China’s ban on crypto

In September 2021, the People’s Bank of China (PBOC), along with nine other authorities including the Supreme People’s Court (SPC), Supreme People’s Procuratorate (SPP), the Ministry of Public Security (MPS), and the State Administration of Foreign Exchange (SAFE), jointly announced that cryptocurrency is not legal tender in China. Further, the notice determined that all cryptocurrency transactions in China are illegal, including offshore exchanges to provide services to Chinese citizens. In this pronouncement it was made clear that China-based employees of offshore exchanges, and third parties supporting them by providing marketing and promotion, payment and settlement, technical support or other services, will be investigated and prosecuted.

Court rules Bitcoin as property rights

Nevertheless, on 5 May 2022, the Shanghai High People’s Court issued a statement on their official WeChat channel regarding a civil case involving Bitcoin. In commentary, the court held that Bitcoin has virtual property attributes and is therefore regulated by the legal norms of property rights, sparking a new debate over its legal status in China. While not the first court in China to characterise Bitcoin as virtual property (a previous dispute in 2019 at the Hangzhou Internet Court reached a similar determination), it is worth noting this is the first case involving Bitcoin to reach the level of the Shanghai People’s High Court.

In China, the judicial authority of the Shanghai High People’s Court is second only to the Supreme People’s Court.

Will China move to legalise crypto?

Some observers see the Shanghai High Court’s ruling as indicating an increasing trend to recognise Bitcoin as virtual property which may influence future civil disputes involving cryptocurrency. Others, however, point out that under the sweeping prohibition announced late last year, Bitcoin cannot be considered legalised by identifying it as virtual property.

In China’s civil law system, the law means statutes and excludes case law. In other words, because only rules codified by the legislature, the executive, and the judiciary are laws, and except for “Guiding Cases” (指导性案例) selected by the Supreme People’s Court, rulings from lower courts do not often serve as a precedent. For that reason, it remains to be seen what impact the Shanghai High Court’s determination will have on the status of Bitcoin in China.

Contributor:

Toby Graham

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This was a landmark transaction for the digital economy, as this is the first time an Australian bank has minted a digital asset linked to the value of the Australian dollar.

In this case, the ‘transaction’ was a proof of concept test case which involved ANZ minting a stablecoin, backed dollar for dollar by an AUD denominated deposit lodged with ANZ by its client, in a quarantined bank account. The stablecoin was then transferred to a digital currency exchange, and to a global digital asset custodian. A separate group provided anti-money laundering assurance for regulatory purposes and another group audited the capabilities of the coin and certified its existence on the blockchain and issuance to the highest security standards.

As this was a proof of concept, the client did not actually transact to purchase digital assets in this instance. The ‘transaction’ was unwound by reversing the process and ultimately ‘burning’ the stablecoin (i.e. removing it from the blockchain) and returning the customer’s fiat currency held in the quarantined ANZ bank account to them.

The next step to finalise prior to an actual transaction being facilitated is for the bank to arrange relevant licensing and ‘prove’ the process to exchange the AUD stablecoin for a USD denominated stablecoin to facilitate the purchase of digital assets by their client.

Potential for broader application

An interesting feature of ANZ’s stablecoin is that it is programmable for different use cases, such as execution and automation of different elements of smart contracts, making the scope for use in due course potentially limitless.

As an example, the bank is separately working on a use case that automates payment of excise duty to a digital wallet with the Australian Taxation Office when stock moves from a manufacturer to a wholesaler in a client’s supply chain.

A key element of the ANZ stablecoin is that it is issued by a regulated approved deposit-taking institution in Australia, which provides a layer of trust and gives clients confidence in the security standards surrounding issue and use of the coin. In the proof of concept transaction, the client’s fiat currency remained securely in the Australian banking system, while the stablecoin was utilised to move value through various elements of the transaction chain.

These types of transactions are only in the early stages of development in Australia, and accordingly are currently only potentially available to our largest institutional businesses. As the technology becomes more familiar over time, it is expected that they will become more mainstream and available to a wider range of users.

How can SW assist?

SW is working with a number of clients in the digital asset space in preparation for regulation of the sector in Australia following issue of the Bragg Report in October 2021  (Senate, 2021).

