Understanding the Tax Implications of Wrapping Tokens in Australia

Introduction

Examples of wrapped tokens

• Wrapped Bitcoin (WBTC): WBTC is a popular wrapped token that represents Bitcoin (BTC) on the Ethereum blockchain. It enables users to utilize BTC within the Ethereum ecosystem, accessing decentralized finance (DeFi) protocols and other applications.
• Wrapped Ether (WETH): Similar to WBTC, WETH is a wrapped token that represents Ether (ETH), Ethereum’s native cryptocurrency, on other blockchains. It allows users to leverage ETH’s functionality and liquidity across various decentralized platforms.
• Wrapped BNB (wBNB): wBNB is a wrapped token that represents Binance Coin (BNB), the native cryptocurrency of the Binance exchange, on other blockchains. It facilitates the use of BNB in DeFi applications and other cross-chain interactions.
• Wrapped Matic (WMATIC): WMATIC is a wrapped token that represents Polygon’s native cryptocurrency, MATIC, on other blockchains. It enables users to utilize MATIC’s capabilities and participate in DeFi activities across different networks.
• renBTC: renBTC is another popular wrapped token for Bitcoin that utilizes a decentralized custody mechanism. It ensures the security of BTC while allowing it to be used on various blockchains.
• Wrapped Stablecoins: Wrapped stablecoins, such as wUSDC and wUSDT, represent stablecoins like USDC and USDT on other blockchains. They maintain a stable value against fiat currencies and facilitate cross-chain transactions.

Taxation of Wrapped Tokens in Australia

The process of wrapping tokens involves utilising smart contracts, which execute predefined conditions on the blockchain.

When a user wraps a token, the original cryptocurrency is sent to a smart contract address. This results in the creation of a wrapped version of the asset.

The ATO’s revised stance considers that the act of wrapping or unwrapping a crypto asset triggers a capital gains tax (CGT) event.

This implies that gains or losses from this action are subject to taxation, resetting the 12-month CGT discount period.

According to the ATO, despite the economic substance of the transaction remaining unchanged, the act of wrapping involves an exchange of one crypto asset for another. Consequently, the capital proceeds for CGT purposes are determined by the market value of the wrapped token at the time of exchange.

Case study

Consider a scenario where an individual purchases 10 Ether (Eth) tokens for $20,000 in November 2023.

In May 2024, they wrap the Eth into 10 Wrapped Eth (wETH) using a smart contract. The market value wETH being $2,500 per token.

This wrapping process triggers a CGT event. The resultant capital gain being $500 per coin. So a total gain of $5,000.

Alternative Viewpoints

Criticism towards the ATO’s stance revolves around the belief that wrapping tokens does not equate to an economic realisation.

Comparisons have been drawn to variations of share rights, which are not typically taxed.

Suggestions have been made to extend similar treatment to crypto assets, considering that wrapping changes the rights associated with the asset.

However, the ATO maintains a narrow interpretation of Australian tax law and has shown reluctance to adopt alternative perspectives.

It is unlikely that this stance will change without new legislation or legal challenges that challenge the current position.

Conclusion

While wrapped tokens offer substantial advantages in enhancing liquidity and interoperability in the crypto space, the ATO’s taxation approach raises concerns for users.

The risk of unintentionally incurring significant cryptocurrency tax liabilities necessitates seeking tailored professional advice to navigate these complex tax implications effectively.

Awareness and guidance are key to mitigating potential tax risks associated with dealing in wrapped tokens within Australia’s tax framework.