The income tax and VAT consequences for crypto asset mining and staking will vary, depending on how participants earn rewards.
Broadly, cryptocurrency can be earned in two main ways:
- Proof-of-work (POW) mining – where the miner owns the machines (Scenario 1a) or rents the computing power (Scenario 1b).
- Proof-of-stake (POS) rewards.
POW mining uses a validation method where crypto miners compete using algorithms to verify transactions on a blockchain network.
This requires computers to solve cryptographic equations, putting in “work” to be rewarded for the ability to validate transactions on the blockchain.
Coins mined using POW include Bitcoin, Ethereum, Litecoin, Bitcoin Cash, and Monero.
Ethereum is scheduled to switch away from proof-of-work in September with the “Merge” upgrade and transition to proof-of-stake.
POS requires crypto miners to stake a certain amount of cryptocurrency as collateral to have a chance of becoming a validator node that mints a new block of transactions.
Generally, validators receive rewards for minting blocks and keep at least a portion of the transaction fees paid.
However, should they make a mistake, go offline, or attempt to defraud the system, they lose some or all of the collateral staked.
Your chances of being selected as a validator usually increase with the size of your stake.
Examples of blockchains using proof-of-stake include Cardano and Solana.
Scenario 1a: Tax deductibles and implications as a POW miner that owns the machines
POW mining requires processing power, usually from graphics cards or Application Specific Integrated Circuit (ASIC) machines. These are used to solve the computationally difficult problems to validate a transaction.
Some algorithms are designed to be ASIC-resistant (such as Monero), in which case miners can only use standard CPUs and graphics cards.
Section 11(e) and Interpretation Note 47
According to Joon Chong, a partner and tax specialist at Webber Wentzel, Section 11(e) of the Income Tax Act (ITA) and Interpretation Note 47 (IN 47) will determine how to claim the costs of using the graphics cards or ASIC machines.
If an item is less than R7,000, then you can claim a full write-off in the year of acquisition.
Where an item costs more than R7,000, the recommended write-off periods in IN 47 would apply.
ASIC machines and graphics cards are considered “personal computers”, and IN 47 generally allows personal computers to be written off over three years, as follows:
- Graphics cards can be written off over three years in line with IN 47, as miners can use them for other purposes.
- ASIC machines can only be used for proof-of-work mining, and their useful life is less than two years, based on Moore’s law. Coined by Intel co-founder Gordon Moore, the law states that the number of components on an integrated circuit doubles every two years. Loosely, this translates to a doubling of computing power every other year. Therefore, miners can write off ASIC costs over two years.
Other tax-deductible costs during POW mining include electricity, maintenance, rental of premises, salaries, and shipping — according to section 11(a) of the ITA.
Section 2(1)(o) of the VAT Act
Crypto mining is exempt from Value Added Tax (VAT), and VAT paid by the miner in expenses cannot be claimed back as input VAT, as there is no output VAT on the supply of cryptocurrencies by the POW miner.
VAT can only be claimed back when included as a deduction against income for income tax purposes.
Additionally, if the miner in this scenario also has digital wallet management services for which a fee is charged, this fee is not exempted, and normal VAT rules apply.
Coins which appear in the wallets are considered “trading stock”, as defined in the ITA.
Gains or losses on these coins are taxable on the disposal of the asset, similar to ordinary revenue from a scheme of profit-making.
Scenario 1b: the POW miner rents computing power from a supplier
In this scenario, the POW miner does not own the computing power used to solve the algorithms to validate a transaction but rents them from a supplier.
Chong used Nicehash as an example, where crypto produced is either paid into a wallet or Nicehash will liquidate the coins for US dollars.
Nicehash then pays the fiat currency to the customer after deducting the rental for the computing power.
The supply of computing power falls into the category of “cloud computing” and is an electronic service in terms of the VAT electronic services regulations.
Nicehash is carrying out an “electronic service” in terms of the VAT regulations and would need to register as a VAT vendor if the supply to South African recipients is more than R1 million in 12 months.
The POW miner will not be able to claim the VAT paid on the rental as input VAT, because the service was used to generate an exempt supply (cryptocurrency).
For income tax purposes, the POW miner renting the machine who earns coins or dollars from mining is accumulating trading stock.
The gains or losses of revenue are taxable on the disposal of the asset. In the arrangement where Nicehash sells these coins for dollars, the amounts paid (less rental due) to the POW miner would be income.
Tax deductibles and implications for proof-of-stake
Proof-of-stake generates rewards in the form of coins for putting cryptocurrency up as collateral to secure the network, and is therefore similar to being a shareholder of a company on any given stock exchange.
According to Chong, coins earned through POS are similar to dividends in the form of capitalisation shares, and these coins become taxable as income when they appear in the wallet.
This article was first published on Daily Investor and is republished with permission.