Is the receipt of an airdrop always ordinary income?
By Dr Elizabeth Morton (2 min read)
So, you have a crypto wallet, and you receive some crypto assets free of charge via an ‘airdrop’. An airdrop can be anything from a legitimate marketing campaign, to a project’s mechanism to increase the supply of its tokens, or even an illegitimate scam.
What does the Australian Taxation Office (ATO) tell us regarding the tax implications of this blockchain activity?
Image by Alexas_Fotos from Pixabay
The ATO official guidance states in very clear terms:
The money value of an established token received through an airdrop is ordinary income of the recipient at the time it is derived.
In addition (and arguably less controversial) is an equivalent acquisition of a CGT asset, being the crypto asset(s) acquired through the airdrop. Here we are assuming that the taxpayer’s activities fall within the CGT regime rather than for example the trading stock provisions. The latter is beyond the scope of this article.
How black or white is the derivation of ordinary income really?
‘Ordinary income’ is an area of law debated in the courts over many, many years.
Numerous characteristics have been established through the common law process, one of which being the establishment of a sufficient nexus with an income earning activity.
A receipt is generally not going to be ordinary income if it arises from a windfall gain (think about the luck involved in winning the lottery), nor is it generally ordinary income if it is gifted (think birthday present).
There is certainly an appreciation that airdrops *can* be ordinary income derived at the time of receipt. Many project airdrops require numerous steps and/or activities to be carried out. They may arise from particular crypto asset holdings.
But is it always going to be the case? We are not so convinced.
Are all airdrops the same? This one is easy, no.
Does the airdrop amount to a gift?
Does the airdrop amount to a windfall gain?
Does the taxpayer even know they received an airdrop?
If receipt of a drop arises without expectation, without existing investment, is the nexus more debatable?
The consequences that flow from the ATO guidance
Even if we agree that the airdrop is ‘ordinary income’ on receipt, this does not necessarily mean we are getting taxed twice. *Phew*
What is declared as ordinary income is likely to represent the cost base of the CGT asset. Thus, when the asset is sold, only the movement in respect to that cost base will be taxed. However, the taxpayer may still be liable for tax in that initial tax year so may, and for cash flow reasons, need to immediately sell a portion (or all) of the airdrop to cover the tax burden.
Asymmetry in treatment arises though through the subsequent disposal falling within the statutory income provision, ie the CGT regime.
Whilst this could work out well: the taxpayer may access a 50% discount if a gain is made and the crypto asset is held for at least 12 months. The 50% discount is not available for ordinary income items. As such, if the value of the crypto at the time of the airdrop is low and the value then rises over time, this may defer much of the tax burden whilst obtaining the benefit of the discount (all the while supporting the blockchain project in question).
However, what if the price drops? The value would have been included as ordinary income on acquisition, whilst the loss derived would be locked within the CGT regime and only be able to be utilised if there are sufficient other gains to be offset against. If there are insufficient (or no) gains, the capital loss is carried forward to future years – until such time as capital gains are derived. In this case, a tax burden is immediately established without the ability to directly ‘offset’ the losses ultimately realised. This analysis does not then consider whether special rules with respect to personal use or collectable assets apply.
Do unexpected airdrops create a form of forced compliance burden?
The short answer is – following the ATO guidance – yes!
Can you think of any other economic activity that could force a compliance burden onto a taxpayer in such a fashion? Bonus share issues come to mind; however, this implies initially that the taxpayer is invested in the project. We return to the fundamental point that not all airdrops are the same, nor necessarily require any action or investment.
But when it comes to the ‘airdropper’ in this Twitter thread, they may not have thought this through. A taxpayer doing the airdropping is likely to be characterised as disposing of their crypto assets. Capital proceeds can be deemed to be the market value when no proceeds are received… thus may lead to a hefty tax bill in their own right.
Overall, the ATO’s guidance appears to fall short of reflecting upon the bespoke scenarios that are vastly different to staking and highlight the importance of seeking tax advice.
TLDR: Blockchain has made understanding tax cool