The income tax and VAT consequences for crypto asset mining will vary depending on the different ways that crypto assets are earned as rewards.
Cryptocurrency can be earned in two ways:
- proof-of-work (POW) mining – where the miner owns the machines (Scenario 1a) or rents the computing power (Scenario 1b).
- proof-of-stake (POS) rewards.
POW mining uses a validation method where crypto miners compete using algorithms to validate transactions on a blockchain network.
This requires computers to solve cryptographic equations, putting in “work” to be rewarded for the ability to verify transactions on the blockchain.
Coins that are mined using POW include Bitcoin, Litecoin, Bitcoin Cash, and Monero.
Alternatively, POS requires crypto miners to “stake” a certain amount of cryptocurrency as collateral to have a chance of becoming a validator node that mints a new block of transactions.
However, should they make a mistake, go offline, or attempt to defraud the system, they lose some or all of the collateral staked.
Your chances of being selected as a validator usually increase with the size of your stake.
Examples of coins that are mined using proof-of-stake include Cardano and Solana.
Scenario 1a: Tax deductibles and implications as a POW miner that owns the machines
POW mining requires graphics cards or Application Specific Integrated Circuit (ASIC) machines. These are the machines used to solve the algorithms to validate a transaction.
Some algorithms are designed to be ASIC-resistant, wherein a miner can only use graphics cards to solve them.
The important difference between these machines is that the GPUs used for mining are usually top-of-the-range gaming graphics cards, which means they can be used elsewhere if not for POW crypto mining.
Conversely, miners can only use ASIC machines for POW mining and nothing else.
Section 11(e) and Interpretation Note 47
According to Joon Chong, a partner and tax specialist at Webber Wentzel, Section 11(e) of the Income Tax Act (ITA) and Interpretation Note 47 (IN 47) will determine how to claim the costs of using the graphics cards or ASIC machines.
If an item costs less than R7 000, then a full write-off can be claimed in the year of acquisition.
Where the cost of an item is greater than R7 000, then the recommended write-off periods in IN 47 would apply.
ASIC machines and graphics cards are considered “personal computers,” and IN 47 generally allows for personal computers to be written off over three years, and this applies as follows:
- Graphics cards can be written off over three years in line with IN 47, as they can be used for other purposes.
- ASIC machine is only used for proof of work, and Its useful life is less than two years, based on Moore’s law (an empirical law held since 1965 that says computing power doubles every two years). Therefore, the costs of ASIC machines can be written off over two years.
Other tax-deductible costs during POW mining include electricity, maintenance, rental of premises, salaries, and shipping — according to section 11(a) of the ITA.
Section 2(1)(o) of the VAT Act
Crypto mining is exempt from Value-Added tax, and VAT paid by the miner in expenses cannot be claimed back as input VAT, as there is no output VAT on the supply of cryptocurrencies by the POW miner.
VAT can only be claimed back when included as a deduction against income for income tax purposes.
Additionally, If the miner in this scenario also has digital wallet management services, for which a fee is charged, this fee is not exempted, and standard VAT rules apply.
Coins which appear in the wallets are considered “trading stock”, as defined in the ITA.
Gains or losses on these coins are taxable on the disposal of the asset, similar to ordinary revenue from a profit-making scheme.
Scenario 1b: the POW miner rents computing power from a supplier
In this scenario, the POW miner does not own the computing power used to solve the algorithms to validate a transaction but rents them from a supplier.
Chong used Nicehash as an example, where the crypto produced is either paid into a wallet, or Nicehash will liquidate the coins for USD.
Nicehash then pays the USD to the POW miner after deducting the rental for the computing power.
The supply of computing power falls into the “cloud computing” category and is an electronic service in terms of the VAT electronic services regulations.
Nicehash is carrying out an “electronic service” in terms of the VAT regulations and would need to register as a VAT vendor if the supply to South African recipients is more than R1 million in 12 months.
The POW miner will not be able to claim the VAT paid on the rental as input VAT because the service was used to generate an exempt supply (cryptocurrency).
For income tax purposes, the POW miner renting the machine who earns coins from mining or USD is accumulating trading stock.
The gains or losses of revenue are taxable on the disposal of the asset. In the arrangement where Nicehash sells these coins for USD, the USD paid (less rental due) to the POW miner would be income.
Tax deductibles and implications as a POS miner
POS mining generates rewards in the form of coins for locking away cryptocurrencies (it “stakes” the coins). It is, therefore, similar to being a company shareholder on any given stock exchange.
According to Chong, coins earned through POS mining are likened to dividends in the form of capitalisation shares, and these coins become taxable as income when they appear in the wallet.