Like it or not, Bitcoin and other cryptocurrencies do not stop you from paying tax. They are not designed for such a purpose. Rather, they can facilitate fair taxation. It is possible to integrate a value-added tax directly into Bitcoin using script. Doing so would allow an organisation to pay its VAT instantly on the sale of goods or services. Further, it can be integrated in such a way that even a reversal from the customer would allow instant and automated taxes to still apply without fraud.
Anti-money laundering rules apply to Bitcoin and other cryptocurrencies (such as BTC). What people fail to see is that money-laundering protections require exchanges to capture your identity. If they are not doing so, they are a criminal organisation and will be shut down. If you’re using a criminal exchange, you can expect it to be seized and your funds to vanish. In other words, your investment will become worthless in moments. Anti-money laundering provisions apply even when we’re talking about peer-to-peer exchanges (such as the mythical unicorn, a DEX). The reality is that they are simply money services providers that are run by criminals seeking to avoid regulation and law. It is not only an unfair advantage for the illegal actor, but is also an incredibly risky strategy if you’re an investor. All such exchanges will be seized, and all the funds on them will disappear in the same way that e-gold or Liberty Reserve US Dollar vanished in an instant.
Nobody Likes Tax
I don’t like being taxed, nobody does. Having said so, the reality is that the more we allow people to get away with scamming the system and cheating, the more we give government departments an excuse to crack down on us and invade our lives and our privacy. If we want to be treated like adults, we need to start acting in such a way and understand that we live in a world of rules. If you don’t like the rules, work to change them. You work to change them by lobbying parliamentarians and having those who represent you support your idea.
People don’t seem to realise that Bitcoin was designed as an immutable evidence trail. It is anything but an anonymous system. It was designed not to allow all of the under-the-table deals and frauds delivered by systems such as e-gold or bit gold.
If we want a fair society, it needs to be one under the rule of law. If you want a fair society, it needs to be one where everyone has an equal treatment under the law and pays the same amount of tax. That is, a single rate likely based on what people consume. Right now, the rich pay very little tax. Even things like VAT are easy to avoid if you have money. Utilising Bitcoin, we can change the scenario. We can make people pay the tax that is due, and do so fairly. We can have scripting built into Bitcoin such that any individual transaction automatically pays the required amount of tax, which is settled immediately so that there is no incentive for a merchant or others to try and skate such issues.
With an automated consumption tax, the rich pay when they waste money on idle goods and services and are incentivised to reinvest in building more. They are incentivised to invest in more capital, and take risks to increase the value of their holdings — which leads to more growth throughout society. The poor don’t use as much. The poor don’t eat at restaurants where meals cost thousands of dollars a sitting, and the poor do not drink £5000 bottles of wine. If you live frugally, you pay less tax. If you waste money on yachts and fast cars, you pay more. Such a system is inherently fair.
Bitcoin allows us to create such a system. One that doesn’t allow people to avoid taxes legally by holding money overseas. One that taxes people on what they spend in the respective country.
There are ways to ensure your privacy. If you buy 10 bitcoin on an exchange, it will be necessary to demonstrate that you either pay the tax on the bitcoin and claim a gain or loss or pay a penalty. If we want privacy, the best way to achieve it is to work within the system to ensure that those in charge of the system do not unduly crack down and stop people from being free. It is the anarchists and those who seek fraud that bring restrictions upon the rest of us unfairly.
If You Spend and Use Bitcoin, You Need Records.
The principle is important to remember, because if you cannot provide evidence of where you purchased bitcoin and for what rate, you can be held to have purchased it at zero. It means you will pay 100% capital gains and cannot use the purchase price to offset the gain. If you attempt to use addresses that don’t belong to you and then move or transact, you can be held liable and have to pay tax. It’s important to register your addresses, because otherwise, if people alter records on you as it happened to me in the past, you could be liable for more tax than you should be.
For small amounts, such as exchanges under US$200 and selective purchases as at restaurants et cetera, the use of bitcoin does not invoke money-handling rules. For instance, if a department store accepted bitcoin, I would be able to go in and buy a camera as if it was cash. The other side of it, of course, is that the department store would need to keep a full record of the exchange. It would need to be available for tax records. Using bitcoin also requires that you maintain full records, or you will discover very quickly that you owe a lot more in tax than you believe.
Let us think of a small scenario. We have a few individuals:
- Mike the miner;
- Alice who purchased from Mike;
- Bob who exchanges goods and services with Alice for bitcoin; and
- Charlie who works for Bob and is paid in bitcoin.
