The FTX situation in Australia
When FTX US, the ultimate holding company for FTX Australia Pty Ltd, filed for bankruptcy on 11 November 2022 due to a major liquidity crisis, all investor funds were frozen. Crypto investors were locked out and unable to access their funds on the exchange.
On the same day, FTX Australia Pty Ltd and its subsidiary FTX Express Pty Ltd (FTX Aus) were placed into voluntary administration in Australia. This is a process initiated by the directors of a company when they believe that the company is, or is likely to become, insolvent. Usually this means the company is likely to become unable to pay its debts, and going into administration gives the company the opportunity to consider its financial position and its future. This may lead to a bankruptcy situation in the future, but as of now, the Australian entities have only ceased trading until further notice.
Given the uncertainty of the FTX situation in Australia, it is not yet clear if Australian crypto investors (who are now creditors of the companies) will be able to recoup all, if any, of their crypto.
Comparison to Mt. Gox
Mt. Gox, a large Tokyo-based crypto exchange had filed for bankruptcy back in 2014, due to a hack resulting in the loss/ theft of hundreds of thousands of bitcoins worth millions of dollars.
After a long 8 year insolvency process, there has at last been some consolation for investors when Mt. Gox announced in December 2021, a rehabilitation plan to return a portion of recovered bitcoins to investors who had lost their assets in the infamous Mt. Gox hack.
If Mt. Gox is anything to go by, then the FTX group situation could also be a lengthy ordeal. Australian crypto investors may have to wait a long time before they find out if they will receive any payout.
Can FTX crypto investors write off their tax loss?
Generally, the ATO allows crypto assets to be written off as a capital loss, provided you can prove the crypto asset is lost, or you have lost access to your crypto assets.
FTX Aus is currently in administration and is being assessed of its future viability. During this process, all withdrawals and trading on the exchange has been halted. Despite these events occurring, there has been no confirmation from the administrator as to the amount that each investor has lost, if any.
Until confirmation is provided from the administrator, Australian crypto investors will not be entitled to claim a capital loss. It may take years before the administrator can fully assess what has occurred and what is left over to distribute to users.
To better understand why the capital loss can not be claimed at this stage, we can go into a bit more detail.
Tax technical reasoning
You can only make a capital loss when a CGT event happens to your crypto assets. We can speculate on the two likely CGT events that may apply, but we won’t have complete certainty of the resulting tax outcomes until the full details of the FTX situation are known.
In this instance we expect that either CGT event C1 or C2 may apply, and we look at the tax treatment of both approaches below.
CGT event C1
CGT event C1 occurs when a CGT asset you own is lost or destroyed.
The words lost or destroyed are not defined in the legislation, so they take their ordinary meaning.
Taxation Determination TD 1999/79 provides guidance on the ordinary meaning of lost and states it to be in involuntary action — the loss cannot be intentional.
As a creditor, you generally can’t claim a capital loss until the proceedings are concluded, as you will not know what portion of your investment is permanently lost.
Due to the voluntary administration of FTX Aus, there is uncertainty around the future of the companies, and the likelihood of creditors to be able to recover, at least partially, their crypto assets. This may not be enough to render the crypto assets as lost within the ordinary meaning, as there is a chance that recovery of assets is still possible.
However, in the event that FTX Aus does end up being liquidated and funds redistributed, it would mean the portion of the crypto that you were not able to recover is likely to fall within the ordinary meaning of lost.
What amount can you claim as a capital loss?
The reduced cost base will be the amount that can be claimed (i.e. the amount paid when the asset was originally acquired).
The market value substitution rule does not apply, due to the operation of section 116-25 (1) and section 116-10 of the Income Tax Assessment Act 1997 (The Act).
What is the timing of the capital loss?
The ATO guidance specifies the timing of the capital loss to be when compensation is first received or, if none, then when the loss is discovered.
With the ongoing voluntary administration proceedings, the timing of when you can claim your capital loss will depend on the outcome of the administration process and if a subsequent decision is made to liquidate the company.
Depending on that, the timing of the capital loss would be based on whether you receive compensation or not.
If the decision is made to liquidate FTX Aus, and the amount of crypto assets recoverable is known, (i.e. compensation is receivable), you may then be able to recognise a capital loss for the unrecoverable portion. The timing would be when a written declaration is made by the company administrators as to any recoverable amounts.
If no compensation is receivable, then you would recognise a capital loss for the whole of your original investment at the time the declaration is made.
CGT event C2
CGT event C2 happens when your ownership of an intangible asset ends in certain ways, including because the asset expires or is redeemed, cancelled, released, discharged, satisfied, abandoned, surrendered or forfeited.
What is the timing of the capital loss?
The time of the event is when a taxpayer enters into the contract that results in the asset ending, or if there is no contract, the time is when the asset ends.
An interesting analysis and comments were made in ATO ID 2008/58 regarding unsecured notes held in a company placed in voluntary administration and subsequent liquidation. Further references were made to comments in the case of Federal Commissioner of Taxation v. Macquarie Health Corporation Limited & Ors (1998) 88 FCR 451 at 472; 98 ATC 5214 at 5230; (1998) 40 ATR 349.
In summary, it was noted that a taxpayer’s ownership of an underlying debt does not end if the company is placed into administration or liquidation. In such cases CGT event C2 would not happen and the debt continues in existence unless the taxpayer executes a deed of release in favour of the company, or the company is deregistered. It is when a company is deregistered, it ceases to exist and it is at that time, that the debts are discharged, released, satisfied for the purposes of CGT event C2.
How CGT event C2 may apply to FTX?
With respect to FTX Aus, you (who are now creditors of FTX Aus) have a debt owed to you by the companies which is a CGT asset.
The time at which the asset would end, and a capital loss is likely to arise, is when a contract or deed is made to acknowledge that the debt is formally discharged or released. And if there is none, at the time the debt is discharged by law, in this case when the entity is deregistered.
FTX Aus is currently in voluntary administration. The debt owed to you still exists while FTX Aus remains in administration, unless a deed of release is executed acknowledging the debt is discharged (such that you are legally barred from collecting the debt) or, until FTX Aus is deregistered. Until either of these occur, CGT event C2 has not happened and a capital loss cannot be claimed.
Records required for claiming FTX tax loss
While the administration of FTX Aus is underway, we recommend collecting the necessary records so you can substantiate your claim for the capital loss in the future.
Important records to substantiate the FTX loss include:
- full historical transaction records.
- screenshots to confirm holdings.
- other records such as emails, articles, and official insolvency notices confirming the events that occurred.
How to download a tax summary of my investments on FTX
A Customer Claims Portal has been released that will allow you to export your transaction history and account balance on FTX. You can use these exports to assist in your tax calculations.
You should not claim a capital loss until you know with reasonable certainty what amount can be recovered, if any.
As FTX Aus is in voluntary administration proceedings, you can’t know with reasonable certainty until the proceedings have concluded and a decision is made on the future of the companies or until an official declaration is made by the administrators.
How you claim a capital loss is dependent on how the FTX Aus situation unfolds and whether it develops into liquidation proceedings. Either CGT event C1 or C2 are most likely to occur allowing for the capital loss to be claimed.
You can take action now to collect documentation and records of your FTX crypto investments. In particular, you should obtain records of your transactions on FTX, and any transfers to and from FTX. Keeping appropriate records are required to support your eventual claim of a capital loss.