Is tax law change the death knell for SA's crypto R&D?

Robert Hare, senior associate, Bowmans

Cyptocurrency is categorised as a financial instrument in the draft Taxation Laws Amendment Bill, published for public comment in July 2018. If this change becomes law, it will prevent start-ups, incubators, and any other companies that develop cryptocurrencies in South Africa from claiming a significant income tax incentive – the research and development (R&D) allowance.

This tax break can’t be claimed for activities associated with creating or developing financial instruments.

R&D incentive out of reach

The R&D allowance is a longstanding tax incentive intended to encourage various forms of innovation in South Africa, including computer programs, which could otherwise include new cryptocurrency development.

Developing a cryptocurrency is a substantial undertaking, involving considerable technical know-how and teams of highly skilled software developers writing large amounts of sophisticated code.

On the other hand, developing a financial instrument, which would usually take the form of a loan, share, or derivative, amongst other things, is less likely to require scientific or technological expertise. Developing a cryptocurrency is also more likely to attract sought after technical know-how and skills to South Africa, and unlock new growth in the economy, than developing a financial instrument.

These are presumably some of the reasons financial instruments developers are prevented from claiming the R&D allowance. This makes sense, in principle.

It is therefore surprising that cryptocurrency developers will not be able to claim the R&D allowance for income tax purposes.

No reasons given for the change

What makes the situation even more difficult to understand is that the South African Revenue Service (Sars) and National Treasury have not explained the thinking behind their plans to classify cryptocurrency as a financial instrument. This outcome may have been intended, or it may be the result of a simple oversight. So far, however, no reasons have been forthcoming.

Usually, when provisions of a tax law are being amended, Sars will explain the change and give reasons for it in an accompanying explanatory memorandum.

Not this time.

The explanatory memorandum simply says that the proposed definition of a cryptocurrency as a financial instrument for income tax purposes is intended to “clarify” the existing provisions relating to cryptocurrencies in South African tax law. This is in fact a completely new reference and not a clarification at all.

South Africa desperately needs to grow its economy and create skills and jobs. The country can move towards these goals by positioning itself as a leader in fintech on the African continent, and by creating a regulatory framework that will encourage entrepreneurs from around the world to anchor their fintech businesses here. For the reasons explained above, the supposedly small change of categorising cryptocurrency as a financial instrument is an unnecessary step in the opposite direction.

National Treasury usually calls for comments in relation to tax proposals for the following year’s legislative cycle, in November. It is therefore still possible for the public to make submissions on this issue. In the meantime, a proper explanation for this change from either body, clarifying whether it was intentional or unintentional, would be welcome.