Inland Revenue is upping the heat on New Zealand crypto investors, but with little guidance, many are flying blind and risk falling foul of the law or being hit with hefty tax bills.

Bell Gully special counsel Campbell Pentney said Inland Revenue had started to take an interest in cryptocurrency over the past few years, with the intensity of that interest waxing and waning depending on how the market is going - which correlates to how much tax is likely to be collected.

※Inland Revenue has target sector areas where they think there might be underpayment or underreporting of tax, and every year they will report on what these are. And this year, among other industries, cryptocurrency is one that has been targeted.

※That’s partly perhaps because the markets have obviously rebounded to all-time highs and Inland Revenue are interested in whether people have been reporting on their tax obligations.§

The price of Bitcoin has been bouncing around the high end of the $60,000 to $74,000 range for much of this year.

With crypto markets performing well, Inland Revenue sent out targeted questionnaires to individuals it had identified as investing in cryptocurrencies last year, followed by another batch of letters in July.

Pentney said Inland Revenue already had data from local and international crypto exchanges, meaning they can fairly easily identify users and assess their tax returns.

The letters read: ※Dear Sir/Madam, it has been brought to our attention that you have significant crypto-asset activity. This activity has increased in recent years. We are aware you operate on both New Zealand crypto-asset exchanges and offshore exchanges such as [ names of exchanges ]. Furthermore, we can trace crypto-asset transactions through major banks via bank account [details]＃.We have reviewed your income tax returns and it appears you have not included your income from crypto-assets.§

The letters then went on to seek further information - or the receiver could be at risk of an audit.

While close to 230,000 New Zealanders are understood to be involved in cryptocurrency trading or investing, the value of their holdings or the frequency of their trades isn’t known.

Pentney expects some investors would be surprised that they had to pay tax on cryptocurrency even if they haven’t made withdrawals.

※I talk about money coming in and out of exchanges, but it’s a misconception that you only get taxed when you take your money out into New Zealand dollars.

※In fact, if you exchange Bitcoin to another crypto-asset, or you do some trading, that can also trigger a tax liability, so you could have a tax liability despite not having taken any money out into your bank account.§

Those activities don’t have the same visibility to Inland Revenue as a withdrawal into a bank account, but could be revealed in a wider audit or if it receives wider exchange records. Under a new OECD crypto-asset reporting framework that more than 50 countries have signed up to, including New Zealand, Inland Revenue will also receive information about crypto-asset activity from overseas counterparts in the future. Investors shouldn’t assume their international transactions won’t be seen, he said.

Ideological positions about cryptocurrency being decentralised aside, a lot of the confusion around crypto tax obligations comes down to there being no crypto-specific tax laws, outside some narrow rules such as GST and rules that cover non-fungible tokens (NFTs).

※Instead, it’s based on Inland Revenue’s interpretation, formed over time, of how the existing rules work. They’re making comparisons to assets like gold bullion and collectibles in terms of whether you pay tax when you sell.§

Pentney said many might operate on the assumption that as New Zealand lacks a capital gains tax for property, that position would apply to other assets.

※However, here is a rule that says if you acquire something for the purpose of reselling, then you pay tax on your profits. That’s how gold is treated and Inland Revenue treats Bitcoin like that.§

The comparison with gold is becoming more difficult as the crypto world evolves and less traditional products such as decentralised finance are on offer. Those types of products have more in common with shares than gold, especially those that offer some form of revenue stream. There may well be some good arguments that some crypto-assets could be treated as a capital asset with any gains free from tax, but this depends entirely on the circumstances. The tax status of crypto-assets is a point that is ripe for dispute and Inland Revenue appears to be adopting the default position that they are taxable for the time being.

Tax bills from Inland Revenue are hit with potential short-fall penalties and compounding interest, so Pentney says making use of the voluntary disclosure regime, where you approach Inland Revenue to say that you’ve had a shortfall, can see your penalties reduced dramatically.

※That’s the main mechanism people should be aware of, and the full benefit may not be available once Inland Revenue decides to audit you.§

Because of this, he says crypto investors should be proactive and approach a professional if they’re unsure about their obligations. Pentney also said: ※Time is of the essence as use of money interest will be applied to historical tax liabilities - this can compound and with the current rate of nearly 11 percent it is better to act sooner than later. Inland Revenue also has the ability to go back at least four years to look at earlier activity and sometimes even further in time§.

The lack of clarity around cryptocurrency laws and regulation is commonplace worldwide.

In New Zealand, Inland Revenue’s interest seems to have historically waned when crypto markets are down and there’s going to be less tax to recover. Inland Revenue only has so many resources to put towards any given area, but the lack of consistency hasn’t helped. ?

※In 2018 and 2022 it felt like the crypto-asset market was in a serious decline, maybe forever, and I can see how officials could then say it’s not worth the resources trying to come up with new rules or interpretations of the law.

※The problem is that if you wait for the good times, they’ve already arrived before you can act, and it’s very difficult to give people consistent clear guidance that would let people transact with their crypto-assets in a way where they know what they’re doing and what the tax implications are.§

Pentney said the major issues where guidance would be useful included the tax implications of generating passive income from crypto-assets and what happens when your assets are frozen or lost on an insolvent exchange.

※The hard part for Inland Revenue [in forming guidance] is there’s just an ever-evolving series of new questions that come up because the space changes so quickly.

※The alternative way of doing it would be some kind of law change, we have special regimes for forestry, petroleum and property sectors, so having a special regime for crypto-assets might be the easy way to do it.§

A law change similar to the bright line test for property could be an answer.

Some crypto currency enthusiasts see crypto-assets as a rejection of the financial system, but Pentney says acceptance of tax implications varies between investors.

※New, sophisticated investors accept that’s simply how it is. Taxation might be seen as unfair, and certainly it’s seen as lopsided compared to other asset classes, but on the other hand you can have very large historical gains.

※When I look at smaller investors, maybe those that have been around for a really long time, there is a sense that this is anti-government, it’s about having financial sovereignty which itself is removed from the tax system.

※But the question is, does the law apply to you? And it does, so the implications need to be looked at and treated seriously and with urgency.§

As both cryptocurrency and regulatory oversight evolves, Pentney says it’s likely Inland Revenue’s interpretation on the taxation of crypto-assets as equivalent to gold would be tested Iegally at some point. ※The only caveat is whether an investor has the fortitude to put themselves forward and go into a tribunal or the court because that often involves costs, but also potentially being in the public spotlight.§