With the four people we can follow the tax consequences associated with bitcoin and tracing addresses.
Mike is a miner, and he creates a new block. The block has a transaction Tx(M0) that has a block reward including transaction fees of 17.5 BSV. We’ll say that Mike is located in the USA, for example. Mike has average costs for each block he mines of USD15,000. The block is valued on the market at USD21,875. This gives him a net profit of USD6,875 for the creation of the block. I won’t go into accounting principles and all of the aspects of depreciation or other areas that Mike could claim, but without anything else to depreciate, Mike will now pay tax on the USD6,875 that he has earned as profit for his block.
Mike will need to account for the value of the block either at the end of the tax year as a nominal asset that can go up and down in price or when he sells it. If Mike is holding his bitcoin as an investment, he accounts for tax gains and losses each year. If he sells immediately, he doesn’t need to mark the value to market but can use the rate he exchanged at. For our example, we will use the instance where he sells in the same tax year for simplicity.
Mike sends a transaction from his wallet. To improve privacy, Mike conducts a transaction where he moves his mined bitcoin into new addresses. The process is:
- Mike earns bitcoin from mining to Pub(M-0).
As Mike is a miner, he does not need to pay fees — he is not in a rush. He pays to each of the addresses, and mines the transaction without fees into a new block. The process takes several blocks to be accepted, but Mike doesn’t care as he is not in a rush.
Alice decides to buy 10 BSV from Mike because she wants to invest in some bitcoin. She wants to be able to use the coins to purchase goods and services, but hopes the price will go up and that she will gain from the investment. Alice buys 10 BSV from Mike at a rate of USD1,250 per bitcoin for a total expense of USD12,500. It is conducted with an exchange through Alice’s bank account into Mike’s bank account.
In our instance, as Alice is not an exchange, she does not need to register as an MSP, and nor does Mike. The process is detailed below:
Mike sends a transaction from his wallet to Alice. Mike cares about privacy — it is very important to him. As such, Mike sends each transaction separately, and doesn’t send everything as one into Alice’s wallet. He could do so, which would allow him to consolidate the UTXO set, and Alice would receive one single transfer of 10 BSV, but as Mike and Alice care about privacy, they conduct three separate transactions. To ensure privacy, Mike even moves other transactions. If Mike is lucky, he will get his fee back in a future mining reward, but this is probabilistic. Alice and Mike have exchanged multiple templates, and have multiple addresses rather than just one. Alice and Mike are doing so to ensure that they maintain maximum privacy. Alice has a privacy-enhanced wallet that never spends across different coins unless she chooses to put them in the same group.
In Pub(M1-B), Mike is sending to himself so the transaction is not broadcast and he gains 100% of the fee — but to a new address. Doing so helps Mike appear to be sending a transaction to other people, and helps improve his and other people’s privacy.
Mike could save himself a very small amount in mining fees, and Alice could do the same if she was willing to wait, but doing so would reduce privacy — and we are talking about a cost of 1/4 of a cent to Alice for a USD12,500 purchase and a cost of 1/8 of a cent to Mike as they now increased the privacy in the chain and all the expenditures.
If Mike holds the remaining 7.5 BSV until the end of the tax year, he will account for the value based on the market value at the time. Every good accounting platform can handle such a valuation process. The value of the bitcoin sold to Alice is set by their exchange, which is the market value. Alice can now account for the value of her bitcoin based on her purchase price. Any gain or loss will be calculated against the deduction obtained from the purchase price.
It is important that Mike maintains good records of his transaction with Alice. Let us assume that it’s been a very good year and between now and the end of the year, the price of bitcoin has increased from USD1,250, where it was when Mike sold to Alice, to a value of USD2,500 just before the tax year ends.
Mike did not sell the remaining 7.5 BSV. As long as he can prove that he made the sale to Alice, he has no problems with the tax on the initial sale being paid on his smaller profit. If he loses the record of the transaction with Alice, then Mike will have to pay tax not on the increase and the remaining 7.5 BSV at the increased rate, but rather he may need to pay tax on the full amount (ignoring the small fee rounding value).
As such, if Mike fails to keep good records of his sale or cannot prove that he made a sale to Alice, he is now deemed to have maintained the bitcoin that he sold and will mark to market the profit. In the first year, Mike has now made a loss of USD3,750 in potential revenue from the block by not maintaining details of where he sold to. If Mike sold to a responsible exchange, one that maintained proper accounting and records, the scenario would likely be simpler than if he was selling to the general populace. But, if he was selling to an exchange such as Binance that does not maintain good records, it is possible that Mike may not be able to claim the sale.
