Currency collapse has been a feature and often a precipitating cause of political upheaval and social unrest around the world. Therefore, control over monetary policy – including a measure of control over the currency and the money supply – is an important tool for governments to use in their management of the economy.
Control over the currency in Australia is exercised by the Commonwealth under the Currency Act 1965 and part V of the Reserve Bank Act 1959. The Currency Act establishes the Australian dollar as this country’s official currency, and dollar notes in various denominations are printed and issued by the Reserve Bank.
New technology has created ubiquitous alternatives to sovereign-backed or sovereign-authorised currencies. These new forms of currency are called cryptocurrencies. The best known of these is bitcoin.
The emergence of these new forms of currency raises a variety of issues including issues concerning tax.
What is bitcoin?
Bitcoin is not issued by a sovereign state. It was originally developed for use in online transactions in which one party sending money to another would ordinarily use a third-party intermediary, like PayPal.
The third-party intermediary maintained ledgers that recorded funds going in and funds being paid out. This process resulted in transaction costs. Bitcoin solves this “double spending” problem by distributing the necessary ledger among all the users of the system via a peer-to-peer network.
Every transaction that occurs in the bitcoin economy is registered in a public, distributed ledger, which is called the blockchain.
New transactions are checked against the blockchain to ensure that the same bitcoins have not previously been spent, thus eliminating the double-spending problem.
The Commissioner of Taxation in the Seribu case, considered the nature of bitcoin in the course of his determination TD 2014/5. The determination says at [8], that bitcoin: “operates a decentralised peer-to-peer payments network whose implementation relies on the issue of public-key cryptography to validate transactions involving existing Bitcoin and in so doing generates new Bitcoin. The Bitcoin system is decentralised in that it is not under the control of a central authority.”
El Salvador and bitcoin
Laws were passed in El Salvador on 8 June 2021, giving bitcoin the status of legal tender within El Salvador as a parallel legal tender alongside the US dollar. They came into effect in September 2021. Bitcoin is now an official currency authorised or recognised by a sovereign state.
They were proposed by President Nayib Bukele. The text of the law claims that “the purpose of this law is to regulate Bitcoin as unrestricted legal tender with liberating power, unlimited in any transaction, and to any title that public or private, natural or legal persons require carrying out”.
According to Mr Bukele, the law is aimed at the approximately 70 per cent of Salvadorans who are without bank accounts and it will increase inclusion for them. Mr Bukele argues that the law will increase investment as well as reduce fees from current services for remittances.
Outside of the US and its territories, a number of sovereign nations, including Ecuador, El Salvador, Zimbabwe, Timor-Leste, Palau, Panama, the Marshall Islands and the Federated States of Micronesia, use the US dollar as their official currency.
While dollarisation was implemented to reduce currency risk and increase international investment and trade, the consequence for these nations is that they are effectively outsourcing their monetary policy to the US Federal Reserve. This has created a problem because they have forgone many of the tools required to influence their own economies. For example, they cannot adjust the money supply or exchange rate.
So they have some valid reasons to be weaned off the US dollar.
As regards El Salvador, the “wallet” is available on iOS and Android devices that are far more accessible than bank accounts in the country.
Transactions and conversions are free, no commissions are charged to merchants (unlike credit cards) and users will be able to access free US dollar withdrawals from over 200 ATMs. The government has agreed to absorb conversion costs as they are much cheaper than the administration of the pre-June 2021 US dollar system.
Central bank digital currencies (CBDCs)
Apparently other developing countries are opening up to the opportunities that bitcoin can bring.
Many CBDC projects are on the rise with the G20 economies, whose finance ministers and central bank governors are working with the IMF and the World Bank.
Some argue that the People’s Bank of China has made the most progress although the Bank of Japan’s CBDC project is not far behind and the US Federal Reserve is currently working to develop a digital dollar.
The worldwide monetary system looks like it may undergo the biggest change since the Bretton Woods agreement that led to the US dollar becoming the global reserve currency in July 1944.
Can bitcoin be treated as foreign currency for the purposes of tax?
Division 775 of the Income Tax Assessment Act (ITAA97) sets out the rules governing the treatment of foreign currency gains and losses for tax purposes.
In the Seribu case, the applicant – Seribu Pty Limited (Seribu) – dealt in bitcoin. The company made a loss on those dealings. It said it should be entitled to deduct that loss under the rules in division 775.
The Commissioner of Taxation maintained that division 775 is limited to losses on foreign currency as defined in s 995-1. The commissioner insisted that a cryptocurrency like bitcoin was not a foreign currency as defined in s 995-1.
