Edited version of private advice

Authorisation Number: 1052041759482

Date of advice: 14 December 2022

Ruling

Subject: CGT - cryptocurrency - wrapped tokens

Question

Does exchanging your wrapped tokens to native tokens constitute a disposal event under subsection 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You invest in cryptocurrency.

You acquired wrapped tokens.

You have provided the toke website and the White Paper, which outline how the tokens work.

The White Paper further states that once it is launched, all wrapped tokens will be 1:1 exchangeable for native tokens held securely in a third-party custodian.

Because each circulating wrapped token will be backed by a custodied native token, these tokens share a single circulating supply equal to the total supply of tokens.

During the 20XX income year, you transferred wrapped tokens to native tokens using the bridging service.

You have provided the User Terms of the bridging service (User Terms).

The bridging service is provided by a company incorporated in country X.

Clause Y of the User Terms provides that tokens deposited in the account are held as security and subject to a general and specific lien and may not be returned accessed or redeemed by the token owner.

Upon initiation of the transfer, all legal and beneficial right, title, interest and risk in any Tokens held in the Account, corresponding to the wrapped or native tokens shall be become the property of the service and be deemed to have been transferred to the service with full title guarantee, free from all liens and encumbrances together with all rights privileges and chose in action relating thereto.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 108-5

Reasons for decision

Section 102-20 of the Income Tax Assessment Act 1997 (ITAA 1997) states that a capital gain or capital loss is made only if a capital gains tax (CGT) event happens.

Section 108-5 of the ITAA 1997 provides that a CGT asset is any kind of property, or a legal or equitable right that is not property. CGT assets include part of or an interest in property or a legal or equitable right that is not property.

Taxation Determination TD 2014/26 Income tax: is bitcoin a 'CGT asset' for the purposes of subsection 108-5(1) of the Income Tax Assessment Act 1997? explains that Bitcoin, and by extension, cryptocurrency in general is a CGT asset. The tax treatment of bitcoin can be applied to other crypto or digital currencies that have the similar characteristics as bitcoin.

Guidance on www.ato.gov.au provides that there are many types of crypto assets, with their form and function continuing to evolve. You can control different types of crypto asset in the same digital or hardware wallet. However, for tax purposes you need to treat each crypto asset you hold as a separate asset.

The disposal of cryptocurrency that is not part of a business or commercial transaction will give rise to CGT event A1 under subsection 104-10(1) of ITAA 1997. This includes exchanging or swapping one crypto asset for another.

When you exchange or swap one crypto asset for another crypto asset, you dispose of one CGT asset and acquire another. Therefore, CGT event A1 happens to your original crypto asset.

Subsection 104-10(3) of the ITAA 1997 provides that you dispose of a CGT asset when you either enter into a contract for its disposal, or where no contract exists, when the change of ownership occurs.

Application to your circumstances

The token website states that a wrapped token emulates some but not all of the functionality of the native token.

You contend that due to the limited functionality of the bridging service, a token holder who would elect to exchange their native tokens for wrapped tokens via the service, would not be receiving a different asset, as it does not have the functionality to create or supply wrapped tokens or create a separate asset. Each circulating wrapped token corresponds to a native token, locked out of supply on the Network. The bridging process cannot be seen as creating separate CGT assets, as it is the same asset that is being substituted between the networks and counted towards a single circulating supply.

It is our understanding that while the wrapped token is algorithmically tied to a quantity of native token, it is not itself the native token.

The Ainsworth test was explained in TD 2014/26 at paragraph 7 that a property right must be definable, identifiable, capable of assumption by third parties, and permanent or stable to some degree. Given the need for definability, identifiability, permanency and stability, this provides the basis for concluding that wrapped token is a distinct CGT asset from native token. The two tokens would not exhibit these characteristics if treated as a single asset.

Accordingly, it is considered that the two tokens are separate CGT assets.

You contend that the value of the tokens remains the same before, during and after the bridging process because the nature of the token does not change as a result of the bridging process. The tokens are reformatted so it can function in a different environment.

As a result, you retain ownership of wrapped token in the process to enable no CGT event to take place, which is similar to CGT implications of varying rights attaching to shares (Taxation Ruling TR 94/30 Income tax: capital gains tax implications of varying rights attaching to shares) where a variation of rights attaching to a share does not result in a full or part disposal of an asset.

However, it is our understanding that the wrapping or unwrapping does not involve the 'reformatting' of the original token. The arrangement cannot be described as a single CGT asset which undergoes a transformation comparable to the variation of a share's associated rights. Instead, the wrapped token is locked up at the bridge and an equivalent amount of native token is issued on the other side of the bridge.

The variation of rights attaching to shares and the analysis in TR 94/30 is irrelevant to the current arrangement. When the rights attached to a share are varied, there remains continuity in ownership of the share itself. In this case, there is no continuity in ownership of the tokens.

There is a change of legal and beneficial ownership in the wrapped tokens when you deposit them in the bridging service. The service is an 'entity'. You will not receive the same asset in return as a consequence of the bridging process. Therefore, the wrapped tokens have been disposed of to an entity, which triggered CGT event A1.

Accordingly, exchanging your wrapped tokens to native tokens constitutes a disposal event under subsection 104-10 of the ITAA 1997.