By Ashlin Perumall, Tsanga Mukumba and Simon Mateus
Tax and blockchain are niche, technical fields and solving the puzzles encountered where the two complex systems interact can be daunting, even for the initiated.
The ever-evolving spectrum of use cases for blockchain technology and investment types has generated an equivalent number of tax compliance permutations.
For example, the scope of tax compliance obligations of cross-border digital service providers, such as exchanges, is far removed from those of an individual trading in cryptocurrency, let alone institutional investors structuring crypto-focused funds or investment products for the retail market.
The decentralised nature and anonymity inherent in blockchain technology create the impression that such transactions fly under the radar of revenue authorities. However, blockchain’s interface with traditional institutions and financial systems provides revenue authorities with a digital trail. With the heightened risk of tax evasion and fraud in crypto-investments, authorities are incentivised to pursue recalcitrant taxpayers. Aside from good governance considerations, wherever the values involved are material, the financial risks of tax non-compliance are equally high.
Tax compliance for crypto-investments incorporates the standard considerations, viz correctly determining the amount of tax payable, compliance with the applicable disclosure requirements for the tax payable to be confirmed by a revenue authority, and finally, timely payment of the relevant amount of tax.
The SA Revenue Service’s (Sars) position has been that gains and losses arising from crypto-investments can be dealt with under the ordinary tax rules and principles applicable to any other transaction. Given the flow of value between taxpayers, this is correct and the normal rules of income tax will seamlessly apply.
In 2018, “Cryptocurrency” as a concept was introduced into the definition of “financial instrument” in the Income Tax Act, 1958. This brought cryptocurrencies within the scope of a broad range of targeted provisions of the Income Tax Act, including certain anti-avoidance rules dealing with tax avoidance using financial instruments. In 2020, the definition of “financial instrument” was further broadened by amending “cryptocurrency” to “crypto asset”, bringing a wider range of intangible assets within the scope of the targeted provisions.
Despite their inclusion within the SA tax law framework, applying the tax rules in a crypto-investment environment can be challenging. The evolving nature of crypto-investments generates novel tax compliance scenarios that require professional expertise to navigate. Where the amount of tax owed has been incorrectly determined, Sars is empowered to levy understatement penalties of between 0% and 200% of the shortfall.
Although the law can capture all relevant transactions, there are practical shortfalls with respect to enforcement. Sars requires taxpayers to disclose crypto-investment gains and losses as the primary source of information. Where a taxpayer does not voluntarily disclose and refuses requests for disclosure, Sars may rely on its potent information-gathering powers to force the taxpayer, their advisers who do not benefit from attorney-client privilege, and third-party service providers to produce the relevant information.
For Sars to apply relevant tax laws and determine compliance requirements, it must first be aware of the transaction. This may prove complex, given that without a taxpayer’s blockchain address or wallet ID, it is difficult to assess their on-chain digital trail. With the advancement of technology, such activity may become easier to track. For off-chain audits, some tax authorities have begun leveraging the information available at digital currency exchanges and peer-to-peer facilitators. Clearly, tax authorities are becoming more dynamic in their assessment of crypto asset transactions.
Aside from technology, revenue authorities are increasingly using information from other revenue authorities through automatic exchange of information rules and specific requests for information. This has been facilitated over time by developments such as the Foreign Account Tax Compliance Act, country-by-country reporting, the Convention on Mutual Administrative Assistance in Tax Matters and the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting.
Taxpayers should therefore not discount the risk of otherwise anonymous transactions being revealed to a revenue authority. Considering the significance of tax compliance risks, external tax professionals are playing a critical role in safeguarding economic returns from crypto against unnecessary tax costs.
* Perumall is a partner in the IPTech Practice, Mukumba is an associate in the Tax Practice, and Mateus is a candidate attorney at Baker McKenzie Johannesburg