Since their introduction, crypto assets held have resulted in some uncertainty over the treatment of these assets for tax purposes.
Tax of crypto assets is still in some ways less certain than other areas of investments as there is no specific tax legislation for these assets. However, we can apply broader existing tax rules and HMRC guidance on tax treatment of crypto assets to advise clients.
In this blog, we look at some of the risks associated with crypto assets, some of the complexities around tax and crypto assets and the evolution of guidance and tax law when it comes to this type of asset.
Crypto assets as an investment
Firstly, it is worth highlighting, that crypto is a high-risk investment and can be incredibly volatile. The purpose of this blog is to understand how crypto assets are taxed with emphasis on tax implications for individuals when they are buying and selling Cryptos.
Crypto assets are a complex field – with evolving technology and applications, and the fact that we have over 4,000 cryptocurrencies and still counting.
In this blog, we are not providing any financial or investment advice, the matters covered are purely from a tax perspective. Our suggestion is to do your research, ensure that you are happy with the risks associated, and never invest more than you are willing to lose. We will also not cover the technical detail regarding the underlying technology as that is not where our expertise lies.
What are crypto assets?
Cryptography is mainly about secure communication using codes. Something stored, transferred or traded electronically using distributed ledger technology (DLT) and that technology operates using cryptography and hence the word “crypto” in crypto assets. For example, block chain is a type of DLT.
DLT is a digital system that records details of transactions in multiple places at the same time. The main difference between a bank and crypto is record keeping or ledger keeping. With bank there is a centralised system that records the transaction centrally. Unlike traditional databases, distributed ledgers have no central data store or administration functionality. Every participant of a network has a record of the transaction ledger. The key benefit is everyone can trust the data without involving a third-party intermediary. Because unlike a central system where data must be tampered only in one place, under DLT you will need to have consensus of every single node to make changes, so there is no single point of failure.
What are the different types of crypto assets?
Let’s look at some of the main type of crypto assets:
Are typically crypto assets used for payments. They provide digital store of value and used as a means of exchange or payment secured by cryptography – Most by popularly used as investments. Example Bitcoin, Dodgecoin
- Stable coins
The premise is that these tokens minimise volatility as they may be pegged to something that is considered to have a stable value such as a fiat currency (government-backed, for example US dollars) or precious metals such as gold.
- Utility Tokens
These provide holders with a product or service, they have additional functionality, often issued to raise funds for the development of projects connected to those goods/services, e.g. Civic token (used to verify user identity), Funfair tokens (gives access to online casino), Golem (gives access to computing power) etc.
NFTs are non-fungible tokens that represent possession of a unique item that cannot be replicated like artwork. They can represent digital or real-world items like real-estate.
There are other major crypto assets like security tokens – provide holder particular rights or interests in a business, smart contracts – contract written in codes and will operates after certain conditions are met.
Is crypto taxable in the UK?
The simple answer to this is that crypto assets are taxable in the UK.
The taxation of crypto assets - some basic information to consider
- When cryptos caught many governments off-guard, HMRC in the UK was relatively quick in setting out their views in the briefing published in 2014. The more detailed HMRC manual was published in March 2021 largely derived from the positions set out in the policy papers entitled Crypto assets: tax for individuals and Crypto assets: tax for businesses, which were first published in December 2018 and November 2019 respectively.
- There is no specific tax legislation, so we need to rely on existing legislation.
- Gambling transactions are exempt from CGT. So, a professional gambler is non-taxable, similarly no relief for losses. HMRC has made clear in their guidance that they do not consider trading in crypto assets as gambling.
- Further they do not consider cryptos as money or currency as per the taskforce Report – To be classed as money, an asset must satisfy three conditions – medium of exchange, unit of account and monetary store of value. Cryptos are too volatile to be a good store of value, they are not used as a unit of account, and they are not widely accepted as means of exchange.
- The tax treatment of all types of tokens is dependent on the nature of the transaction and use of the token and not the definition of the token. It is what one does with the cryptos is what determines the tax treatment, which is true for other assets as well like land/shares.
