Traditional blockchain networks employ “proof-of-work” (PoW) consensus mechanisms to ensure reliability across their distributed ledgers. These PoW networks, such as Bitcoin, rely on energy-intensive mining activities. However, a more sustainable alternative has emerged: “proof of stake” (PoS) or staking.  

Ethereum (ETH) and several other blockchain platforms have adopted staking as a fundamental component of their networks. Participants (or forgers) in these networks are rewarded with staking rewards for their efforts to support the integrity of their network’s transactions.  

As blockchain technology progresses, addressing its own challenges such as power and broadening its scope to new applications, existing tax legislation has somewhat fallen behind. The Australian Tax Office’s position on the taxing of staking rewards is simply:  

The money value of additional tokens is ordinary income at the time you receive the tokens. 

However, in systems that often restrict access to the rewards, when does the taxing point arise?  

HOW DOES STAKING WORK?  

Staking involves participants locking up their cryptocurrency to be randomly selected by the protocol to validate transactions. If chosen, participants validate the transactions and generate a new block on the blockchain. Instead of being mined, these blocks are considered forged, and as a result, validators are sometimes referred to as “forgers”. 

Similar to miners in PoW blockchains, successful forgers are rewarded. However, accessing these rewards is not immediate. For example, staking rewards in Ethereum’s ETH2 were stored in a separate locked account that forgers could not access until a trigger event occurs. The trigger event in the case of ETH2 was the completion of “Phase 1.5” of the ETH network upgrade which occurred on 12 April 2023.   

WHEN IS INCOME TAXED? 

Under the Income Tax Assessment Act 1997 (Cth) (the Act) assessable income includes ordinary income derived from any source. However, for income to be assessable, it must be derived and not contingent.  

This raises an important question: When can we consider staked rewards as derived income for taxation purposes? 

BUILDING ON PRECEDENTS: ARTHUR MURRAY AND SENT  

In many staking arrangements forgers are temporarily restricted from determining when they receive or how they utilise their rewards. Simply put, taxpayers may be unable to access, control, or handle these rewards until after the trigger event takes place.  

Consequently, does this imply that the income is yet to be obtained and therefore not yet subject to assessment? 

Arthur Murray (NSW) Pty Ltd v FC of T (1965) 114 CLR 314 (Arthur Murray) sets out the leading principle on the derivation of income. The High Court stated (at 318) that: 

… A judicial decision as to whether an amount received but not yet earned or an amount earned but not yet received is income must depend basically upon the judicial understanding of the meaning which the word conveys to those whose concern it is to observe the distinction it implies. What ultimately matters is the concept; book-keeping methods are but evidence of the concept. 

Further, as noted by Murphy J in Sent v FC of T 2012 ATC 20-318; [2012] FCA 382 (Sent) (at [100]), if a taxpayer has a contingent right to income, that income is only able to be derived after the contingency is satisfied: 

This is an uncontroversial proposition, and an example of the general principal that where the right of the taxpayer to an amount is contingent, there will be no derivation of income before the contingency is satisfied: Barrat v Commissioner of Taxation 92 ATC 4275; (1992) 36 FCR 222, at 231 (“Barrat”) per Gummow J, Northrop and Drummond JJ agreeing. 

These legal precedents provide helpful analysis as to the derivation of income. They establish that if a taxpayer’s right to income is contingent, the income can only be derived once the contingency is satisfied. Hence, the precise terms and trigger events stated in staking contracts become pivotal in determining the taxation point. 

THE CRUCIAL ROLE OF STAKING CONTRACTS 

Understanding all the terms and conditions of a staking contract is important, as they may affect contingencies which dictate when tokens come under the control of the forger. Incorrect interpretation could expose the taxpayer to interest and penalties on tax shortfalls. 

Given the complexity and variations in staking contracts, it is advisable for individuals to seek professional tax advice to determine the correct trigger point.  

EFFECTIVE PLANNING  

It’s vital to note that staking rewards cannot be apportioned over previous periods. They are considered income for the year in which the trigger event occurs. Recognising the timing of the taxation point is essential for effective cash flow planning and provisions. 

CONCLUSION 

As staking gains prominence, determining the taxing point of staked rewards becomes crucial. However, the taxation assessment relies heavily on the specific terms and trigger events outlined in staking contracts. Seeking expert tax advice and understanding the contractual nuances are essential steps to navigate the complexities and ensure compliance with tax obligations. 

If you have questions about your tax position, please contact our Tax & Structuring team.