Cryptocurrency investors who profited from selling their bitcoin last year may be worried about the prospect of taxation on their gains. However, only active traders of the cryptocurrency actually fall into that category.
According to the Inland Revenue Board of Malaysia (LHDN), active traders of cryptocurrencies have to declare their gains to be taxed. An active trader is one who trades frequently with an intent to profit, among other things.
“LHDN referred to Section 3 of the Income Tax Act 1967 and mentioned that it would apply the same tax treatment on income earned from conventional businesses to income earned from digital platforms. This means gains or profits from trading in cryptocurrencies, if it is revenue in nature for the investor, will be viewed as taxable income under the Act,” says Koh Leh Kien, partner at Ernst & Young Tax Consultants Sdn Bhd.
This tax treatment is similar for active traders of shares and other assets. The profits made by individuals who occasionally trade cryptocurrencies or shares may be viewed as capital gains, which is not taxable in Malaysia. But the profits earned by individuals who trade frequently may be viewed as revenue and thus, deemed as taxable income.
How does one determine whether one is an active trader? One way to do so is to refer to the badges of trade (see table) test. It is generally used by tax authorities to determine if an activity is a proper economic activity or just a hobby that also generates some income.
“If a person is just investing on the side as a hobby, then it’s fine. But if the frequency of transactions is high, that can become an issue. Some people borrow money to invest and this can be flagged [by the tax authorities as an intent to profit] as well, since they will need to pay back the loan,” says Chong Mun Yew, executive director at Crowe KL Tax Sdn Bhd.
This also applies to those who bake cakes and make crafts to sell on the side, he adds. “It may be a hobby initially, but if the nature has changed to involve repetitive transactions, with the operations run in an organised and systematic manner, [the tax authorities] may interpret that your motive [for running this activity] is to generate income.”
If the active trader works in a related field such as finance, the individual may be put under more scrutiny by the tax authority, says Chong.
For active traders who are subject to income tax, they need to disclose their net gains in their income tax return form under the “any other income” section.
“Deductions can be claimed on expenses related to the transactions, subject to the general deduction rules. Investors will also need to keep proper records related to their cryptocurrency transactions,” says Koh.
“The gains to be declared refers to gains realised from the disposal of cryptocurrency, whether it is used to obtain goods or services, exchanged for fiat currency or another cryptocurrency. Any increase in the value of cryptocurrency held by an investor that has yet to be realised will not be taxable.”
Any future taxes to be aware of?
Tax regulators globally are showing increased interest in taxing digital currency transactions as it becomes more popular. Regulations on digital currency assets for anti-money laundering purposes and in considering tax evasion risks are also emerging, Koh observes.
While there are no specific guidelines on the tax treatment of digital currencies in Malaysia yet, it is expected to be issued once a comprehensive study is undertaken on the cryptocurrency ecosystem, she adds.
A cryptocurrency is a type of virtual currency that is used within a blockchain network. Cryptocurrencies, such as bitcoin and ethereum, and other virtual currencies (also known as digital tokens) are a subset of digital currencies.
Currently, digital currencies are taxed differently around the world. In the US, virtual currencies are treated as a property and subject to capital gains tax. The Inland Revenue Authority of Singapore has already released guidelines on the income tax treatments of digital tokens and initial coin offerings.
In Malaysia, capital gains tax is only applicable to gains from the disposal of real properties or shares in a real property company.
A cryptocurrency is viewed as an asset by the Malaysian tax authorities, who “have mentioned that capital gains tax will be important to deal with the taxation of cryptocurrencies, intangibles and other digital assets in the future”, says Koh.
Meanwhile, an Initial Exchange Offering (IEO), which are initial offerings of digital assets to raise capital, is bound to launch in Malaysia soon. Future IEO investors should understand the characterisation of the digital tokens issued as the tax treatment for investors will differ, says Koh.
“It depends on whether it is a token to redeem goods and services or a token for the issuance of debt or equity. The rights and obligations created by the digital token will determine the tax treatment of IEO investors based on prevailing tax laws.”
For instance, in Singapore, businesses that receive payment tokens are taxed on the value of the underlying goods or services performed. Use of utility tokens, which involves an exchange for goods or services, is unlikely to be taxed. Security tokens could be taxed depending on whether the return is in the form of interest or dividends.