In April this year HMRC updated and consolidated their guidance on the taxation of cryptoassets or cryptocurrency.
The guidance manual they produced contains advice to its officers on HMRC’s views of the tax treatment of various profits, gains and losses arising in this rapidly expanding financial area. The guidance itself is not based on any new tax laws but rather HMRC’s interpretation of existing tax laws as applied to this new marketplace.
In time we may see some historical tax concepts and their application in the digital world challenged in the Courts. However, for now our advice to investors and participants in the crypto world is to regard HMRC’s guidance as being the place of first resort. This article is based on our interpretation of that manual.
Explanations of common terms
It may be useful to explain a few of the common terms used in the world of crypto and, where appropriate, and then to see how they fit into the UK taxation rules:
- Exchange tokens - these are digital currency coins like Bitcoin.
- Utility tokens - tokens issued by business with utility purposes.
- Security tokens - represent a form of equity in a business.
- Exchange - an electronic platform through which cryptoassets are traded.
- Airdrop - a distribution of a cryptocurrency token or coin, usually for free, to numerous wallet addresses.
- Wallet - can be a device, app or online service which stores the public and private keys required to buy cryptocurrencies.
- Public & private keys – a public key allows you to receive cryptocurrency. A private key proves you’re the owner of the crypto and allows you to unlock and trade them.
- Hard fork - results in new tokens coming into existence when the original distributed ledger splits.
- Staking - Is a process that involves buying and setting aside a certain amount of tokens to become an active validating part of the network. By holding these coins, the buyer becomes an important piece in the network’s security infrastructure and is compensated accordingly.
HMRC’s perspective of the crypto market
HMRC’s guidance asserts that tokens are cryptoassets. Buying and selling them gives rise to a potential liability under the Capital Gains Tax (CGT) rules.
It goes on to explain that individuals may be liable for income tax on cryptocurrency like Bitcoin received via data mining activities. The same applies to crypto received as salary from an employment. Exceptionally individuals running a business making profits from trading cryptocurrency may also be charged income tax on those profits.
So, with the vast majority of taxpayers involved in buying and selling exchange tokens via online exchanges how do the CGT rules apply?
Each UK individual has a CGT Annual Exemption of £12,300 (2021 onwards). If the total of gains, after deducting losses, is less than this allowance no tax is payable. Any gains over the exemption amount will be charged at 10% for a basic rate taxpayer or 20% for a higher rate taxpayer.
Before calculating the gain it’s important to understand how a ‘disposal’ of crypto is defined for CGT purposes. A disposal which creates a charge is deemed to occur when a crypto is not only exchanged for ‘fiat’ or actual currency like dollars, euros or sterling but also another crypto.
A gain can arise even if no actual conversion to fiat currency takes place. The simple exchange of one type of crypto for another can create a chargeable event with a resulting gain or loss.
Readers who have engaged in online quoted share transactions will be familiar with the format of buying and selling shares into and out of a portfolio either directly or through a broker. The same scenario applies to crypto and the same CGT rules also apply.
Creating separate ‘pools’ of crypto
If an investor has holdings of say Bitcoin, Ethereum, XRP, Stellar etc each needs to be ‘pooled’ separately for CGT purposes and that ‘pool’ grows and diminishes both in number and value as coins are bought, sold or exchanged. For CGT purposes these are called “Section 104 pools” after the section of the 1992 Taxation of Capital Gains Tax Act.
However, before any CGT can be calculated on a disposal of coins out of the ‘pool’, the value of those coins needs to be converted into a fiat currency, ultimately GBP sterling here in the UK.
The CGT rules permit certain costs directly relating to the acquisition and disposal of chargeable assets to be allowed. In the crypto world this is usually confined to fees, commission etc incurred on a transaction basis.
Normal business expenses income tax rules would apply to professional traders and data miners accepted by HMRC as carrying on a business.
Cryptos becoming worthless
Investors may find that their crypto acquisitions become worthless or untradeable. In that instance a negligible value claim can be filed and, if successful, an allowable loss can be created.
The loss of a private key will not automatically lead to a successful negligible value claim unless the owner can prove that there is no prospect of ever recovering the key.
In the event of theft or fraud a capital loss can’t be claimed because the crypto itself has not necessarily become worthless.
The importance of record keeping
With the volume and volatility of online trading in cryptos, it is essential to maintain records to track trades in order to perform calculations of gains or losses on transactions in every pool.
A further complication which reinforces the need for keeping proper transaction records is the application of the generic ’30 day’ and ‘bed & breakfast, rule (Section 105) which is aimed at identifying specific disposals with specific acquisitions to prevent ‘wash sales. These are disposals of assets at a loss with immediate or short period re-purchases of the same asset at a bargain price.
Using calculation services
For investors using reputable and established crypto trading exchanges there are options to use their online services to carry out the various pooling and bed & breakfast calculations. Exchanges don’t always maintain visible transaction records indefinitely so investors must ensure that they download their personal portfolio details regularly. Calculation software can be purchased to provide investors with the facility to work out their own gains/losses.
Other taxable activities
Other activities within the crypto world can give rise to UK tax liabilities. It was mentioned earlier that few individual traders in crypto will be regarded by HMRC as carrying on a trade but those engaged in data mining probably will be. These activities giving rise to profits, received as either crypto coins or in fiat currency will be liable to income tax.
HMRC have indicated that investors may be chargeable to income tax on ‘Airdrops’ which are given in return for services and on ‘Staking’ where interest may be paid, albeit in the form of cryptocurrency.
Payment of tax
Finally, how is tax payable on gains, profits and interest arising from the crypto world?
If there is any CGT payable it will normally be due on or before 31st January in the year following the tax year. So, tax on a gain made in the year ended 5 April 2021 would be payable on or before 31st January 2022.
Profits subject to income tax are taxable on the basis of the accounting period of the trade and again is payable on or before 31st January each year.
There is an annual Personal Savings Allowance of £1000 for basic rate taxpayers and £500 for higher rate payers. So, if the value of any interest received is less than this, no tax will be payable. If it’s greater then the tax due will again be payable by 31st January in the year following the tax year in which it was received.
Individuals needing to report gains and profits to HMRC will need to do so through a Self Assessment Tax Return.
Beware of the tax trap – a tax on nothing!
Careful readers will have spotted the potential tax trap that many investors can fall into. It’s all about timing.
Because there can be a long gap between a gain being realised through one or more disposals and when the tax is due, the value of an investor’s cryptoassets could have fallen so much that they don’t have the means to pay the tax!
It is vital that investors are constantly thinking about how to pay their tax bills, potentially making withdrawals to do so. If the crypto is worthless they will nevertheless have to pay tax on gains that have disappeared!
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