South African innovators hoping to position the country as a hub for fintech innovation are bound to be disappointed by a seemingly small tax law change that National Treasury and the South African Revenue Service (SARS) are proposing.

The small change – which will have a big effect – is that cryptocurrency has been 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. The R&D allowance may not be claimed in relation to activities carried out for the purpose of 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 the creation and development of computer programs of an innovative nature – which could otherwise include the development of new cryptocurrencies.

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. The development of 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 the development of a financial instrument.   

These are presumably some of the reasons why developers of financial instruments are prevented from claiming the R&D allowance for income tax purposes. 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 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. South Africa 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 to National Treasury on this issue.  In the meantime, a proper explanation for this change from National Treasury or SARS, clarifying whether it was intentional or unintentional, would be welcome.

Written by Robert Hare, senior associate, Bowmans