We anticipate that a licensing regime for the sector could be introduced as early as the end of 2022, and that it will include the establishment of capital adequacy requirements, auditing and responsible person tests, together with anti-money laundering and counter-terrorism financing regulation, in line with recommendations from the Report.

For advisory, tax or accounting assistance with your digital assets, reach out to your SW contact or the SW Digital Assets team to see how we can assist you.

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The increased accessibility and uptake of digital assets by personal, retail, wholesale and institutional investors throughout 2021 has had global regulators playing catch up and in Australia, crypto assets and associated platforms have become increasingly mainstream.

Driven predominantly by evolutions in global payment technologies, several domestic industry reviews have culminated in the final report and recommendations from the Senate Select Committee on Financial Technology and Regulatory Technology in 2021.

The Australian Government announced on 21 March 2022 that the next stage of the reforms to Australia’s payment systems are now being progressed. Industry feedback is being sought for crypto asset licensing and custody requirements by the end of May, including terms of reference for the taxation of digital transactions and assets.

Existing legal and regulatory challenges with crypto assets

There has been some legislative reform related to digital currencies with regard to GST, and whilst the Australian Taxation Office (ATO) has provided some guidance on the income tax treatment of crypto and digital assets, this has been particularly limited given the prevalence of crypto ownership in Australia.

The inability of the ATO to provide comprehensive binding guidance is due, in part, to the fact that crypto includes a broad range of tokens and other ‘things’ with different rights, entitlement and obligations. Therefore without a specific crypto regime it is difficult for the ATO to administer the law in a consistent and sensible way.

ASIC has also provided some guidance from an investment asset and corporations law point of view. For the most part, however, crypto investments will tend to fall outside of the ambit of the Corporations Act, and therefore effectively outside ASIC and the government’s control. 

In terms of financial reporting, the Australian Accounting and Standards Board (AASB) has not provided any interpretive view on the classification of crypto assets in Australia. The International Financial Reporting Interpretations Committee (IFRIC) has considered this issue and has provided an interpretation that crypto will either be regarded as an intangible asset or trading stock, subject to its use. Importantly it will not be classified as a financial asset in any circumstance.

The AASB is relying upon the IASB to set the standards in this area and is following their interpretation. Such an interpretation does itself cause challenges for crypto as an investment class for its tax treatment where it is held as an investment asset in an Australian managed fund.

On the whole, tax and other regulatory reform for crypto/digital assets is now a necessity.

Board of Taxation review

A review by the Board of Taxation into the appropriate policy framework for the taxation of digital transactions and digital assets, including cryptocurrency and non-fungible tokens (NFTs), is due for completion by 31 December 2022. Considering the pace of innovation in the sector, the landscape may look quite different by this time again.

The review is being conducted on the basis that it will not increase the overall tax burden.

The terms of reference for this review have been released by the Government. Specifically, the Board is asked to:

• consider the current Australian taxation treatment of digital assets and transactions and emerging tax policy issues
• consider the awareness of the taxation treatment by both retail and wholesale investors and those transacting in digital assets as part of their business
• consider the characteristics and features of digital assets and transactions in the market, including the rapid evolution of technology supporting the broader digital asset ecosystem
• analyse the taxation of digital assets and transactions in comparative jurisdictions and consider how international experience may inform the taxation of digital assets and transactions in Australia, and
• consider whether or not any changes to Australia’s taxation laws and/or their administration are warranted in the context of digital assets and transactions, both for retail and wholesale investors.

We expect the Board to consult with taxpayers, tax representative bodies, industry stakeholders, and academics both domestically and abroad, and carefully consider experiences from other governments in regulating and enforcing the taxation of these forms of transactions and assets.

Looking forward

This move by the Government signals an increasing desire for Australia to be at the forefront of technology and innovation, and we are excited to see what the Board of Taxation releases following this review.

In the meantime, the range of guidance provided by the ATO and other regulatory authorities attempts to apply existing principles to the tax and accounting process of these assets.

SW experts are fully across these principles and continue to advise and work with a range of clients working with digital assets of all kinds. Reach out to your SW contact or the SW Digital Assets team for a complimentary consultation to see how we can assist you.