Let us assume now that Mike does not have records and cannot prove the sale to Alice. She has held all of her bitcoin in our hypothetical scenario for another year, and the prices skyrocketed. Mike would now need to account for the value when Alice sells unless he can prove that he was not holding the key. Let us assume that bitcoin skyrockets to USD10,000 for each bitcoin. He has already claimed all of the expenses associated with mining the bitcoin, and cannot claim again.
The market value in the previous year for the 10 bitcoin started at USD2,500 for each bitcoin held and has increased fourfold. Mike can of course claim the value that he paid tax on from the previous year.
So for each bitcoin that he sold to Alice, the tax office can now claim that he has again made further profit at the end of the year. Let’s further assume that each of the addresses owned by Alice has moved and sold at the USD10,000 mark. Which will preclude Mike arguing to have lost keys. As the keys have been used, there is a presumption that they exist unless Mike can demonstrate his sale to Alice.
There’s a very good chance Mike is now bankrupt. The tax office can assess him as having hidden the “cryptocurrency” earnings he made and as if he did not make the sale to Alice. It is your responsibility to maintain records, and as a business, if you fail in such an endeavour, the tax office can and will assess you as if you did not make the sale. There are important reasons why things work in such a way. It is not just to maintain correct levels of taxation but also to minimise fraud. If Mike was able to operate without records, he would gain an advantage over honest businesses. Importantly, shareholders and other parties would not know whether Mike had stolen assets or manipulated his earnings. Bitcoin does not work in isolation. For Bitcoin to work as an honest system within the world we live in, it requires records. Luckily for Mike, you can store such records on-chain.
Allowing Mike to transact with Alice in a manner that captures her details ensures that Mike remains profitable. Mike can seek to aid criminals by not declaring his sales and not maintaining proper record-keeping, but doing so will quickly make Mike unprofitable and go out of business. In such a way, Bitcoin helps to incentivise honest businesses, and pushes those who are not honest into bankruptcy.
Next, Let Us Move On to Alice…
We already know that Mike is going to want to ensure that he is covered from tax liabilities. In selling to an individual such as Alice, he will ensure that he has all the details required and stored to maintain regulatory compliance. If he doesn’t do so, he is dancing with the devil in a matter of time, and eventually he will be audited and lose his business. More so, it turns out that if Mike is found to be reckless by the tax authority, they can even double the amount he owes. Consequently, Mike is incentivised to ensure that he never loses any details about the people he buys from and sells to. Some sort of on-chain storage with backup, and the blockchain would be a massively effective idea for him.
So the next phase is Alice. Alice also wants to maintain details. The reason is, Alice is eventually going to spend money. In our scenario, Alice is incentivised to ensure that she records all her information when she purchases from Mike.
Alice has split up her keys because privacy matters to her. She has her 10 BSV split into four different addresses. In the current tax year, Alice is going to spend from two of the addresses, leaving the others untouched.
Alice makes two purchases from Bob — of a laptop and a high-end monitor. We will not consider the depreciation or other aspects of the purchase from a tax point of view in our analysis.
In our simple example, Alice has made two purchases from Bob. The first purchase was made when bitcoin was at USD2000. The second purchase was made when bitcoin was at USD2400. In the first purchase, Alice was at the store and purchased her laptop using a corporate account. Bob linked the purchase to the used account, and issued an invoice on-chain. As Alice has a corporate account with Bob, all invoicing and other requirements are stored seamlessly on-chain allowing Bob and Alice to know that when tax time comes, they will be compliant and breezed through their filings and any possible audits.
Let us now say that Alice sells a further 5 BSV at the end of the tax year; she already has her equipment that she has bought for a total of USD1,991.48 on the first purchase and of USD603.39 on the second. Now she makes an exchange on a compliant regulated exchange because she knows she needs records. In the tax year she sells 5 BSV, and gets a rate of USD2,800 for each BSV she sells, giving her USD14,000 as we can see below:
So, when Alice ensures that she gets all the details from those she is trading with, she knows she will be tax compliant. Doing so is important; the reason is that if either Mike or Bob are audited, Alice knows they will provide the tax office with her details for validation. If Alice tries to spend her bitcoin without filing for the correct taxes, she knows the tax department will be able to instantly penalise her. Besides, it’s not worth the risk. Alice has managed to make a gain as bitcoin increased in value, and has purchased a laptop and a monitor. Alice is actually very happy, and pays her tax without fuss because she has 3.7 bitcoin remaining at the end of the year and money in the bank. Even with the subsequent drop in value to only USD2,100, at the point of the new tax year, Alice is happy.
