How Bitcoins are Taxed in UK
The bitcoin is a new system of payment and the world’s first decentralised digital currency, also known as a “cryptocurrency”. The introduction of crypto currencies such as bitcoin is an innovative and developing area and their legal and regulatory status has not been established yet. Owing to their unique identity, cryptocurrencies cannot be directly compared to any other form of investment activity or means of payment.
Although bitcoin transactions have been declared as illegal in some countries, and other countries have disallowed their banks from handling the currency, bitcoin is available to use in the UK. Consequently, there are tax impacts, too. Here, we will discuss the tax implications of bitcoins in the UK.
Bitcoin activity - just a hobby or a trade?
Questions are now being asked about bitcoin activity, on whether this should be considered a hobby or trading. There have been several tribunal cases on the issue. It is important to mention here that a hobby does not fall within the ambit of the taxation system, but trading does. Hence, the labelling of bitcoin activity as either a trade or a hobby is going to be a determining factor in the consideration process of its tax position.
Tax practices of bitcoin activities in UK
The HMRC guidelines on the tax treatment of transactions relating to the sale or use of bitcoins and other similar cryptocurrencies are applicable for bitcoin (miners, traders, exchangers, payment processors and other service providers).
What is bitcoin mining?
As bitcoin does not operate under any central authority or bank, each and every transaction is recorded in a shared public account book called a ‘block-chain’. A change in ownership of a bitcoin must be registered for it to be effective. Every time a block is added to the block-chain, the user gets a number of bitcoins. This entire process is called ‘mining’.
Besides mining, bitcoin is also bought and sold, and exchange services are provided for parties to trade bitcoin with accepted currencies. Bitcoin may be used to pay for goods or services or held as an investment in places where it is accepted as payment.
Bitcoin’s growing popularity in the UK means increasing number of transactions is taking place. This makes it necessary to think about the VAT, income tax, capital gains tax and corporation tax treatment of bitcoin activities, and therefore, all tax advisers must now understand this new mode of trading.
Bitcoin and VAT
Before the recent regulation, bitcoins and other virtual currencies used to be viewed as vouchers by HMRC and were therefore subject to VAT. However, due to the changeable value of bitcoins, HMRC has clarified its stand in HMRC Brief 09/14. The recently published HMRC guidance upholds that:
- incomes generated from bitcoin mining activities will usually be outside the ambit of VAT;
- miners’ income for other activities, for example, charges related to the confirmation of specific transactions, will not be subject to VAT because they fall within the definition of transactions, including negotiation, relating to deposit and current accounts, payments, debts, transfers, cheques and other negotiable instruments;
- there will be no VAT due on the amount of the bitcoins when bitcoins are transacted for sterling or for a foreign currency;
- Surplus charges on the value of the bitcoin for arranging or executing any transactions in bitcoin will be free from VAT.
For payment made with bitcoins for supplies of goods or services, VAT will be due in the standard way, based on the sterling value of the bitcoins close to the sale.
Defenders of bitcoin wanted HMRC to rethink their position that the cryptocurrency should be subject to VAT, therefore, the decision to exempt bitcoin from VAT comes as welcome news for many businesses.
Since VAT is a tax that is exercised all over the EU, any dealing with VAT for cryptocurrencies in the United Kingdom essentially needs to be consistent with EU practices.
The guidance provided by HMRC is thus temporary and may be subject to change. However, any alterations to the guidance will not come into effect retrospectively.
Different taxes and their activities concerning bitcoins
In the case of activities concerning bitcoins and other cryptocurrencies, the taxes like income tax, corporation tax and capital gains tax transactions will hinge on the very activities taking place and the parties involved, in the similar way as transactions involving a normal currency, such as sterling, are decided.
No special instructions are there for income tax, corporation tax and capital gain tax for the transactions relating to bitcoins. Mentioned below are some relevant rules:
Corporation tax: The incomes and losses on exchange movements between currencies, that also cover virtual currencies, are chargeable as per the general rules on foreign exchange and loan dealings.
Income tax: Under general income tax rules, the profit and losses of a non-incorporated business will be chargeable.
Chargeable gains and losses: If a profit or loss on a currency agreement is within the loan dealing rules or not within trading incomes, it will be liable to tax or allowable for capital gains tax if received by an individual or, for corporation tax on chargeable gains if received by a company.
When payment for goods or services is accepted in the form of bitcoins, it is to be treated just as a payment made in sterling. There will be no change in the way taxable profits are calculated.
Badges of trade and transactions
Even though bitcoins are regarded as a recent development, the guidance on badges of trade have existed since the 1950s.
The Royal Commission on the Taxation of Profits and Income, in June 1955, laid down the following main parameters to determine the badges of trade:
- the topic of the realisation;
- the duration of ownership;
- the number of similar transactions by one person;
- additional work on or in connection with the material goods realised;
- the circumstances in which the realisation took place; and
Badges of trade will also be reviewed when the tax treatment of bitcoin undergoes a revision.
Speculative bitcoin activity
The HMRC guidance states that depending on the circumstances, the transactions may be so highly estimated, that it may not have tax liabilities, nor any losses recorded can be entitled for relief. For instance, gambling or betting wins are not chargeable and gambling losses cannot be compensated by other taxable profits.
Gambling is normally not within the ambit of tax and so this ‘tax free’ treatment will be applied to bitcoin activity.
According to HMRC guidance, in the UK, a trading activity will continue to be considered on the basis of preparing profit and loss accounts to ascertain taxable profits; and the value of goods or services bought or sold using virtual currencies must still be accounted for at their market value or the exchange value of the virtual currency converted into UK pound sterling.
For a trader, this is understandable. However, an individual having bitcoin or other virtual currency may not be certain whether their investment or holding is chargeable or whether the losses are acceptable. If speculating on the coins growing in value, it may be that this activity is viewed as similar to gambling; and if HMRC agree there would be no tax due on wins, but no relief for losses either. If the purpose behind holding the virtual currency is the creation of long-term assets, then this is more like investment and the gain or loss on disposal or sale is expected to come into charge to tax as a capital gain.
HMRC says that the evaluation of whether or not a profit or gain is taxable, or loss allowable, will be case-specific. Before setting out on a venture, potential investors should seek guidance on whether their activities would be considered a trade.
- Tax advisers must accept and understand the activity of bitcoin from the beginning;
- Tax advisers just cannot ‘process’ the loss claims. The whole purpose, subject matter and circumstances of realisation have to be scrutinised. Evidence to support all claims is essential;
- Any bitcoin movement has to be examined on a ‘case by case’ basis, as do all sideways loss claims, which have to be dealt with on a ‘loss by loss’ basis. All loss claims must be substantiated by evidence and business plans.
The matter in hand
The cognizance of bitcoin transactions together with any hobbies that results in earnings (and losses) from a tax perspective and how these activities are addressed in terms of tax planning and compliance on tax returns
What is important?
It’s necessary to scrutinise bitcoin activity, and in fact all clients’ affairs, on a case-by-case basis and to get hold of strong evidence in each case
The key message
Facts about any changes and developments in clients’ tax affairs are important, together with the need to ask for information from clients about all new activities, focussing on situations that are not clear, abnormal transactions and to substantiate all claims with evidence.