Contributors

Jae Debrincat

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Since the first transaction of bitcoin in 2009, new cryptocurrencies, networks, platforms and brokers have been established and continue to evolve. This new world of digital assets offers different ways for both providers and customers to think about investment opportunities.

There has been a significant uptake in institutional investment from well-established multinational companies such as JP Morgan, MicroStrategy, Mastercard, Microsoft, Tesla, Amazon, Facebook and many more. This institutional uptake of crypto assets has been attributed to an inflationary hedge, as well as a sign that diversified investments will ultimately include crypto.

Currently in Australia, there is no specific regulatory regime that caters for the various financial assets that have developed, and cryptocurrencies have specifically been classified as not being a foreign currency. Accordingly, any gain or loss from any disposal (including staking and wrapping) is subject to the capital gains tax provisions, the trading stock provision or ordinary income concepts, depending on the activities and circumstances of the investor.

Additionally, without it being classed as a financial product, in a lot of cases the Corporations Law will not apply to cryptocurrencies. In these instances, the application of cryptocurrencies as an investment asset will be outside of the jurisdiction of ASIC unless bundled up into a fund or a derivative.

Regulatory change is currently being explored. The resulting regime could mean that businesses investing, dealing or advising in relation digital or crypto assets may require some sort of financial licencing.

In this article, we look at both the origins and current trends for crypto and digital assets as Australian regulators will be considering how to manage these as part of the broader industry and payments landscape.

Crypto beginnings

The origins and development of the technology can be used to further understand the crypto market and its potential to revolutionise financial markets. Below we give a high-level overview of the developments, and the core ideological underpinnings that drive innovation in the crypto asset market.

Bitcoin (BTC) was the first decentralised cryptocurrency. BTC was created by Satoshi Nakamoto (the pseudonym give to the anonymous creator/ creators) as a means to operate an international payment system without the need to rely on financial intermediaries. Bitcoin was intended to function as money that did not rely on intermediaries to process and authorise transactions. Instead, Bitcoin relies on cryptographic hashing to generate proof of work to authorise transactions.

The second largest cryptocurrency network, Ethereum, was created by Vitalik Buterin in 2014. Ethereum introduced greater functionality by enabling smart contracts, which could facilitate the creation of decentralised applications (dApps), which ran off the Ethereum network. This increase in functionality spurred further innovation into significant new areas such as Decentralised Autonomous Organisations (DAOs), Non-Fungible Tokens (NFTs) and Decentralised Finance (DeFi).

DeFi, DAOs and NFTs are three of the most significant and innovative developments in the crypto-asset ecosystem. They pose a significant challenge to the way we think and interact with finance services, art and governance online.

DeFi

Decentralised finance (DeFi) is a financial technology that is used to undertake peer-to-peer transactions on distributed ledgers called blockchains. Rather than transactions being made through a centralized intermediary such as a cryptocurrency broker, securities exchange or a financial institution transactions are executed between participant directly which are verified through the programmed rules of the relevant blockchain

Because of this DeFi is a means of providing financial services without a financial intermediary. It is primarily used in crypto loans, decentralised exchanges, generating interest on tokens (known as yield) through staking, and play-to-earn gaming. DeFi applications rely on smart contracts to execute these functions. DeFi can be risky as the assets locked are an attractive target for hackers or nefarious actors who may want to defraud the DeFi platform.

DAOs

DAOs are Decentralised Autonomous Organisations, which are a new type of organisation structure. Participants of the DAOs can vote on decisions in accordance with the number of tokens or stake in the organisation. Voting power is often granted through governance tokens, which are allotted to users. DAOs can be used as investment vehicles, or other such dApps.

DAOs have attracted academic inquiry across the world as many jurisdictions struggle to define where the liability for a DAO will lie. Many DAOs are not yet fully decentralised, with key individuals holding the majority of governance tokens. Attributing liability in the case of fraud, or gross negligence in a truly decentralised organisation, will challenge existing company laws.

NFTs

Non-Fungible Tokens (NFTs) are by far the most popular and mainstream crypto asset outside of the major tokens such as Bitcoin and Ethereum.

