According to Joon Chong, partner at law firm Webber Wentzel, a gain on the sale of crypto assets may be taxed as either revenue or capital, in line with the same income tax regulations that apply to the sale of shares or unit trusts.
For cryptocurrency traders and investors who believed it was a simple way to make money, the market gyrations have served as a first wake-up call. The second alarm is about to go off as SARS is looking at how to tax all possible crypto activities.
The South African Reserve Bank (SARB) is drafting new banking and tax regulations that will apply to crypto assets which the regulation institute defines as “a digital representation of value that is not issued by a central bank, but is traded, transferred, and stored electronically by natural and legal persons for the purpose of payment, investment, and other forms of utility, and applies cryptography techniques in the underlying technology.”
The deputy governor recently announced that the SARB was working on a number of workstreams, including a framework for crypto exchange platforms that will assure compliance with anti-money laundering and countering the financing of terrorism policies, as well as exchange control rules and tax laws. Finalizing this would take a year to 18 months.
As of now, there are no specific provisions for crypto assets in the South African Income Tax Act 58 of 1962 (ITA). This means that the tax treatment of crypto assets would be determined in terms of the usual income tax rules for financial instruments such as equity shares or unit trusts.
According to the Webber Wentzel partner, cryptocurrency asset sales are taxable transactions. When products or services are purchased using cryptocurrencies, crypto assets are sold for a profit equivalent to the market value of the goods or services purchased. As a result, when crypto assets are sold, there is a cash outflow and tax due.
The question will be whether the taxpayer was involved in a profit-making plan when determining whether the gains or losses from the sale of crypto assets are capital or revenue in nature.
If a taxpayer has held an equity share for at least three years, section 9C deems the gains from the disposal of the share to be capital in nature, regardless of the intention. The definition of an equity share includes shares in companies or a participatory interest in a portfolio of a collective investment scheme. It does not include crypto assets.
Section 9C of the Income tax act arguably does not apply to the holding of crypto assets, which makes it more difficult for taxpayers to prove that their crypto gains are capital rather than revenue in nature, and therefore subject to capital gains tax (CGT) rather than income tax.
Webber Wentzel provides three examples below to show how it might be possible to establish the reason behind cryptocurrency gains.
In the first scenario, AB, who is finishing up his articles at a medium-sized audit firm, bought bitcoins with personal resources with the intention of holding them for at least a year. Two months later, though, AB sold the cryptocurrencies for one of two reasons.
1a) AB sold because he needed the funds to repair his car when he had an accident. AB had a small loss but was glad to recover most of the capital put down.
1b) AB sold and made a small gain on the sale, as his risk appetite diminished at the first signs of a crash. He had also done more research and realized that he was not as comfortable with the risks as he thought he would be.
He says that these losses (1a) or gains (1b) are capital in nature. However, AB may find it difficult to satisfy the burden of proving a capital intention, especially if the coins were held in an exchange wallet and not in a personal wallet. In an exchange wallet, crypto assets are stored on a platform that lends itself to easy liquidation and trading.
A third party, namely the exchange, is given the right to dispose of the coins. In contrast, coins stored in a personal wallet cannot easily be traded.
If AB is in the highest marginal bracket (ZAR1,731,601 for the 2023 tax year), crypto asset assessed losses could also be ring-fenced only to be set off against future crypto asset gains.
In the second scenario, the CD is a full-time employee of a bank. She invests all of her free time in studying and monitoring the cryptocurrency markets with the intention of buying and selling cryptocurrencies as a long-term retirement investment. She understands that making money with cryptocurrency investments requires being quick and nimble.
The first year of CD saw 200 disposals of 10 different cryptocurrencies, testing the waters, while the second year saw 1000 disposals of 30 different cryptocurrencies.
All profits or losses from the two years are likely to be viewed as revenue, in Joon’s opinion.
In the third scenario, EF works full-time as a content creator for YouTube, a dog trainer, and a social influencer. EF also keeps a few machines in a spare bedroom which he uses to mine cryptocurrencies.
According to Joon, this person gains on disposal of the crypto assets mined would be capital in nature. EF’s situation is similar to a homeowner who has a home and builds another house on the plot which is then sold after subdividing the land.
However, the gains would be more akin to revenue from a scheme of profit-making if the value of coins minted became a few million Rands and the number of coins minted numbered in the hundreds and not fractions. When EF requires an infrastructure upgrade or has to rent more space for the machines and installs a cooling system, then in our view EF would have crossed the Rubicon and is carrying on a scheme of profit-making.
Joon concludes that when deciding whether gains or losses from the sale of crypto assets are capital or revenue in nature, the taxpayer’s intent is crucial. However, given the high risk and volatile character of this asset class, taxpayers will have a difficult time demonstrating that their gains or losses are of a capital nature.
