The Australian Taxation Office (ATO) has recently released their guidance on Decentralised Finance (DeFi) and wrapping crypto (QC 73649). Illustrating the ATO’s intention of ensuring Australian tax payers are navigating this space correctly. This article will highlight key areas of the new views the ATO has published that you need to be aware of when operating in this space.
What’s it about
The new guidance from the ATO illustrates their views on DeFi including:
- Lending and borrowing
- Liquidity pools
- DeFi interest and rewards, and
- Wrapped tokens
With the ATO’s views now available, this will likely shake up previous interpretations of the income tax law by tax agents (and taxpayers alike) on how particular DeFi transactions should be treated for tax purposes. It is an uncommon view that the providing of liquidity, or lending crypto would trigger Capital Gains Tax (CGT). According to the ATO’s new guidance, most DeFi transactions will indeed trigger a CGT event (being either A1, E2, C2 or H2). Let’s dive into the specifics.
Lending and borrowing
According to the ATO most DeFi lending and borrowing arrangements will result in a CGT event. This is due to the beneficial ownership of the underlying asset changing, even though there may be a right to receive the same amount of the same asset later. This is a contentious position that the ATO has taken regarding lending crypto assets as there are similarities to staking which is not viewed in the same light and broadens the tax implications of affairs concerning DeFi.
To illustrate how the ATO views these transactions, let’s consider the following example:
Elon acquires 1 BTC in November of 2023 for $50,000 (AUD). In December of the same year Elon decides to lend 0.5 BTC worth $30,000 (AUD) to a popular lending platform offering an attractive return.
When Elon lends the BTC, this triggers a capital gains event. The capital gains event will result in a capital gain of $5,000 ($30,000 less ($50,000 * 0.5/1).
The lending period ends a year later in December 2024, and Elon receives back the original 0.5 BTC that he lent. The price of BTC when received back is $120,000 (AUD), meaning the 0.5 BTC received in December 2024 will have a cost base of $60,000 (AUD) ($120,000 * 0.5/1). Elon must keep records to substantiate the cost base for when the BTC is eventually sold. When the lending period ends, Elon also receives his return on investment. This amount will be included in his taxable income and treated as ordinary income (similar to other crypto rewards).
The associated tax implications to providing liquidity to liquidity pools via crypto assets are viewed by the ATO as a taxable event triggering CGT. The ATO views providing liquidity similar to a swap between one crypto asset to another. When liquidity is provided to a liquidity pool a capital gains event will be triggered, where the capital proceeds will equal the market value of the crypto asset at the time of disposal. The cost base of the liquidity pool token (received in return for providing liquidity) will equal the market value of the crypto asset disposed.
When the liquidity originally provided is redeemed, a capital gains event will trigger for the liquidity pool token being swapped for a crypto asset (typically what was originally deposited). A capital gain will occur if the capital proceeds exceed the cost base, and a capital loss will occur if the capital proceeds is less than the cost base.
DeFi interest and rewards
Like other crypto income or rewards, any subsequent return received as part of interacting with DeFi protocols will likely be assessed as ordinary income and will be included in your total taxable income for the year.
Surprisingly, the ATO has taken the view that the assessment of interest and rewards as ordinary income will be done when the income is received. As some protocols allow you to select when to claim the interest, or reward, this allows for the manipulation of when the income is required to be reported in your income tax return. For example, your investment matures on the last day of the financial year (30th June), and you choose to redeem the reward on the first day of the following financial year (1st July). This allows you to delay declaring the reward as income as it was not received in your crypto wallet until the next financial year.
Although not legislation or official ATO guidance, the ATO’s position on wrapping tokens has remained consistent over the years on the ATO’s community forum responses. The consistent view that was held has now been published and remains the same. That is, wrapping crypto assets will trigger a capital gains event. Despite receiving an almost identical asset in return, fundamentally the assets do not share the same characteristics and therefore are treated as a swap.
What does this mean for you?
Whilst not recommended, if you intend to self-prepare your income tax return for the 2024 financial year and you were active in DeFi during the period 1st July 2023 to 30th June 2024, you must ensure you have adequate records necessary to calculate your capital gains considering the ATO’s new guidance. Use a trusty crypto tax software and ensure that the correct settings are selected to ensure that the disposal of your crypto holdings to lending platforms and liquidity pools are recognized as taxable events – remember most crypto tax software providers are international, and do not only consider Australia’s tax jurisdiction. The same applies to wrapping tokens.
You may consider reducing the overall complexity of your year end tax affairs, by ensuring networks and protocols are being used that are compatible with a reputable crypto tax software. This will ensure that your year end taxes are seamless, and if preparing through a crypto tax specialist like Fullstack Advisory, will help to reduce your overall compliance costs.
The most important thing to remember is if you are not satisfied that the crypto tax software is providing you with accurate results for the financial year, including year ends holdings, then reach out to a trusty Fullstack crypto tax specialist. If you are here, find the form submission at the top of the page and we will reach out to you within 24 hours (typically).
As one of the original crypto tax and advisory firms in Australia, Fullstack Advisory is committed to the ongoing tax compliance and advisory support to the crypto community. Fullstack Advisory’s Crypto Tax Team has extensive experience working with crypto matters, including complex DeFi situations. As part of our commitment, we welcome you to schedule a free 15-minute consultation to discuss your affairs and how we can help.
Reach out to the Fullstack Crypto Tax Team today.