NFTs are tokens that can be used to represent ownership of unique items. They allow things to be tokenised like art, collectibles, contracts, limited edition handbags and even real estate because each of these items are not interchangeable for other items because they have unique properties.

They can only have one official owner at a time, and no one can modify the record of ownership or copy/paste a new NFT into existence. Conversely, Fungible items, can be exchanged because their value defines them rather than their unique properties.

An NFT is essentially a unique token that can have metadata attached to it, for example an avatar picture. This metadata could contain anything (that fits within the limited storage capacity), and has been used most notably for art.

By attaching the metadata to the token, a public, immutable ledger of ownership is created on the blockchain. Ownership of art can be traced and authenticated to an individual wallet address, and therefore enables royalties to be earned in perpetuity. The use of NFTs in digital art demonstrates the growing importance and significance of the online world and digital identity.

NFTs have also been used for other purposes, such as certification of authenticity for pearls, and many foresee the use of NFTs to create digital identities and communities.

Australian Regulation

The crypto market capitalisation surpassed $3 trillion in January 2022 and while it dipped significantly afterwards, it is climbing back at a rapid rate. Despite this volatility, there is significant economic value in products and technological innovations using blockchain.

The rapid growth of digital assets and associated products have seen governments across the globe scramble to create new and suitable regulation. The Australian Government’s Blockchain Roadmap includes plans to update Australia’s payments system, with new regulation expected by the end of 2022. Three recent reviews on the topic, including the Senate Select Committee on Financial Technology and Regulatory Technology led by Senator Bragg in 2021, have issued a total of 41 recommendations to the government and regulators.

A particular focus of the reforms is to regulate buy now, pay later (BNPL) companies, digital wallets such as Apple Pay and Google Pay, and cryptocurrency. Treasurer Josh Frydenberg announcing this will be the largest legislative reform made to our payments systems in 25 years.

While there is tax guidance on how to treat digital assets by the ATO, fluctuating values of assets make it a more complex asset for accounting calculations. Furthermore, the difference between the protocols of cryptocurrencies make it extremely challenging for the ATO to make blanket interpretations across the universes of tokens.

Part of the reforms announced by Treasury include working with the ATO to create more specific guidance around current tax laws alongside a review of the current tax laws by the Board of Taxation. SW has reviewed these laws and can answer any questions you might have.

Where to from here?

Crypto experienced a breakthrough in 2021, with prices at all-time highs (followed by huge drops), multiple institutional buy-ins by major companies and explosive interest in crypto from payments companies to private and everyday investors. However, the industry is still in its infancy and continues to evolve.

While it’s difficult to predict the long-term trends, in the coming months, regulators and governments will be grappling with questions of  long-term regulation that remains fit for purpose and institutional adoption of crypto payments.

How SW can help

Understanding the risks, rewards and potential legal implications of blockchain opportunities can assist in being more confident with how you choose to engage with any crypto assets.

If you have any questions, feel free to contact SWs Digital Assets team.

Contributors

Natasha Woods

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Australia is a major producer and exporter of natural resources and energy, food and agricultural commodities, education and tourism. We also export many other goods and services globally.

Regardless of what you are exporting, there are several aspects to understand and consider – from trade structuring to the currency in which your trade is denominated, to payment protections employed.

Let’s review some essential background knowledge and then provide some suggested tips.

Capital vs current account

A number of countries globally still have closed capital accounts, but open current accounts. It is important to distinguish the nature of a payment when addressing this issue.

Countries with a closed capital account and an open current account restrict capital payments and receipts (loan repayments, foreign investments, capital injections into a business etc), but allow current account payments such as international trade transactions supported by appropriate documentation. Capital payments and receipts in such countries generally require approval from a foreign exchange regulator.

Currency

Some currencies are restricted to domestic trading only, but remain hedgeable. An example, is the Chinese currency – known on the China mainland as Chinese yuan (CNY) and outside the mainland as CNH – the ‘H’ notionally stands for ‘Hong Kong’, but really means Chinese currency anywhere outside the mainland. CNH foreign exchange risk can be hedged by Chinese and global banks just the same as mainstream global currencies such as the USD, EUR, GBP, JPY and AUD.