Taxation of crypto for individuals
- There are two ways generally an individual would acquire crypto assets – they may have bought cryptos or they would have earned cryptos.
- Majority of the individuals subject to tax would have bought cryptos - it’s the nature of the transaction which determines the tax treatment.
- If the individual’s activity of buying and selling of cryptos is regarded as a financial trade - they will be subject to income tax. The bar to meet the trading requirement is very high, and we will cover this below.
- Individuals buying crypto assets as a personal investment, usually for capital appreciation or to make particular purchases – will be subject to Capital Gains Tax.
- If it’s being bought for use in a business, the tax treatment will follow as normal. Charge to income tax at fair value of the asset when received – loss or gain when encashed.
Trading vs Investment
- When a person is making a profit, it is undesirable for the activities to constitute as trade as they will be subject to income tax and national insurance. However, there are benefits like potential flexibility of setting trading losses against general income of the current year or prior years.
- As a “trade” is not fully defined in the legislation, the interpretation of what is meant by the term “trade” has been left largely to the Courts. The Courts have developed a number of tests to determine whether somebody is trading. These tests are known as the “badges of trade”. 9 factors are considered and sometimes even the existence of one single badge is enough.
- HMRC view is individuals are unlikely to be trading in crypto – CRYPTO20250. The further say “Only in exceptional circumstances would HMRC expect individuals to buy and sell exchange tokens with such frequency, level of organisation and sophistication that the activity amounts to a financial trade in itself. It is better for HMRC to regard as investor as can’t claim loss relief.
- There are no case laws on cryptos but the analogy can be drawn from cases on shares and securities.
- In recent cases Akhtar Ali v HMRC (2016) and Gill the taxpayers were able to demonstrate that they had a deliberate and organized way of operating and the First-tier Tax Tribunal held that an individual buying and selling shares can be classed as trading for tax loss purposes.
- In case of Mr Akhtar, he had traded in large volumes (thousands a year) of quoted shares for 20 years. He had used a specially set up office for his share dealing while employing a locum to manage his pharmacy business. It was considered significant that the individual had a deliberate and organised scheme of profit making. It appears that it will depend on the facts of each individual situation.
- But in majority circumstances n individual trader will usually be regarded as an investor even if?they undertake 100’s of transactions.?
What constitutes disposal?
- Disposal of cryptocurrency is taxable event, irrespective of whether funds are withdrawn or?reinvested?.
- Buying land and property in exchange of cryptos or a piece of art. Converting crypto assets to sterling
- Gifts – if you are gifting cryptos to another family member - connected party rules will apply - all transactions between them take place at market value for capital gains tax purposes. - ancestors, descendants, relatives. Gifts/transfers between husband and wife will be at no gain/no loss.
- Exchange of one crypto asset for another crypto asset. Example bitcoin for Ethereum.
- Medium of exchange - Buying goods or services using cryptos.
- Hard fork – update of a blockchain software you may receive new coins as a single currency is split into two– part disposal.
What is not disposal?
- Transfer between wallets – i.e. from one exchange to another will not be a disposal.
- Misplacing your private key is not disposal. Misplacing your computer or hard drive which stores your crypto assets (if not held on an exchange).
- Tumbler/mixing – Software services breaks a connection between crypto sending addresses and receiving address. Stops from being traced. It’s not a disposal as you get the same amount back.
- If your cryptocurrency is stolen/hacked
- Rugpull – a new crypto project is pumped and attracts investors, once the price is peaked – those connected with the project dump their tokens, leaving the price to crash, leaving the tokens worthless.
- If you donate tokens to charity, you will not have to pay Capital Gains Tax on them.
Capital Gains Tax
- The disposal of cryptos by an individual will be subject to CGT.
- The CGT payable will depend on your marginal rate of tax. Generally, if you are a higher rate taxpayer you will pay tax at 20%. For basic rate taxpayer, you will pay tax at 10% on the unused basic rate band and the higher rates once the basic rate band is fully utilized.
