Cryptocurrency

Tax implications of the Ethereum Merge and what to do to prepare

We spoke with Tony Dhanjal, Head of Tax at CryptoSlate. coinleya crypto-focused tax software company.

Koinly allows users to create tax reports by linking wallets and exchange accounts and using on-chain data to calculate tax liability.

Creating a cryptocurrency tax report is nearly impossible for the average user and can be costly for accountants due to the potentially huge number of transactions that need to be processed. I have.

Given Koinly’s deep understanding of both taxes and cryptocurrencies, CryptoSlate spoke with Dhanjali about the upcoming Ethereum merger to find out if the event would trigger a taxable event.

What are the main tax implications of the merger?

It all depends on whether there is an incoming Proof of Stake (PoS) chain (currently on the Beacon chain) and a (hard) fork of the original Proof of Work (PoW) chain.

Without a hard fork, due to the change in consensus mechanism from PoW to PoS due to a merger, a taxable disposal event is unlikely and ETH would remain ETH as there are no new crypto assets.

Existing ETH holders will only get ETH PoS tokens in exchange for their original tokens on a 1:1 basis, and the original cost base will be attributed to the new PoS tokens.

In the event of a hard fork, there are potential tax implications depending on where the taxpayer resides.

Are there specifics for regions like UK and US that people should know?

In the United States, the IRS has not issued guidance regarding the merger event itself. However, the IRS provides clear guidance regarding hard forks. This means that if an investor receives an airdrop of new coins after the hard fork, they will receive taxable income. Taxable income is based on fair market value at the time of receiving the airdrop of her PoW her tokens in the hands of investors. If it’s zero when you receive it, then in the end this is fair market value and mathematically your tax. On-zero is zero.

It can be assumed that in the UK, according to current guidance, no income tax will be applied upon receipt of PoW tokens. Instead, investors are subject to capital gains tax on materialized gains or losses based on ETH (PoW)’s allocated cost base.

How do you think a PoW hardfork token like ETHw will be viewed by HMRC in terms of value? Is the token worth $0? Is it an airdrop as it has never been traded?

The value of PoW tokens based on their original acquisition cost should be distributed on a fair and reasonable basis. This could be a 50-50 or time-based allocation as a starting point, but HMRC does not define ‘fair and reasonable’ in this context. Disagree.

In terms of market value, it theoretically starts at $0, assuming PoW tokens are backed by oracles and exchanges and have a reliable price feed. At the start of the fork, the total gain/(loss) of the combined PoW and PoS tokens should be balanced with the ETH gain/(loss) before merging.

Do you think current tax laws are adequate for the current state of cryptocurrencies?

In short, no.

One of the goals that tax law should, in principle, achieve is tax neutrality. This is if his tax framework for one asset class, such as Crypto, does not unfairly incentivize or de-incentivize investors compared to similar asset classes such as equities and securities. is.

While the tax treatment of ordinary cryptocurrency transactions (buying and selling) is much the same as stocks and securities, DeFi activities are not on par with traditional finance. Many tax authorities like the IRS in the US have remained silent on the tax treatment of defi transactions, but if guidance were to be issued by HMRC in the UK it would be complex and, in my opinion, hinder DeFi activity. only.

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