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What is cryptocurrency and what are the potential implications in the event of bankruptcy?

Having hit an all-time high of around USD$68,000 in November 2021, the value of Bitcoin then fell sharply and in January 2022 was valued at under USD$35,000. Its value has been steadily rising ever since, currently sitting at just over USD$46,000 in early April 2022. Whilst Bitcoin is by far the most well-known of the cryptocurrencies, there are many others available to buy and sell in the digital marketplace. An increasing number of individuals and corporations own, invest and trade in cryptocurrencies, meaning they are featuring much more regularly in all types of insolvency matters and in particular, bankruptcies. Cryptocurrencies have been around since 2009 and they are here to stay.

Cryptocurrency Explained

Cryptocurrency is any form of currency that exists digitally or virtually that is secured by cryptography. Most cryptocurrencies are decentralised networks based on blockchain technology – a distributed public ledger that facilitates the process of recording transactions and tracking assets in a computer network.

The decentralised structure allows cryptocurrencies to exist outside the control of governments and central authorities, rendering them theoretically immune to government interference.

Disclosure of Cryptocurrency Ownership

Digital assets vest in the Trustee in Bankruptcy on or after the date of bankruptcy, just the same as any other asset a bankrupt may own. An exclusion to this general rule may arise in certain circumstances as set out in the provisions of the Bankruptcy Act 1966 (Cth) (Bankruptcy Act).

Like with all other assets, a bankrupt is required to disclose any digital assets they own to their Trustee in Bankruptcy, including any digital assets acquired after the date of bankruptcy and before the date of discharge. Bankrupts who fail to disclose ownership of any digital assets, or who transfer, dispose of, or otherwise deal with such assets may be committing offences under the Bankruptcy Act that can carry harsh penalties.

Identifying Cryptocurrency

Unlike other types of assets, there is no publicly available information or registers to enable searches to be conducted on digital assets owned by individuals or other entities. This makes it extremely difficult, though not impossible, for a Trustee in Bankruptcy to identify cryptocurrencies held. If not disclosed by the bankrupt, evidence of digital asset ownership is often found in bank statements. A Trustee may also require the provision of, or obtain, email and internet browsing records and/or physical hardware including computers, mobile phones and hardware wallets – a small plug-in device similar to a USB drive.

Determining the Value of Cryptocurrencies and Realisation by Trustee

The digital currency market is highly volatile. As a result, valuing cryptocurrency can be extremely challenging. Trustees in Bankruptcy require access to the ‘public and private crypto keys’ in order to ascertain the relevant account balance/s. Whilst it is possible for a Trustee in Bankruptcy to exercise their requisite powers to compel the disclosure and provision of this information by the bankrupt and others, it is difficult to implement when it involves international territories.

The inherent volatility of cryptocurrencies will often mean that where possible, a Trustee in Bankruptcy will waste no time in realising the asset for the benefit of the bankrupt’s creditors. Depending on the market trends at that time, this early realisation may either work in favour of or against the Trustee in Bankruptcy. However, where the likely recoverable value of the cryptocurrencies is less than the costs of realising the assets, more often than not, a Trustee will deem any recovery and sale of the cryptocurrency to be uncommercial to pursue.

Tax Implications on Sale of Cryptocurrency

As with other types of assets sold, a Capital Gains Tax (CGT) event occurs when an entity disposes of cryptocurrency. According to the Australian Taxation Office (ATO), a disposal occurs when an entity:

  • Exchanges one (1) cryptocurrency for another;
  • Trades, sells, or gifts cryptocurrency; and/or
  • Converts cryptocurrency to legal tender (e.g., Australian Dollars)

A point to note is that merely transferring cryptocurrency from one (1) digital wallet to another digital wallet does not constitute a disposal so long as the ownership is maintained. For the calculation of CGT, each type of cryptocurrency is treated as a separate CGT asset.

No matter what, it is essential that records are kept for all cryptocurrency transactions. These records must be kept until the conclusion of five (5) years after the disposal of the cryptocurrency.

Currently, a Trustee in Bankruptcy who has disposed of a CGT asset and has derived a net capital gain from the sale is responsible for the payment of the associated CGT. The Trustee is required to apply for a separate Tax File Number (TFN), lodge separate trust income tax returns to account for any income, profits or gains derived by the bankrupt estate, retain amounts sufficient to pay tax on the relevant capital gains and ensure the CGT is paid to the ATO.

An Important Message

While every effort has been made to provide valuable, useful information in this publication, this firm and any related suppliers or associated companies accept no responsibility or any form of liability from reliance upon or use of its contents.  Any suggestions should be considered carefully within your own particular circumstances, as they are intended as general information only.

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