What will the ATO do if you are scammed out of your crypto?

Written by Campbell Gould,  Partner at Pitcher Partners

On November 1 this year, the promoters of a new cryptocurrency named after the popular Squid Game Netflix series walked away with US$3.36 million ($4.65 million) — money that speculators had invested in the new currency after it became a short-term runaway success.

Cryptocurrency, the best known of which is Bitcoin, is decentralised and lacks any sort of guiding authority. Anyone can start a cryptocurrency on the various blockchains currently in operation and there’s no one, aside from the community surrounding those blockchains, to vet whether they’re legitimate or not.

As in the Squid Game scam, there are ample numbers of people out there willing to separate you from your hard-earned money.

The question that arises is how does the Australian Taxation Office (ATO) view crypto losses? And is there any chance of getting your money back?

Australians love crypto

Nearly 20% of Australians have crypto holdings, most commonly Bitcoin, and the main reason they’ve got crypto assets is for portfolio diversification.

The view taken by the ATO on crypto assets and losses is nuanced. Perhaps the most important factor to take into consideration is the ATO doesn’t see cryptocurrency as a currency like US dollars or the Euro. Instead, any cryptocurrency you hold is viewed as an asset, and therefore any gains made are likely subject to capital gains tax.

For mum and dad investors who might take the long view, holding a crypto asset for more than 12 months will reap a 50% discount on any profits made from the disposal of crypto (something referred to as ‘holding on capital account’).

On the other hand, if you’re regularly trading crypto to make a profit on short-term price fluctuations, or in the course of carrying on a business, you’re likely to be subject to tax on the full gain (referred to as ‘holding on revenue account’).

The difference between the two categories is important in terms of your tax.

To take an example, Bitcoin reached an all-time high in November 2021, with values exceeding US$65,000 ($89,000) per coin. The price has since fallen back a little, but it’s a volatile market with an upwards trajectory.

If you invested in a Bitcoin holding at its all-time high and then decided, for some reason, to get out of the market when it receded, you should be aware that a capital loss on the disposal of crypto may have limited impact on reducing your current year tax bill.

If you were holding the crypto on capital account, then the losses on crypto are restricted to reducing other capital gains.

That means they can’t be used to offset any other assessable income such as your salary and wages or taxes on investment income such as interest and dividends.

But you could offset a crypto loss against other capital gains tax assets, such as if you made a capital gain on the disposal of a property or shareholdings.

Under these circumstances, you would be able reduce the gain on the property or shares subject to tax by the amount of the crypto capital loss.

If you were a taxpayer holding crypto on revenue account, you should be able to offset a crypto loss against any other assessable income.

What happens if you lose your key, or are scammed?

In 2013 a British investor named James Howells mistakenly put a hard drive containing 7500 Bitcoins into the rubbish. Today those Bitcoins would be worth more than US$300 million ($415 million), but despite his best efforts in excavating the tip, those coins are long gone.

Howells’ situation is an extreme example, but it’s possible to lose the encryption key to your digital wallet or, as the Squid Game example demonstrates, be scammed out of your holdings.

In these sorts of situations — say you lost the key, and it can’t be replaced — being able to claim a capital loss is complicated.

First, you would need to provide the ATO evidence of when the key was acquired, and when it was lost. You would also have to give the wallet address and verify how much crypto was lost when you misplaced your private key.

This might include providing evidence of transactions between a digital currency exchange and your wallet.

Once all that is done, you will also have to demonstrate the wallet was controlled by you and you were in possession of the hardware (such as a hard drive or virtual wallet) at the time the key was lost.

If you have taken all those steps, then it’s possible to claim a capital loss on the crypto holdings.

The same goes for scams like the Squid Game crypto heist. Being able to claim a capital loss depends on your circumstances and being able to demonstrate, through evidence, the asset is worthless and can’t be recovered or replaced.

The Squid crypto coin also raises an interesting scenario as the coin was promoted as a token to enable the holder to participate in an online game based on the Netflix show.

If the ATO considers the coin a personal use asset — something kept or used mainly to purchase items for personal use or consumption — it will disregard a crypto loss.

That means that an individual who acquired Squid coins and had no history of holding other crypto could be considered by the ATO as holding the coin as a personal use asset and, unless the taxpayer has evidence to the contrary, the loss would be denied by the ATO.

It’s also worth noting the ATO has full access to crypto exchange records here in Australia, along with freedom of information agreements with foreign jurisdictions. Put simply, you won’t be able to pull the wool over the ATO’s eyes if you’re looking to make false or misleading claims about your crypto holdings and losses.

Crypto currency is a complex area, and one where investors should take specialist advice when it comes to matters like capital gains and capital losses on their holdings. With more and more Australians holding crypto, this area is only going to become more mainstream over the next few years.