAB, cryptocurrency will be found alongside, for example, loans, debentures, financial arrangements determined with reference to the time value of money, bonds, option contracts and interest-bearing arrangements in the definition of “financial instrument” in s1 of the Act.
One of the contexts in which the inclusion of cryptocurrency in the definition of “financial instrument” in the Act is relevant is the trading stock provisions in s22 of the Act. The section sets out the amounts to be taken into account in respect of values of trading stocks in relation to determination of taxable income, and financial instruments are, for example, excluded from the considerations at s22(1)(a).
Furthermore, there may be capital gains tax (CGT) implications for including cryptocurrency in the definition of “financial instrument”. One example of where its impact may be felt is in the context of paragraph 42 of the Eighth Schedule to the Act, which provides for the taxation of short-term disposals and acquisitions of identical financial instruments. The paragraph applies 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 taken into account 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 a year of assessment, in order to realise losses. Considering the nature of cryptocurrency trade, it is conceivable that short-term disposals and acquisitions are common, and that paragraph 42 will therefore seek to ensure that traders who hold 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 paragraph 42(3) and 42(4) will still apply.
Ring-fencing provisions now apply to cryptocurrency
The acquisition or disposal of any cryptocurrency is now, due to the proposed amendments in the draft TLAB, contemplated as a specified trade in s20A, should the amendment come into effect. As such, s20A becomes relevant to cryptocurrency traders, as the section ring-fences assessed losses associated with the acquisition or disposal of any cryptocurrency. The section applies to natural persons only and effectively prevents the taxpayer from setting-off assessed losses incurred from the kinds of trades contemplated in the section against the income derived from carrying on other trades. In other words, assessed losses derived from a trade listed in s20A, may only be set-off against income derived from that trade in future years of assessment.
Colloquially, s20A has been said to ring-fence the setting-off of assessed losses associated with “suspect trades”. The Act lists amongst such contemplated trades at s20A(2)(b), for example, the dealing of collectibles, the rental of residential accommodation to connected persons, any form of gambling or betting and the practicing of sports. In this way, s20A differentiates between losses resulting from the actual trading activities of a taxpayer, and the losses resulting from what could be perceived as the taxpayer’s hobbies or lifestyle activities.
As a result of this proposed amendment, taxpayers who trade in cryptocurrency may face potential restrictions in netting off their assessed losses incurred in trading cryptocurrency against their taxable income. The inclusion of “acquisition or disposal of any cryptocurrency” certainly limits the taxpayer who does not hold cryptocurrency as a capital asset, however, cryptocurrency traders are not prevented from setting off losses from their cryptocurrency trade specifically against the income from their cryptocurrency trade.
National Treasury’s stance on cryptocurrency
In a volatile market such as cryptocurrency trading, losses are to be expected. The proposed amendment to s20A 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 cryptocurrency in the anti-avoidance provisions of paragraph 42 of the Eighth Schedule to the Act.
The draft TLAB has given an indication of National Treasury’s approach in respect of the tax treatment of cryptocurrencies, with the proposed amendments displaying an identifiable impact on cryptocurrency traders at the outset. Whilst taxpayers may welcome the further clarifications in the ever-expanding cryptocurrency environment, SARS and National Treasury have invited written public comment in respect of the suggested amendments and are engaging in a full consultation process herein.
Written by Jessica Carr