Welcome to episode 3 of That's a good Question.
A question that regularly pops up on Knowledge Shop's help desk is
Here's the question...
My client has recently sold some crypto assets and made a significant loss. They receive salary income, dividends and have made capital gains from the sale of shares. Will they be able to apply the crypto losses against their other income and gains?
So, what's your answer? See what Tax Director Michael Carruthers has to say on the issue and the decision making process.
Knowledge Shop's help desk is just one of the benefits of Knowledge Shop membership. Find out how we make professional life less of a hassle for thousands of accountants and advisers across Australia.
Edited transcript
In this session of that's a good question we look at the increasingly common question of what happens when clients make losses from cryptocurrency sales. The scenario that we're looking at today is as follows:
My client has recently sold some crypto assets and made a significant loss. They receive salary income, dividends and have made capital gains from the sale of shares. Will they be able to apply the crypto losses against their other income and gains?
And that's a really good question because it really does depend on the client's circumstances and there isn't necessarily one right or wrong answer here. It really depends on your client.
The first thing we need to figure out is whether those losses will be dealt with on revenue account or capital account.
If your client has been carrying on a business of buying and selling cryptocurrency, so a cryptocurrency trading business for example, then the losses that they're generating are likely be dealt with on revenue account as business losses. In some cases, you might also find that a client who does not actually carry on a business of trading cryptocurrency, has still held those assets on revenue account in connection with an isolated profit making undertaking. If so, the losses again would be dealt with on revenue account.
On the other hand, and pretty much in every other situation, we would be dealing with losses that are going to be dealt with on capital account - they'll arise under the CGT rules. And that gives rise to some quite different tax implications.
Now, if we just quickly run through those three possibilities in terms of how they would apply and whether those losses can be offset against other income.
So, if we have that client who's carrying on a business of trading cryptocurrency and the loss relates to a business activity, we need to look at the type of taxpayer. Is it an individual, a trust, or a company?
Individual carrying on a business
If we're dealing with an individual then we need to work our way through the non-commercial loss rules. If the relevant tests can be satisfied then the business losses typically can be offset against other types of income - and that could include salary and wages, dividends, and net capital gains.
In that case, we're applying the losses against net capital gains which is the figure that remains after applying the CGT discount.
However, if the non-commercial loss rules cannot be satisfied, those losses will be quarantined. This means they can only be offset against income generated from the same or a similar business activity. Typically, that will mean carrying forward those losses to next year, then reassessing the position. If there's a profit made from a similar activity, which might be a bit unlikely if we're dealing with crypto sales in the 2023 year, then we could potentially offset the loss against that income. Otherwise, we're going through those non-commercial loss rules and tests again to see whether those losses can be offset against other types of income.
Isolated profit making activity
Now, if we're dealing with a loss on revenue account that does not relate to a business activity, so it relates to an isolated profit-making undertaking, then the good news is that those losses are dealt with on revenue account and they're not subject to the non-commercial loss rules. Those rules only apply to
losses relating to a business. That's probably the most flexible scenario that you can find yourself in because you can offset that loss against things like salary and wages, dividends and net capital gains without having to worry about the non-commercial loss rules.
Losses on capital account
The third scenario is when those losses are dealt with on capital account; they arise under the CGT rules. In that case, we don't have a whole lot of flexibility because capital losses can only be offset against capital gains. While your client might have some capital gains during the year – remember that capital losses are applied against gross capital gains, which means that they are applied before you apply the CGT discount, so the benefit of the loss is somewhat reduced.
That's roughly how things will play out.
Losses in entities
If you're dealing with a client that is a company or a trust, then things are a little bit different and we would need to apply the company loss recoupment tests or we would potentially need to consider the trust loss tests - depending on whether we're dealing with a revenue loss or a capital loss.
That becomes a little bit more complex and there are a separate set of tests that we would need to consider.
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