- Additionally, every individual has an annual exemption/capital gains allowance for capital gains tax. This annual exemption is £12,300 currently. The annual exemption is similar to the personal allowance for income tax in that the first £12,300 of capital gains in the year are not chargeable to CGT.?
- To calculate the chargeable gains - We simply take proceeds of sale and deduct all costs of acquisition to leave us with the capital gain. In essence, we are simply working out the cash profit on the transaction.
- As cryptos are subject to CGT, any losses on disposal are allowable to be deducted from other gains.
- The losses can be offset against the gains of the same year or carried forward indefinitely to be offset against other gains in the future.
- Losses have to be notified to HMRC within 4 years from the end of the tax year in which they occurred, or they are completely lost. So, if you incurred a loss in 2018/19 and not informed HMRC, it is completely lost.
- If you invest in a crypto asset that turns out to be worthless, lost, destroyed than you can submit a negligible value claim.
- There is no prescribed form in which the claim needs to be made. Only in writing to HMRC – your details, crypto assets in question, the number of crypto assets held, and the value to be treated as consideration. The claim should be signed. – LUNA example.
The following are allowable costs you can claim against crypto gains.
- Consideration for the crypto
- Exchange fee HMRC has given detailed breakdown in their manual as some fees are allowable and rest of them not.
- Advertising cost – might be more relevant for NFT’s to find a purchaser.
- Professional costs – drawing up contracts for acquisition or disposal.
- Costs of making an apportionment or valuation in order to calculate the gains or losses.
- Costs for mining activities (for example equipment and electricity) do not count toward allowable costs in respect of tokens because they’re not wholly and exclusively to acquire the tokens, and so cannot satisfy the requirements.
- The nature of the crypto tokens means they are dealt in without identifying the particular tokens being disposed of or acquired and therefore the same pooling rules that apply to shares apply to cryptocurrencies.
- Non-Fungible Tokens (NFTs) are separately identifiable and so are not pooled and no matching rules are applied.
- Each type of token will need its own pool. For example, if a person owns bitcoin, ether and litecoin they would have three pools and each one would have its own ‘pooled allowable cost’ associated with it.
- Stop people from selling and immediately acquire assets to amplify their losses. Good examples.
- Same day rule - where securities disposed of are matched with acquisitions of the same securities on the same day. If s.105 rule does not apply or does not apply to all tokens, consider the 30 day rule.
- 30 day for securities disposed of and then re-acquired within 30 days of the disposal, securities disposed of are matched with subsequent acquisitions in priority to any acquisition of those shares before the disposal date. If s.106A rule does not apply or does not apply to all tokens.
A wallet is simply an identifier on the blockchain – an address that has certain assets attributed to it. It is possible to assign this to a company, in the same manner that other assets can be contributed to a company and would suggest the relevant documentation is drafted accordingly. I would also look out for any gains that might crystallise on transferring to a limited company.
Airdrop: Allocation of tokens Marketing ploy to promote tokens. Charged as miscellaneous income could this include, not clear say, a supportive Instagram post or a Facebook like?. Presumably no tax charge on receipt if, for example, tokens are received randomly as part of a marketing campaign.
Mining: Tokens provided for verifying additions to the blockchain digital ledger (i) payments provided for a service where it has been agreed that the service would be provided for reward and (ii) payments received under an agreement or arrangement not otherwise taxable (regardless of whether or not agreement/arrangement is legally enforceable). Relevant arrangement here seems to be the protocol itself.
Staking: Fees received for validating transactions on proof of stake blockchains taxable as misc. income (if not trading)
Earnings: Crypto assets received as employment income count as ‘money’s worth’ and are subject to Income Tax and National Insurance contributions on the value of the asset.
