15 August, 2015
WHAT YOU NEED TO KNOW
- Bitcoin is the most prominent digital currency but does not have legal tender status
- Digital currencies are not currently subject to financial sector regulation including Australia's AML/CTF
- Last year the ATO decided that digital currencies are neither money nor a foreign currency and that individuals should be charged GST when they buy digital currencies
- The Senate Report on Digital currency recommends that digital currency transactions should be treated as national or foreign currency for the purposes of GST
- The Senate Report supports the extension of AML/CTF regulation to digital currency exchanges, but concluded that it is too early to decide whether digital currencies such as Bitcoin should be potentially treated as a regulated financial product
In August 2015, the Senate Economic References Committee published its Report on Digital Currency. The Report considers the regulatory challenges presented by the emergence of new forms of digital currencies and how best to address them. In particular, the report recommends digital currency, including Bitcoin, should be treated as money for the purposes of GST, which recommends a different approach to that adopted in the Australian Tax Office (ATO)'s rulings last year.
What is Bitcoin?
Released in 2009, Bitcoin was the first decentralised cryptocurrency and is currently the most prominent digital currency. Essentially Bitcoin is digital currency that can be used in a peer-to-peer payment system, in online transactions, outside the established payment and banking systems. It is described as decentralised because it is not issued by any central authority, and also known as a cryptocurrency because it involves the use of public-key cryptography to validate transactions and issue more bitcoins.
The main characteristics of a digital currency are that they are digital representations of value which can be digitally traded and function as a medium of exchange, unit of account or a store of value. Digital currencies do not possess legal tender status (a valid and legal offer of payment).
There are currently around 13.5 million bitcoins in circulation and each Bitcoin is currently worth approximately AUD$420. In August 2015, an average of over 110,000 Bitcoin transactions have been made globally every day.
To transfer bitcoins, participants interact directly with each other and verify transactions themselves through a clearing and settlement service involving complex cryptographic puzzles. Network participants, known as "miners", compete to solve these puzzles and are rewarded with newly created bitcoins. All verified and validated transactions are included in the blockchain, which is a public ledger recording where each bitcoin unit is located and a history of all the transfers in ownership.
Bitcoin users may use intermediaries to manage their holdings and facilitate transactions. The Senate Report categorises these intermediaries into the following types: Bitcoin wallets, exchanges and trading platforms, payments processing for merchants, intermediation for consumers and Bitcoin ATMs. Exchanges and trading platforms are the main entry and exit points for the Bitcoin system because they enable bitcoins to be exchanged for fiat currencies (ie legal tender). Payments processing for merchants allow Bitcoin users to pay for goods or services with Bitcoin and convert it into monetary value for the seller, while Bitcoin wallets allow users to store bitcoins at addresses through their wallet accounts.
Issues arising from Bitcoin
In August 2014 the ATO confirmed that it considers Bitcoin to be a form of intangible property (or commodity) and not money or foreign currency. According to the ATO, Bitcoin does not fall under the legal definitions of money and currency because these only include state-issued and state backed currencies.
Bitcoin transactions in Australia are currently treated in the same way as a barter exchange. This means that customers could be charged twice in a Bitcoin transaction: once on the goods or services being supplied and once on the supply of the Bitcoins that are used to make payment for the transaction. Further, where a GST registered business supplies bitcoins to an Australian resident, they must charge and remit GST on the supply, increasing the price by 10%.
As Bitcoin and other forms of digital currency are not recognised as legal tender in Australia, they are not subject to regulation or oversight such as AUSTRAC's AML/CTF regime. Potentially, Bitcoin could be more easily used for criminal activity than the Australian dollar because of the anonymity of transactions.
While Bitcoin intermediaries are subject to consumer protection obligations under the Competition and Consumer Act 2010 (Cth), they do not fall under the Australian Financial Services (AFS) Licensing ( regime. This is because, consistent with the ATO's view, ASIC considers that Bitcoin and other forms of digital currency do not fit within the current legal definition of a "financial product."
Bitcoin's lack of legal or regulatory safeguards presents risks for consumers. Since many Bitcoin users use intermediaries who retain control over their funds, consumers face the risk of losing their Bitcoins if these intermediaries become insolvent. MtGox, a Japanese bitcoin trading platform, filed for bankruptcy in February 2014, stating that it had lost around 850,000 bitcoins with no prospect of recovery for its customers.
The Senate Report recommends that the government should consider amending the definition of money and financial supply in the GST Act to include digital currency. Specifically, the treatment of a Bitcoin transaction as a barter transaction creates a double taxation effect which has placed an additional burden on Australian digital currency business.
The Report also strongly supports the application of AML/CTF regulation to digital currency exchanges (not to the digital currency itself) and recommends that this be one of the considerations in the Attorney- General's current statutory review of the AML/CTF Act.
As the Bitcoin and digital currency industry is still in its early stages, the Report supports a "wait and see" approach to other government regulation. According to the report, other taxation concerns, such as the treatment of Bitcoin regarding income tax and fringe benefits tax need further examination. Further research should also be conducted before digital currency is recognised as either a foreign currency or a financial product.
While further research is being conducted, the Report encourages the continued development of self- regulation in the Bitcoin industry based on the standards set for financial services and payment services.
The Senate Report: Digital currency- game changer or bit player may be viewed here.
For further information, please contact:
Tim Brookes, Partner, Ashurst