CryptoSlate sits down with Tony Dhanjal, Head of Tax at Koinly, a leading platform specializing in crypto tax solutions.
Koinly simplifies the tax reporting process by enabling users to sync their wallets and exchange accounts, automatically calculating tax liabilities using on-chain transaction data.
For many investors, compiling tax reports for digital assets is a complex and costly endeavor, often requiring professional accounting services due to the sheer volume of transactions.
Leveraging Koinly's deep expertise in both taxation and cryptocurrency, we spoke with Dhanjal about the Ethereum Merge to uncover any potential tax events investors should anticipate.
What are the primary tax implications of the Merge?
The entire situation hinges on whether a hard fork occurs, creating a separate Proof-of-Work (PoW) chain alongside the new Proof-of-Stake (PoS) chain.
If no hard fork materializes, it's highly unlikely that the transition from PoW to PoS will trigger a taxable event. This is because no new crypto asset is created—your ETH simply remains ETH. Existing ETH holders will receive a new ETH PoS token on a 1:1 basis for their original token, and the original cost basis carries over to the new PoS token.
However, if a hard fork does occur, there could be significant tax implications, depending on your tax residency.
Are there specific rules for territories like the UK or the US that people should be aware of?
In the US, the IRS has not issued specific guidance on the Merge event itself. However, the IRS provides clear guidance on hard forks: if an investor receives an airdrop of new coins from a hard fork, it is considered taxable income. The taxable income is based on the fair market value (FMV) of the airdropped PoW tokens at the time they are received. If those tokens are immediately sold, the tax on that sale is calculated based on that FMV.
In the UK, according to current guidance from HMRC, income tax is not typically applicable upon receipt of PoW tokens from a fork. Instead, investors will be subject to Capital Gains Tax (CGT) on any gains or losses realized upon disposal, based on an apportioned cost basis for the original ETH holding.
How do you think HMRC would value a PoW hardfork token like ETHW? Would it be valued at $0 because it's never been traded, or could people be taxed on the full equivalent value of ETH?
The cost basis of the original holding would have to be apportioned on a 'just and reasonable' basis between the PoW and PoS tokens. A 50/50 split could be a starting point, or a time-based allocation. HMRC doesn't define 'just and reasonable' in this context; it's up to the taxpayer to decide on a method and keep clear records in case of an HMRC inquiry.
Regarding market value, forward-looking PoW tokens are supported by oracles and exchanges with reliable price feeds. In theory, at the moment of the fork, their value starts at zero. The combined gain/loss of the PoW and PoS tokens after the fork should, in theory, align with the pre-merge ETH gain/loss.
Do you believe current tax laws are adequate enough for the current state of crypto?
In short, no.
One core principle that tax rules should follow is tax neutrality. This means the tax treatment of an asset class, like crypto, shouldn't unduly incentivize or disincentivize investment compared to similar classes, such as stocks and securities.
While the tax treatment of standard crypto trading—buying and selling—is fairly aligned with traditional assets, the world of DeFi is not on par. Some tax agencies, like the IRS in the US, have remained silent on the tax treatment of many DeFi transactions. Where guidance has been issued, like from HMRC in the UK, it is often convoluted and, in my opinion, serves only to disincentivize participation in DeFi.
Tony Dhanjal founded and runs the Business & Tax Academy.
