Currency and forex trading in the 21st century: Bitcoin
Author: Lesedi Seforo (SAIT Technical)
With only six companies in South Africa currently accepting bitcoin as a form of payment, SARS has been mum on the issue, but in lieu of their commentary, section 24I of the Income Tax Act provides enough clarity on how to the treat the gains and losses from speculating in the currency.
We are living in an age of unprecedented technological innovation where each year seems to bring with it a slew of products capable of performing feats that would have seemed impossible even a decade ago. There is no doubt in my mind that if one were to transport an average Joe from the middle ages into modern day society, the poor lad would exclaim ‘what sorcery is this?!’ at the sight of our aircrafts, touchscreen phones and flat-screen TVs. One area that seems to have remained fairly immune from much innovation throughout the ages has been money. We have been using coins for over 2000 years now, and paper money is over 500 years old. Sure we’ve come up with electronic fund transfers (EFTs), internet banking, debit and credit cards, but cash is still king.
The year 2009, however, brought with it a huge technological leap in the realm of money. It was during this year that a digital currency known as Bitcoin made its way into the public sphere.
The CEO of eBay believes that “…there’s no doubt digital currency is going to play an important role going forward, and at PayPal, we’re going to have to integrate digital currencies into our wallet.” It should come as no surprise then that the list of companies accepting bitcoin as a means of payment grows with each passing day. Apple, Amazon.com, Paypal/Ebay, Microsoft’s search engine Bing and Wikipediaare some of the companies accepting this currency as a form of payment.
What is Bitcoin?
Bitcoin is a software-based online payment system: a medium of exchange that is electronically created and stored. According to Wikipedia:
“The most important part of the bitcoin system is a public ledger that records financial transactions in bitcoins. These transactions are permanently recorded in a public distributed ledger called the block chain….”
With physical money, when the payer transfers money to the payee, the payer obviously cannot keep the money. It is now in the hands of the payee. Because digital money is just a computer file, the payer could potentially spend the same money again and again, copying the file over and over.
The way the bitcoin system prevents this from happening is by using the public ledger (block chain), to keep track of who has how many bitcoins at a certain point in time. If I use my bitcoins to buy goods and services, the transaction is added to the block chain, and will show a decrease in the quantity of my bitcoins and a corresponding increase in the quantity of bitcoins belonging to the person I am paying. By tracing each and every bitcoin spent, the potential for double spending is curbed. The coins are stored in a ‘wallet’ that one can install on a computer or smartphone. There are also bitcoin exchanges all over the world where one can exchange traditional money for bitcoin and vice versa. In South Africa, this function is currently performed by BitX.
A big factor in bitcoin’s increased popularity has been the exceptionally low transaction fees. This makes it an attractive payment alternative to credit cards, especially for the international transfer of funds. In South Africa very few companies accept bitcoin as a form of payment. However, during July 2014 PayFast partnered with BitX and is now offering bitcoin as a payment option to affiliated merchants. Buyers will now be able to pay in bitcoin, while sellers will receive South African rand in their PayFast accounts. This development is likely to raise awareness of the currency.
What is of further interest is the currency’s value since its inception in 2009. From 2009 till early 2013, one bitcoin was worth between 10 and 20 dollars. Since early 2013, however, its value has skyrocketed, with the graph below showing a peak of over $1 000 per bitcoin around December 2013. During August 2014 the price hovered around the $500 mark, which translates to approximately R5 000.
South African Income Tax Consequences of Speculating in Bitcoin
In addition to being used for the purchase of goods and services, its volatility as shown in the graph above has attracted currency speculators eager for quick profits. When considering the income tax consequences for residents trading in bitcoin, section 24I of the Income Tax Act No. 58 of 1964 comes to mind. According to section 24I(3):
“In determining the taxable income of any person contemplated in subsection (2), there shall be included in or deducted from the income, as the case may be, of that person—
(a) any exchange difference in respect of an exchange item of or in relation to that person, subject to subsection (10A)”
The persons contemplated in subsection 2 are:
b) trusts carrying on any trade;
c) natural persons who holds any amount contemplated in paragraph (a) or (b) of the definition of “exchange item” as trading stock; and
d) natural persons or trusts in respect of any amount contemplated in paragraph (c) or (d) of the definition of “exchange item”
A natural person speculating in bitcoin would thus have to fall within the ambit of (c) above in order for section 24I to be applicable to him or her. For this to be the case, such a person would first have to hold any amount contemplated in paragraph (a) or (b) of the definition of “exchange item”. Secondly, those amounts would have to be held as trading stock.
Para (a)(i) of the “trading stock” definition in section 1 of the Act includes “anything…purchased or in any other manner acquired by a taxpayer for the purposes of…sale or exchange by the taxpayer or on behalf of the taxpayer”. The bitcoins clearly qualify as trading stock in terms of this very wide definition because they are purchased for the purpose of sale.
In addition, the bitcoins must fall squarely within paragraph (a) or (b) of the definition of “exchange item”. The relevant paragraphs state:
“Exchange item” of or in relation to a person means an amount in a foreign currency—
(a) which constitutes any unit of currency acquired and not disposed of by that person;
(b) owing by or to that person in respect of a debt incurred by or payable to such person.
According to para (a), an “exchange item” must be an amount in foreign currency which constitutes a unit of currency acquired and not disposed of. Foreign currency is defined in section 24I as “any currency which is not local currency”. This begs the question: is bitcoin a unit of currency which constitutes foreign currency?
Is bitcoin “foreign currency” as contemplated in section 24I?
According to para (b) of the “local currency” definition, which is also found in section 24I, “in relation to any resident other than a headquarter company in respect of an exchange item which is not attributable to a permanent establishment outside the Republic, (local currency means) the currency of the Republic”. While the term “currency of the Republic” is not defined in the Income Tax Act, section 15(1) of the South African Reserve Bank Act No. 99 of 1989 affirms that the monetary unit of the Republic is the rand. Bitcoin, then, cannot be local currency.
Is it then foreign currency? Based on a plain reading of the foreign currency definition, this seems to be the case. However, one would first have to determine if bitcoin could even be considered a “currency” in terms of the Income Tax Act. Since “currency” is not defined by the Act, its ordinary dictionary meaning needs to be ascertained. The Merriam Webster Dictionary defines “currency” as:
1. The money that a specific country uses; and
2. Something that is used as money.
Additionally, synonyms of currency include money, legal tender and medium of exchange. Bitcoin is used as money and is a medium of exchange. Because of this, it is submitted that bitcoin qualifies as currency for Income Tax purposes. Because it is not local currency, that makes it foreign currency and an exchange item.
It is therefore submitted that resident natural persons who speculate in bitcoins are subject to section 24I in the same way as speculators of traditional currencies.
The Internal Revenue Services (IRS) of the United States has issued a notice declaring that virtual currencies like bitcoin will be treated as property, rather than a form of currency, for income tax purposes. The Brazilian tax authorities (the BRS) have adopted a similar approach, deeming digital currencies to be financial assets for income tax purposes. SARS, on the other hand, has been silent on bitcoin, probably because very few residents know about the currency. After all, there are currently only six companies in the whole country that accept bitcoin as a form of payment. It would seem, though, that even if SARS were to persist with their silence on the matter, section 24I of the Income Tax Act provides enough clarity on how to the treat the gains and losses from speculating in the currency.
This article first appeared on the September/October edition on Tax Talk.