Tax in the Web3 world: Simple principles, complex reality
Building a venture in the Web3 space involves identifying your product-market fit and answering a host of tricky technical questions.
But there’s another question that needs to be answered early on - what are the tax implications of what you are doing? What’s counted as income and how does Inland Revenue treat the digital transaction activity that has proliferated with the rise of Web3?
All of these issues and others were covered in a recent Taxing Digital Assets 101 Learning Series webinar hosted by Web3NZ and Callaghan Innovation’s Kevin Whitmore. You can play back the video in full, or read a transcript of the presentations, which featured tax experts from Inland Revenue and EY.
They outlined some of the key principles from existing tax law that apply to digital assets and flagged emerging regulatory issues that could influence activity in this fast-changing space.
The bottom line, according to Inland Revenue and EY, is that digital assets, like cryptocurrency tokens or NFTs (non-fungible tokens), are treated as intangible personal property for tax purposes under New Zealand law. Income derived from digital assets or activity such as bitcoin mining is taxable, and ‘disposal’ of digital assets is typically the time when taxation is applied.
Importantly, New Zealanders can offset realised losses on digital assets against their tax liability, a benefit our regime has over many other countries. But beyond applications of well-established common law to this emerging space, understanding tax in the Web3 world requires unpicking every part of the business process - and being willing to ask for advice to remain compliant and avoid any nasty tax-related shocks.
“When we talk to Inland Revenue or [clients], we do have to get quite deep and technical,” admits Rachael Gemming, Associate Director of Tax at consultancy firm EY.
“We need you as Web3 founders to talk to us, to explain how these things work, how we can unpack the transactions. Because effectively in De-Fi (decentralised finance) now you can be your own bank, you can have your own savings you can do borrowing, lending, you can use collateral,” says Gemming, who helped establish the unit at Inland Revenue responsible for crypto and digital assets before departing for the private sector.
“Once you introduce tokens into the mix, then you have to think about different jurisdictions, royalties, withholding tax. If you've got things happening in the metaverse, arguably it gets more complicated.”
An innovation-friendly tax system
It sounds complicated, and it potentially is. But Andrew Evison, Technical Specialist at Inland Revenue, says the tax department is gearing up to stay “agile enough” to deal with new innovations that emerge in the Web3 space - and offer clear tax guidance to businesses and individuals engaging with them.
“We don't have all the solutions, but if things are going down a pathway we want to make sure that the tax policy settings that we do have are able to be adjusted to [and] not to stifle innovation or hold our economy back.”
Will Edmonds, Senior Policy Advisor at Inland Revenue, says a team at the tax department is looking at ways of simplifying recording keeping for digital assets, through the use of software tools.
“Secondly, we may develop a more simple annual tax calculation method,” he told the webinar.
“So rather than taxing on a realisation basis, we could look at the starting value and end value of the portfolio. And of course this would need to be consulted on. But that's something that we'd like to look at,” he said.
A patchwork of regulations is starting to emerge internationally that could have implications for New Zealanders given the global nature of the Web3 ecosystem. Edmonds says the OECD’s Crypto Asset Reporting Framework will require crypto exchanges to provide income-related information on users to tax authorities.
“We really want to have visibility over this so that we can ensure people pay tax and don't conceal their income,” Edmonds says.
Gemming says much of the advice published online about tax implications of Web3 activity wasn’t created with founders in mind and had a bias towards traders investing in crypto currencies.
“Enterprise crypto tax is very new and unsettled,” she says.
“So this is where we're here to help you.”