Deputy president Bernard McCabe posed the following question when giving his judgment: “So what is a foreign currency – and does it include Bitcoin which is not issued by a government or identified with any particular jurisdiction?”
He observed that s 995-1 ITAA97 defines the expression “foreign currency” to mean “a currency other than an Australian currency”.
The deputy president then concluded that the reference to Australian currency in s 995 ITAA97 is a reference to the unit of exchange established under the Currency Act and the reference to “a foreign currency” must be interpreted in light of that comparator. It follows, he said, that the other currency must be an official currency issued or recognised by a sovereign state.
As bitcoin was not an official currency issued or recognised by a sovereign state at the time of the Seribu transaction, no deductibility under s 775 was available. However, the deputy president did indicate that gains and losses from dealings in bitcoin were still accessible under s 6 – 5 or deductible under s 8 – 1 if the bitcoin was held on revenue account and that part 3.1 would assist Seribu if bitcoin was held on capital account.
So if one adopts the definition applied in the Seribu case, bitcoin is currency because it is recognised by a sovereign state – El Salvador.
But this definition differs from the High Court definition of currency that is that “Currency consists of notes or coins of denominations expressed in units of account of a country and is issued under the laws of that country for use as a medium of exchange of wealth…”
So it appears that the definition applied in the Seribu case cannot be adopted with any degree of confidence.
Section 10 PPSA and the definition of currency
Section 10 defines currency as “currency authorised as a medium of exchange by the law of Australia or of any other country”.
This is different from the High Court mentioned above. But it is arguably consistent with the findings of deputy president McCabe in the Seribu case – also mentioned above – and it does capture what has happened in El Salvador.
However some commentators say that “currency” in the context of the PPSA refers only to cash. It does not, for example, include cheques, bank deposits and other mediums that are often treated as cash.
For example, cheques are considered negotiable instruments (see s 10) and a bank account is considered an ADI account that itself is a subclass of the intangible property collateral class – again see s 10.
This view is supported by reference to s 48 PPSA. Section 48 provides that “a holder” of currency takes it free of a security interest if “the holder” acquired the currency without any actual or constructive knowledge of the security interest. Accordingly, some commentators suggest that “currency” should only form part of a security agreement where it is under the possession or control of the secured party.
These discussions clearly assume the subject matter is something tangible.
But is that correct? One can “hold” contractual rights. One can “hold” intellectual property rights. One can also “hold” Bitcoin in the same “intangible” sense.
So just because bitcoin (or any other cryptocurrency) cannot be reduced to coins and paper is not, it seems, sufficient reason to say that it is not “currency” for the purposes of the PPSA.
If our commentators are correct and bitcoin is not currency, then what is it?
If bitcoin is not currency, then what is it?
Is it financial property?
What is the definition of financial property?
The PPSA divides personal property into four main categories:
1. Goods
2. Financial property
3. Intermediated securities
4. Intangible property
Section 10 provides that financial property comprises:
If bitcoin is not “currency”, then is it another form of financial property?
It cannot be a chattel paper – because chattel paper is defined to mean one or more documents that evidence both a monetary obligation and a security interest in (or lease of) specific goods or property.
It cannot be a document of title as this phrase is defined to mean a document issued by or addressed to a bailee (someone who is delivered goods without the transfer of ownership – e.g. a courier), which both identifies those goods and states that those goods are to be delivered to another person.
A bill of lading is a document of title because it evidences that the holder is entitled to the goods to which it relates. In the context of securities, a person who holds a bill of lading can offer that bill of lading as security to another party – for example, to a bank.
For example, if a bank lends some funds to a person who holds a bill of lading, the bill of lading can be endorsed and delivered to the bank as security – to secure the repayment of those funds. If that person defaults in the repayment of those funds, the bank can present the bill of lading to the bailee and take possession of the goods.
It might be an investment instrument. They are generally understood to include a document (such as a share certificate or a bond certificate) that is used as a means to acquire equity capital or loan capital.
The definition of investment instrument extends to a financial product that is traded on a financial market operated in accordance with an Australian market licence… or any other financial product that is prescribed by the regulations. Whilst cryptocurrencies could satisfy the definition of financial product, cryptocurrencies have not been prescribed – yet.
It cannot be a negotiable instrument because a negotiable instrument is a document that guarantees the payment of money, either on demand or at a set time.
A negotiable instrument is comparable to a document of title. The main difference is that a document of title evidences ownership of goods whereas a negotiable instrument evidences ownership of a monetary obligation.
For example, a bill of lading is a document of title because it evidences that the holder is entitled to the goods to which it relates (as stated above). A cheque is a negotiable instrument because it evidences that the holder is entitled to payment of the monetary obligation to which it relates.