Whilst it is generally easier for Australian businesses to structure their trade in Australian dollars (AUD) to remove any currency risk, naturally it is always easiest for a foreign importer to pay in their own currency and this can sometimes secure an exporter a better price, given the convenience for the importer of not having to manage foreign exchange risk.

Tips for successful export relationships

While many of our clients know to engage us to assist with establishment of their offshore operations, we also have clients engage us after they’ve learnt some hard lessons. As always, the key is to surround yourself with experienced advisors and do your homework on any proposed business partners.

1. Due diligence is even more important

Resist the temptation to be blinded by the size of the deal or the size of the market you are entering!

When a foreign company doing business offshore enters into a new business relationship, a common mistake is a failure to undertake the same due diligence as the company would do in their home country.

All countries have different laws, regulations and norms of doing business, so it’s important to engage local expertise and advisors who understand the market to undertake physical, online, regulatory and financial background checks on who you are dealing with prior to entering into new business arrangements.

In some countries an internet search in English won’t help you. Two key reasons:

• search engines such as Google are blocked in a number of foreign jurisdictions
• for non-English speaking countries, you need to conduct searches on local entities or individuals in the local language, rather than English, to get an optimal result.

The key here, is to do the same or more due diligence on your business partner offshore than you would at home. If you are experiencing hurdles, we can assist.

2. The right payment structures can assist

International trade is conducted based on a continuum of trust. If you don’t know who you are dealing with, put payment protection mechanisms in place with providers that you trust.

Think about how you structure your trade:

• currency used – offering your purchaser trade terms denominated in their local currency can potentially secure better pricing and enhance your chances of being paid in timely fashion. Banks can help to hedge foreign exchange risk for widely used currencies.
• payment terms – seek whole or part payment up front, or at least staggered payments that stay ahead of the value provided over the contract period to help mitigate your payment risk.
• consider the use of Letters of Credit (and consider who the counterparty bank providing the Letter of Credit is).  This adds an additional layer of payment protection from your client’s bank.
• consider additional layers of protection – Letter of Credit confirmations, export credit insurance, standby letters of credit for services trade, bank performance guarantees if clear contractual performance criteria can be established and agreed.  This adds an additional layer of payment protection from either your client’s bank, or your bank.
• Importing and exporting? If you have incomings and outgoings in the same foreign currency, consider creating a natural hedge by opening a foreign currency account, thereby obviating the need for currency conversion.

If you’re experiencing debtor payment problems, understand clearly the reason why you aren’t getting paid:

• is the counterparty not creditworthy?
• does the counterparty have cashflow problems that are ‘point in time’, meaning they can pay you later?
• is your documentation incorrect? In some countries, local laws won’t allow the counterparties you are dealing with to pay you if you have not provided the correct supporting documents
• have you invoiced in AUD or USD, and the business you are contracting with can’t buy or remit foreign currency?

Your bank can assist you to ensure your trade documentation efficacy, with opening foreign currency accounts and with other foreign exchange hedging mechanisms.

4. Do what the big exporters do

Sometimes businesses think that the nature of the product they are exporting – perishable versus non-perishable – impacts the mechanisms that can be utilised to assist secure payment. This is incorrect.

Further, structuring of the trade payment security mechanisms of physical goods export activity should be no different for a smaller business than those utilised by the world’s biggest exporters, regardless of product type.

Where it is not feasible to seek payment up front, there are three ways that the world’s biggest exporters try to ‘guarantee’ payment for their exports to countries where payment certainty is more challenging:

1. Primary payment obligation rests with the importing party
2. Letter of Credit (bank guarantee of payment) issued in their favour – you’ll want this from one of the major international or local banks
3. ‘Confirmation’ on the Letter of Credit from one of their trade panel banks, or their house bank. This effectively substitutes the credit rating of their trade panel or house bank for the credit rating of the purchaser’s bank. In essence, in this example, it’s saying that if the importer doesn’t pay and the purchaser’s bank doesn’t pay, then the exporter’s bank must pay – if the trade documentation is correct.

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