UK Inheritance Tax (IHT) for crypto assets
The value of any crypto assets would be included in your estate for IHT purposes and potentially subject to 40% IHT. Due to the nature of crypto, accessing this information by your executors is challenging. To mitigate this problem, many platforms now let you authorise someone to access your account on your death.
Taxation for businesses
It is likely they will be liable to pay one or more of the following:
- Capital Gains Tax (CGT), Corporation Tax (CT), Corporation Tax on Chargeable Gains (CTCG), Income Tax (IT), National Insurance Contributions, Stamp Taxes, VAT
- Similar to individuals, companies or businesses will simply hold as investments and therefore subject to corporation tax as capital.
- If a company or business is carrying out activities which involve exchange tokens, they are liable to pay tax on them. If the exchange tokens are held as part of an existing trade, profits of a revenue nature will need to be included in the trading profits.
Later when sold, the assets will be subject to Corporation Tax as capital.
Business considerations re: crypto assets
- If you are paying employees in cryptos you may have certain reporting obligations and employers NI.
- Qualifying from relief – EIS, activity of trade that matters, this is a new area and you can get non-statutory clearances.
- VAT – If crypto assets are used to pay for goods or services, this is simply consideration (taking the sterling value at the relevant date); the transfer of the crypto asset is not itself a supply.
- HMRC accepts that mining is not generally an economic activity for VAT purposes (no sufficient link) and there is no customer.
What kind of records might HMRC ask for in regard to crypto?
As ever the onus is on the taxpayer to keep records of transactions, ownership etc.
- Transactions via an exchange may be recorded but (a) records may not be kept for long and (b) the exchange may disappear.
- HMRC will expect to see the type of crypto asset, the date of the transaction, the nature of the transaction, the number of units involved, the value of the transaction in sterling, the cumulative total of investment units held and (as necessary) bank statements and wallet addresses.
- Right tech using software signed by HMRC, user friendly, extracting data– Koinly, Crypto Tax.
- Detail log of transactions - Platforms such as Koinly will scrape the data from transactions between exchanges as well as wallets that individuals use to hold their crypto. They will then be able to put together a detailed log of transactions, which may still need some fine-tuning.
- You should keep your records for at least 22 months after the end of the tax year the tax return is for.
Other points to note with regard to crypto assets
- There is no UK tax liability if you are non-resident of the UK.
- No underlying asset, e.g. exchange tokens – HMRC’s view is that situs follows the residence of the beneficial owner as determined by the Statutory Residence Test
- Profits will need to be calculated in sterling (absent adoption of a different functional currency). So one may need e.g., dollar price of Bitcoin converted to sterling.
- How would HMRC know? - HMRC can use normal information powers including 3rd party notices. Some exchanges have already received such requests, nudge letters
- We are pleased to see that the Self-Assessment tax return will start to ask specific questions about crypto assets for the 2024-25 tax year. There has been significant growth in recent years in the number of people buying, selling and investing in these virtual assets, and not everyone is aware that income and gains from such transactions are taxable.
- Decentralised Finance (DeFi) - The government is seeking views on modifying the tax treatment of decentralised finance (DeFi) lending and staking. The intention of the consultation is to create a regime that better aligns the taxation of cryptoassets used in DeFi lending and staking transactions (DeFi transactions) with the underlying economic substance, whilst reducing the administrative burden on users. Find out more here.
- HMRC does not currently accept crypto for payments in tax, which highlights some of the difficulties with dry tax charges arising when swapping between digital assets.
As the crypto asset transactions rise, market continues to grow in value and popularity, and crypto investors ask to understand the tax position on UK crypto tax, HMRCs guidance on the tax status of crypto assets in the UK continues to evolve. All owners of crypto assets should be aware that transactions in crypto assets can give rise to tax charges in the UK, and that HMRC is taking an increasing interest in crypto assets. Keeping accurate records of any dealings, investments and income generated in crypto assets is key to ensure you pay the right tax. It is likely that HMRC will look to develop and expand its guidance on other aspects of the taxation of crypto assets, so seek professional tax advice from dns accountants.
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