The 2016-2017 Budget referred to a suite of proposed changes designed to promote the financial technology or “FinTech” industry, particularly in the context of ‘technological innovation’ and ‘disruption’. This reform package ranges from proposals designed to expand crowd-sourced funding models, to introduce clearer guidance for financial ‘robo-advice’, and to establish a ’regulatory sandbox’ for start-up projects.
Following the Government’s announcement in March 2016 that it would end the double taxation of bitcoin and similar digital currencies, the FinTech reform package confirms the Government’s commitment to doing so. Treasury has released a Discussion Paper on the GST treatment of digital currency, which considers the key methods of overcoming the double taxation issue, and raises a number of practical challenges associated with doing so.
The double taxation issue
The taxation of bitcoin and similar digital currencies has been hotly debated since the Australian Taxation Office issued a suite of rulings in late 2014. In these rulings, the ATO concludes that bitcoin and similar digital currencies do not constitute money in the legal sense, and should therefore be treated as commodities for tax purposes. This disparity between the (at least notional) use of digital currency as money, and its taxation, causes potential taxation of any ‘supply’ of digital currency under the GST regime. This means that, where digital currency is used as payment, GST is levied on a single commercial transaction as though it was two separate taxable transactions. As well as potentially making the use of digital currencies in Australia more costly for businesses and consumers, it also introduces complexity and reportedly inhibits the Australian digital currency industry’s global competitiveness.
The double taxation issue is extensively outlined and analysed by the Senate Economics References Committee’s 2015 Report Digital currency – game changer or bit player?, and is acknowledged by the Productivity Commission’s 2015 Report into Business Set-up Transfer & Closure as a key challenge to the digital currency industry. Both Reports received evidence that the double taxation issue had a particularly deleterious impact on the digital currency industry in Australia.
What’s difficult about solving the double taxation issue?
Having established that there is strong case to rectify digital currencies’ GST treatment – a change which also falls conveniently within the Government’s FinTech policy agenda – the challenge is to ensure that the necessary legislative amendments are drafted effectively. As raised in the Discussion Paper, there are two fundamental challenges that must be addressed.
First, how should digital currencies be defined? There are over 600 bitcoin-based digital currencies, and even more which do not derive from bitcoin software. This number changes rapidly, as do many aspects of digital currency technology. Drafting must be broad enough to adapt to fast-paced technological change, or else the legislators risk playing a constant game of catch-up.
The flip side is that broad drafting has the potential to capture unintended forms of property like in-game money, frequent flyer points, or other virtual property. The broader the definition is, the greater the chance that legislative amendments will have unintended, unforeseen consequences – drafters must strike a fine balance.
Secondly, there are multiple ways in which the GST regime could be amended to resolve the double taxation issue. Choosing which approach is most appropriate will require careful consideration – again, any legislative change risks unintended consequences. It will be necessary to ensure that the approach is consistent with the overarching principles behind the GST regime. The more anomalous the treatment of digital currencies appears to the GST regime, the greater the risk of unintended consequences.
How should the GST regime be changed?
Addressing these challenges requires the legislator to have regard to the purpose of the Government’s reform, as well as the broader operation of the GST system itself. Bitcoin is not the first, nor the last time that a ‘disruptive’ technology has reinvented a pre-existing product. A starting point for determining which treatment is most appropriate is likely be the GST characterisation that best aligns digital currencies’ practical use with the underlying purpose behind the concession. If most digital currencies are used as money, this may support treating them as money; if most are used as speculative investments, this may suggest that they should be input taxed.
Twenty years ago, the United Nation’s Model Law on Electronic Commerce espoused the principle that we should seek to treat technological adaptions of new technology as equally as possible with their traditional counterparts. This general principle is broadly mirrored by the fundamental principles that guide the design of our tax law: generally, it is preferable for a tax system to be neutral and equitable in its treatment of comparable taxpayers, technologies or transactions, in order to minimise economic distortion (at least where there is little basis to use the tax system to influence behaviours). The direction taken by the legislators should be guided by these principles, to achieve fairness or parity of treatment between digital currency and its traditional counterparts.
Encouragingly, the Government’s proposed approach seems to align with these principles, stating that they will “[remove] the impediments to the development and use” of digital currency. In other words, the focus is on updating and amending legal and regulatory frameworks to create a technology-neutral environment.
The Discussion Paper identifies three main categories of ‘exemption’ under the GST regime. The double taxation issue would be resolved if digital currencies fell within any one of these categories:
- GST-free (e.g. akin to medical services);
- Input taxed (e.g. akin to financial services); or
- Treating it as not constituting a ‘supply’, as is the case when money is used as payment for a supply.
It difficult to determine whether digital currencies are best characterised as input taxed or as consideration for a supply (they may be either, depending on the circumstances and their use). However, the basis for exempting bitcoin does not reconcile with the rationale behind the ‘GST-free’ exemption, so it is unlikely that treating digital currencies as GST-free would be the best approach.
The principle behind the GST-free concession is to exempt “basic necessities” such as food and healthcare. The GST regime grants more generous grants credits where a supply is GST-free than when it is input taxed. As digital currencies are not a basic necessity, granting them this form of exemption seems incongruous, to a point that any benefits associated with administrative convenience is unlikely to overcome.
What do these changes mean for digital currency in Australia?
Removing what has been cited as a key challenge for Australian digital currency businesses is good news for the industry. It is commendable that the government has avoided the route taken by some governments to outlaw bitcoin and that taken by others which have done nothing to address tax as a barrier to digital currencies’ adoption. Applying unfavourable regulatory approaches to a technology which is already associated with illicit activity risks cementing its position as a technology mainly for the shadow economy, and losing many of the benefits it may offer.
Australia is fairly early in responding to the issue but is not the first to address this problem internationally. The UK revenue authority announced that it would address the double taxation issue in early 2014. On changing its VAT treatment of digital currencies, the UK was rumoured as a new ‘bitcoin epicentre‘. A ‘first mover advantage’ and hopes of Australia becoming a hub for bitcoin activity may have past. Last year, the Senate Inquiry and Productivity Commission both heard evidence that major Australian bitcoin companies were looking to move offshore to avoid the unfavourable GST treatment. If the changes can be drafted effectively in a way that minimises unintended outcomes, it is hoped that they will arrive in time to promote the growth and attractiveness of the Australian digital currency industry, rather than being too little, too late.
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