Alice is very happy with the scenario as she understands that if she had not maintained records and paid tax, she could have been assessed with a loss where the tax office would have charged her double the usual amount. You see, when you cheat on your tax, other people have records that point to you. Bitcoin includes an immutable audit trail. So if Alice fails to maintain both records of her own keys and cannot demonstrate where she has sent her bitcoin, she can be liable for all the gains in the other transfers.
For instance, when she sends to Bob and if she doesn’t go to a compliant store that keeps tax records, she won’t be able to claim. It may not seem an issue until you realise that the tax office can match all of your sales and movements of bitcoin. When you buy from a registered exchange, the exchange has records. The same applies to all custodial wallets. So, if you move your bitcoin that you have gained through exchanges, eventually you have to account for it on tax. When you don’t, you’re liable for every other purchase and movement of other people’s bitcoin. If you can’t prove where you sent bitcoin, you’re liable. Here lies the mistake that people make. They think they can hide from tax. It’s really important not to try to hide from tax, because Bitcoin is not anonymous. The tax office doesn’t need to prove that you made a sale, you need to prove to the tax office that you made a sale.
I’ll say it again: The tax office doesn’t care, and doesn’t need to prove to you. You need to prove to the tax office.
It’s that simple: they maintain records, and if you fail to lodge the required amounts, then you are liable.
It is actually simple. Software could make the scenario far more complicated with mixed wallets and rules to set up mixing between your own accounts. When you own addresses, mixing with people who are under AML controls is legal and compliant. You keep records of who you have been exchanging with, and Alice could make the scenario even more private.
Bob and Charlie
And so it continues; if Bob pays Charlie using bitcoin, Bob and Charlie need to maintain records. Just like in our example with Alice above, if Charlie fails to maintain records, he will end up being taxed excessively — which will occur because Bob will keep records. If Bob doesn’t keep records, Bob will end up in the scenario in which Mike could have been. In other words, he will end up paying far more in fees and fines to the tax office. If Bob cheats, there are others who have records that link to him. As such, Charlie knows that Bob wants to minimise his taxes, and has lodged to ensure that Bob minimises his own taxes, meaning that Charlie’s income is known. If Charlie uses his pay that is held in bitcoin, any gains must be accounted for.
It is an aspect people neglect, but when you purchase bitcoin from an exchange, the exchange is required, by law, to have anti-money laundering (AML) procedures and know your customer (KYC) procedures in place. If they don’t have full KYC procedures in place, then they are a criminal organisation and will end up shut down with all of the people using the exchange losing 100% of their money. Think of Liberty Reserve.
As such, for those of us who aren’t criminals, there is nothing but pain in avoiding keeping records and reporting your gains in having bitcoin.
Imagine Now if Tax Could Be Automated
We need to help governments and tax authorities understand that Bitcoin allows tax to be built into Bitcoin directly and in a fair manner. A value-added tax can be applied within script. Doing so would allow a merchant to send the required amount of VAT to the government instantly as any transaction occurs. It reduces fraud, and also means that the government can take a less heavy-handed approach to tax audits.
Smart contracts don’t avoid tax and government; they make things simpler, and remove much of the bureaucracy from the means.
Many countries are alike in Australia in the sense that they tax people as they leave the country. As a tax non-resident, if you dispose of assets, you would only be subject to capital gains tax (CGT) if the assets qualify as “taxable Australian property.” Such includes Australian real property and certain holdings of shares in companies that have a majority of their assets as Australian real property.
Further, when you become a non-resident, you are deemed to have sold all your CGT assets that aren’t taxable Australian property for their respective market values at the time. So it is theoretically possible to pay the tax before you sell the asset, although you can generally choose to defer any capital gain or loss until you later sell the asset. If you make such an election, your CGT assets are taken to be “taxable Australian property” and so will fall within the Australian tax net if it is subject to a taxing event (such as the disposal).
The meaning here is that as you properly plan your estate, you will be subject to tax as you move between countries, and having bitcoin does not change the matter.
Note: Miners collect fees in a block, the users do not send them directly to an address; the miner selects it.