Background

Cryptocurrency is a virtual or digital currency that can be digitally traded as a medium of exchange. Virtual currencies were designed to be a type of currency which is solely controlled by its individual user with peer-to-peer technology to operate and removes the central or commercial banks from the process.

Although virtual currencies were originally designed as a type of currency, they are currently being treated as high-risk speculative investments due to their price volatility. Consequently, there is a substantial amount of hoarding and less real trade. Efforts are being made to change this by increasing merchant acceptance and promoting awareness of the advantages. Wide acceptance of virtual currencies could have a substitution effect on central or commercial bank money and roles.

South African regulatory landscape

The South African Reserve Bank (SARB) issued a Position Paper on Virtual Currencies in 2014. The SARB stated that only they are allowed to issue legal tender i.e. banknotes and coins, therefore virtual currencies are not considered a legal tender and should not be used as payment for the discharge of any obligation to settle a debt. There are many legal uncertainties regarding virtual currencies, such as the lack of a proper regulatory and legal framework. Particularly the enforcement of the principle of finality and irrevocability in the payment systems. For those trading in virtual currencies, there is the potential risk to incur financial losses, due to the price volatility as the demand and supply are controlled by individuals.

The main objective of the South African Exchange Control Regulations (Regulations) is to prevent the loss of foreign currency through the transfer abroad of real or financial capital assets held in SA, as well as constitute an effective system of control over the movement into and out of SA of financial and real assets.

The Regulations do not currently explicitly consider virtual currencies in the definition of “foreign currency” as defined. However, if virtual currencies were to fall under this definition the possibility exists that the Regulations will be applied to such transactions.

The anonymity of virtual currency transactions could result in exchange control circumvention as the transfer would not be affected and reported as required. Investors who acquire virtual currency in terms of their foreign capital allowance, do so at their own risk and have no recourse to SA authorities. The Regulations do not support the transfer of virtual currencies in and out of SA, therefore the SARB cannot authorise requests to trade in virtual currency cross-border. Any such trades and the risks associated thereof are for the individuals involved.

Currently individuals are entitled to a single discretionary allowance of R1 million per calendar year, however, exchange control regulations allow individuals to transfer R10 Million out of South Africa each year as part of their foreign investment allowance, subject to obtaining a SARS Tax Clearance Certificate (TCC). SARS require supporting documentation when applying for a TCC which include but are not limited to providing the relevant material that demonstrates the source of the capital to be invested.

South African tax treatment

To date, the South African Revenue Service (SARS) has not issued any guidance paper on the taxation treatment of virtual currency transactions. However, SARS participated together with the Financial Services Board and the Financial Intelligence Centre in the issue of a User Alert to the South African (SA) public in 2014. In essence, virtual currencies are unregulated and no legal protection or recourse will be afforded to users of virtual currencies.

Therefore the common misconception is that this means that no tax has to be paid on such gains, however, SARS have confirmed that transactions or speculation in virtual currencies are subject to the general principles of South African tax law and are taxed respectively.

The dictionary meaning of the term “asset” implies that the asset needs to bear value to the owner. When considering the meaning of the term “asset” as defined in the tax legislation, it appears to be wide enough to include virtual currencies as a form of property (asset). However, due to the fact that virtual currencies are not yet widely accepted in SA as a medium of exchange, virtual currencies are not likely to be classified as a “currency” in terms thereof.

Therefore, when exchanging virtual currencies for Rands, the same taxes apply as any other disposable assets which may result in a capital gain or could qualify as income.

What is of importance in determining whether it is capital or revenue in nature is the intention of the taxpayer when obtaining, keeping and at the time of disposing or exchanging the virtual currency.

If the taxpayer intends trading virtual currencies with the purpose of making a profit, such profit would meet the definition of gross income and would be taxed as income in your hands at the relevant individual tax rate. Such taxpayer will also have to account for trading stock in determining his taxable income. Consequently, any expense that you incur in the production of the income can be deducted. Taxpayers trading virtual currencies may have to include exchange differences of a revenue nature when determining their taxable income.

If a taxpayer buys and sells virtual currencies once off (not regularly) and your intention was to hold the asset for capital gain (long-term investment), the resultant gain or loss would be capital in nature and treated as such for income tax purposes.

Note

Please note that the information contained in this blog post should not be seen as advice in terms of the SARS regulations or Financial Advisors and Intermediary Services Act, but we trust that it provides some clarity on the tax position.