INSIGHT: New Zealand Proposing to Remove Tax Barriers to Cryptoasset Investment

New Zealand’s tax rules have not kept pace with the fast moving cryptoasset sector. This has resulted in confusion over the taxation of cryptoassets, and over-taxation in certain cases.

Take GST (good and services tax—New Zealand’s value-added tax), for example. Under the current tax settings, it is arguable that cryptocurrencies do not fall within any relevant exemption from GST, even though currencies are generally exempt from GST. Accordingly, it is arguable that a New Zealand seller of a bitcoin (for example) could be liable for GST on the sale of the bitcoin to a New Zealand buyer. This would be highly problematic, given the nature of cryptocurrencies and cryptocurrency exchanges as:

• it may not be possible for the seller to verify whether the buyer of the bitcoin is a New Zealand resident or not (this is relevant to whether a GST rate of 0% can be applied to the sale);
• even if it were possible for the seller to verify that the buyer is a New Zealand resident, given the nature of cryptocurrency exchanges it would be impractical (if not impossible) for the seller to try to charge the buyer a GST “gross up,” i.e. the seller would need to bear the full cost of GST;
• worse still, we expect the seller would have difficulty claiming an input tax credit for the purchase of the bitcoin. This could mean the seller is exposed to GST at the rate of 15% on full proceeds from the sale of their bitcoin, with no offsetting input tax credit.

There has also been confusion around whether equity instruments that are structured as cryptoassets are exempt from GST. These issues are acknowledged by IRD officials who note that “The current GST rules provide an uncertain and variable GST treatment making, using or investing in cryptoassets less attractive than using money or investing in other financial assets.”

The income tax treatment of cryptoassets under the current tax settings has also been problematic. To their credit, the IRD has attempted to address this by releasing papers on an ad hoc basis explaining the income tax treatment of cryptoassets in various circumstances (e.g. where employees are paid in cryptocurrency). However, there are more fundamental, broad-ranging questions that have not been addressed. In particular, it is not yet clear how New Zealand’s “financial arrangements” rules apply to the many forms of cryptoassets in existence. If these rules apply to a cryptoasset, the holder of the cryptoasset can be subject to New Zealand income tax on unrealized gains on that asset.

In our experience, the uncertainty around cryptoasset taxation, and the potential for over-taxation, has stymied the development of New Zealand’s cryptoasset sector, and is forcing New Zealand innovators in this space to consider taking their ideas offshore.

IRD’s Proposed Solutions

The IRD acknowledges the uncertainty and potential for over-taxation of cryptoassets under New Zealand’s current tax settings, and has released an officials’ issues paper proposing two different approaches to mitigate these issues. The first proposal is to adopt a theoretically pure “tax neutral” approach to taxing cryptoassets. The alternative proposal is a more practical broad-based approach.

The “Tax Neutral” Approach

The theoretically pure “tax neutral” approach would involve cryptoassets being classified and taxed based on their underlying features. Deeming provisions would be introduced under which:

• currency-like cryptoassets would not be subject to GST, but may be subject to income tax on an accrual basis under the financial arrangements rules;
• share-like cryptoassets would be exempt from GST, and would not be subject to accrual taxation under the financial arrangements rules (with additional complexity around cross-border instruments); and
• other types of cryptoassets would have their own specific GST and income tax treatment, depending on their underlying nature.

While this approach would, in theory, minimize distortions in the marketplace and align the taxation of cryptoassets with the taxation of economically equivalent assets, the IRD recognizes various practical difficulties in taking this “tax neutral” approach. In particular, there are over 5,000 different types of cryptoassets currently on issue, with a wide range of rights and features. Some cryptoassets are “hybrids”, with features that do not easily fit within New Zealand’s existing tax framework. Accordingly, it could be very hard for taxpayers to apply this “tax neutral” approach in the real world.

Broad-Based Approach

Given the difficulties with the theoretically pure “tax neutral” approach, the IRD is proposing a simplified alternative to “exclude most types of cryptoasset from GST and accrual-based taxation under New Zealand’s financial arrangements rules.” Under this approach, “a broad definition of cryptoassets [would] be developed which captures nearly all cryptoassets that are used or invested in.”

Officials note the definition would be broader than Australia’s “digital currency” definition, and Singapore’s proposed “digital payment token” definition. It is also proposed that these amendments should apply retrospectively from January 1, 2009—the date bitcoin was launched. The proposed retrospective effect of these rules will be a welcome relief for many investors in New Zealand’s cryptoasset sector, many of whom will not (for example) have accounted for GST on their bitcoin sales to date.

While these proposals are very positive, the devil will be in the details. There are already signs that the IRD’s broad-based approach may not be as broad or as simple as many in the sector would want. For example, officials note that the financial arrangements rules would still apply to certain cryptoassets, including cryptoassets that are economically equivalent to debt, and cryptoassets that are derivatives. There are also various technical questions to resolve, including how cryptoassets would be excluded from GST.

Our View

We endorse the IRD’s aim to provide more certainty around the taxation of cryptoassets, and mitigate over-taxation. In particular, we commend the IRD for suggesting a practical broad-based approach to resolving these issues, and proposing that these changes should have retrospective effect.

Our main concern at this stage is that these proposals could be watered down over time, in the name of protecting New Zealand’s tax base. If the New Zealand government errs on the side of protecting New Zealand’s tax base, we could be left with a relatively complicated regime that hurts New Zealand’s prospects of becoming a cryptoasset hub.

Ultimately there is a political decision to be made here: should New Zealand be brave and take a risk in this space? Or will New Zealand play it safe and flounder as a just another also-ran jurisdiction in the cryptoasset sector? Time will tell.

Those interested in these issues have until April 9, 2020 to make submissions on the paper.

Simon Akozu is a Senior Associate and Zoe Barnes is a Senior Solicitor at MinterEllisonRuddWatts, New Zealand.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.