Is it intangible property?
Intangible property is defined in s 10 to be personal property that is not financial property or goods or an intermediated security.
The term “intermediated security” describes the rights of a person that an intermediary holds on their behalf. An example of an intermediated security is a share settlement system such as the Clearing House Electronic Subregister System (CHESS). Clearly bitcoin is not that.
The definition of intangible property covers personal property that does not have a physical form. Examples of intangible property include an account, intellectual property or general intangible property.
Accounts include property that takes the form of an obligation to pay. This can come about from:
Bitcoin could fit into one or more of these categories.
Intellectual property: This refers to property that is an expression of or contained in ideas, knowledge and designs. Bitcoin is not intellectual property.
General intangible property: This covers intangible property that is not an account or intellectual property – like contractual rights or authorised deposit-taking institution rights.
Bitcoin definitely gives the “holder” of bitcoin some contractual rights.
Conclusion
If bitcoin is “currency” or an “investment instrument” (which are both subclasses of financial property) then it cannot be “intangible property” because intangible property is defined in s 10 to be personal property that is not financial property or goods or an intermediated security.
But clearly, the rights of a bitcoin “holder” are intangible. Bitcoin could be a form of “account” and it could be a form of “general intangible” and it could also be “currency” and it could also be an “investment instrument”.
Indeed, there is probably no single legal characterisation of bitcoin that can be formulated with the PPSA as it is currently written.
The main issue for the purpose of the PPSA (as currently written) is to identify what property rights a “holder” of bitcoin has for the purposes of the PPSA.
Users of bitcoin can participate in the bitcoin system in various ways. Many users “hold” bitcoin by having an entitlement recorded in their name on the bitcoin exchange (“third-party holding”).
In some ways, a third-party holding likens the third party to a bank. This is because the user will merely have a right of action against the third party. In other ways, a third-party holding is more like a custodial relationship because the third party has custody of some asset belonging to the user. The legal relationship between a third party and the user is not clear.
There are other users who take steps to control directly the private keys that are needed to deal with the bitcoin that they “hold”. In the case of a direct holding, the user has specific knowledge of a long-secret number that confers the ability to transfer an amount of value to any public address for that bitcoin. It is also not clear as to whether this gives rise to property rights and if so, what they are. We do not know what legal “pigeon hole” these rights fit into.
Taking security over bitcoin
As a minimum, a third-party holding or a direct holding of bitcoin (or any other cryptocurrency) must be some form of PPSA property.
Therefore, a third-party holding or a direct holding of bitcoin should be captured by a well-drafted definition of “secured collateral” that always forms part of a general security agreement.
Control
As noted above, bitcoin might be an “investment instrument”. It could be conceptualised as collateral of the kind specified in section 21(2)(c)(iii) of the PPSA. Accordingly it might be possible for a party to perfect its security interest over the collateral by “control” as contemplated in s 27(4) – which deals with control of investment instruments not evidenced by a certificate.
Possession
As to possession, s 24 is quite long but does not seem to capture the concept of cryptocurrencies so arguing perfection by possession would be very risky.
Registration
Given the uncertainty as to the type of personal property that properly defines bitcoin, it is recommended that a registration be effected in the collateral class of “all present and after acquired property, except”.
This should reduce the risk of selecting the wrong collateral class.
The exceptions must of course specify any item or class of personal property that is not covered by the registration.
In light of the above considerations, a secured party that finances a user’s acquisition of bitcoin should be wary about asserting a purchase money security interest as giving the secured party priority. After all, what exactly are you taking security over? A bundle of rights that we don’t know how to describe.
Accordingly, best practice must be that the secured party ensures that its security interest is registered first or that it enters into an appropriate agreement of priority with the holders of prior-registered interests.
Where a secured party is relying on a user’s direct holding or third-party holding, it would be wise for the secured party to control those rights. How do you do that? You do it by transferring the bitcoin to a public address on the relevant crypto blockchain for which the secured party holds the corresponding private key.
Store the private key details on paper. Some suggest using a USB memory stick, however even though paper can fade, USB memory sticks can rust!
If the secured party follows the above approach, then the user will not have the day-to-day benefit of bitcoin. It will not be able to be defined as a “circulating asset” in the nature of currency or funds in a bank. This approach is similar to what the PPSA describes when a secured party takes control of the grantor’s interests in “investment instruments” – s 27 PPSA.
This article was originally published in the ARITA Journal, and is republished here with permission.
Leigh Adams is a special counsel at Owen Hodge Lawyers.
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