How do you pay tax on cryptocurrencies? Are cryptocurrency or crypto-asset gains or profits taxable? Can you obtain tax relief if you make losses on Bitcoin? How do you tax Ethereum profits? Benefits on transactions in crypto assets, bitcoin are potentially taxable in the same way as other investments.
What’s new? Tax on Crypto Currencies
In December 2018, HMRC published guidance on the taxation of crypto assets. HMRC confirms that:
- Most investors will be subject to CGT on gains and losses.
- S104 pooling applies, subject to the 30-day rule for ‘bed and breakfasting’.
- It will be rare for investment in crypto assets to be regarded as trading, although ‘mining’ is likely to indicate a trading activity.
- You can claim a capital loss if a crypto asset becomes of negligible value. Prove of evidence is required in case if the loss of the asset arises as a result of the accidental destruction of a private encryption key or fraud.
In October 2018 the Cryptoassets Taskforce, consisting of HM Treasury, the Financial Conduct Authority and the Bank of England published its Final Report. This report provides an overview of crypto assets and Distributed Ledger Technology (DLT). Assesses the associated risks and potential benefits, and sets out the path forward concerning regulation in the UK.
The tax was outside the Taskforce’s remit.
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What is a crypto asset or cryptocurrency?
There many different types of crypto assets and the so-called ‘cryptocurrencies’ are just one variation.
Many people will have heard of Bitcoin, Ethereum, etc. There are thousands of other forms of crypto assets which are less currency-like and can have other attributes which can make them necessarily a form of tokens tradable on different platforms worldwide.
Cryptocurrency shares many similarities to other currency:
- They have fluctuating exchange rates, which are driven by the market.
- You can buy and sell currency in exchange for other cryptocurrencies or standard currencies, such as £ pounds, Euro, or $ dollars.
- You can conduct transactions online.
- Some cryptocurrencies use blockchain technology, and some use different platforms.
Cryptocurrency has become extremely popular. It uses new technology, which has almost infinite possibilities. Most importantly, for many disrupters, it is not managed by conventional banks, and normal bank charges do not apply as you do not hold currency in a bank but in a digital wallet.
You can buy or sell cryptocurrency via different platforms, both on and off the regular web.
- If you are buying in the UK on the regular web via a standard browser from what you perceive to be a reliable source, you will be subject to money laundering checks under UK rules.
- If you buy on the dark web, ID checks can be almost non-existent; however, depending on how you set up your transactions, on of the risks of some dark web merchants is that you run the risk that you might lose your money.
Many people invested in Bitcoin’ BTC’, firstly as a purely speculative bit of fun and then got slightly hooked on them because high exchange rate created huge profits could be made, provided that your timing was right. You had a detailed understanding of the market.
The exchange rate with cryptocurrency is highly volatile, and between 2016 and 2018, exchange rates have reached extraordinary levels in Europe, the US, and in the far East.
For every profit made, someone may have made a loss. However, it is possible, given that cryptocurrencies feature significantly on the dark web, which helps in money laundering.
The main people to profit from crypto-asset gains appear to be those who have created them or their platforms or mined them. The BTC bubble has accelerated the creation of other forms of crypto assets. When a new product launched, its creators will benefit from their initial holdings or awards of assets. If the launch goes well, these assets may be converted into different assets.
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How to tax profits or gains made on cryptocurrency?
This guide is for individuals and not companies.
Under conventional tax rules, whether your profits are taxed as income or your gains are taxed as a capital depends on whether you are trading (income) or investing (capital).
HMRC does not currently recognize BTC, etc., as a currency. However, crypto assets are intangible assets and appear to fall into s.21(1)(a) of TCGA 1992.
This means that disposal proceeds are taxed as capital gains unless there is evidence of trading.
|Section 21 TCGA 1992 Assets and disposals (1) All forms of property shall be assets for the purposes of this Act, whether situated in the United Kingdom or not, including— (a) options, debts and incorporeal property generally, and (b) currency, with the exception (subject to express provisions to the contrary) of sterling, (c) any form of property created by the person disposing of it, or otherwise coming to be owned without being acquired. (2) For the purposes of this Act— (a) references to a disposal of an asset include, except where the context otherwise requires, references to part disposal of an asset, and (b) there is part disposal of an asset where interest or right in or over the asset is created by the disposal, as well as where it subsists before the disposal, and generally, there is part disposal of an asset where, on a person making disposal, any description of property derived from the asset remains undisposed of.|
Trading or investment?
- If you are actively mining BTC or you are dealer making multiple trades buying and selling different investment assets or mixing currencies, you may well be treated at trading.
- If you are buying and holding your investment and then selling according to the market conditions, you are investing, and your gains or losses will be taxed as capital.
- Although there are thousands of different types of crypto assets in existence, it seems unlikely that HMRC would accept that buying and selling the most popular versions of these assets is a gambling activity.
The key test to determine whether you are trading for tax purposes is to apply what is known at the Badges of Trade. These look at amongst other things that you do in your day job, the frequency of trades, and your objectives in owning the currency. Each case needs to be considered on its own facts, especially given the multifunctionality of some cryptocurrencies.
- If your profits are taxed as income, they are taxed at the same rate as say a salary or profit from trading.
- There are no special allowances or rates that apply to such profits.
- If you make a trading loss, you should be able to offset this as sideways loss relief against your other income.
- If you are trading, you are expected to prepare trading accounts for tax and register as a sole trader for income tax.
Gain on BTC
Suppose your gains are taxed as capital. You should obtain tax relief on the costs of trading, as in buying and selling. You may offset your annual CGT exemption (if unused).
- If you make capital losses, these are carried forward to offset against other gains made in the year or carried forward.
- Cryptoassets are what are termed as fungible assets. Therefore you can pool like with like. Gains in BTC can be offset with losses on BTC etc.
- Where the assets are equity-linked reliefs should be considered and where debt-linked. However, the position is not at all clear, and advice should be sought.
- HMRC confirms that crypto-assets may be pooled under s104 TCGA 1992 subject to the 30-day bed and breakfast rule.
- If an employer awards crypto assets, these are taxable as employment benefits.
- If they fall within the description of readily convertible assets, they are subject to PAYE.
HMRC and cryptocurrency
HMRC published new guidance in December 2018 which cover:
CGT Share pooling: HMRC examples
Under section 104 Taxation of Capital Gains Act 1992 pooling rule, each type of crypto asset is kept in a ‘pool.’ The consideration (in pound sterling) originally paid for the tokens goes into the pool to create the ‘pooled allowable cost.’
For example, if a person owns bitcoin, ether, and litecoin, they would have three pools, and each one would have it’s own ‘pooled allowable cost’ associated with it. This pooled allowable cost changes as more tokens of that particular type are acquired and disposed of.
If some of the tokens from the pool are sold, this is considered a ‘part-disposal.’ A corresponding proportion of the pooled allowable costs would be deducted when calculating the gain or loss.
Individuals must still keep a record of the amount spent on each type of crypto asset, as well as the pooled allowable cost of each pool.
HMRC Example 1
Victoria bought 100 token A for £1,000. A year later, Victoria bought a further 50 token A for £125,000. Victoria is treated as having a single pool of 150 of token A and total allowable costs of £126,000.
A few years later, Victoria sells 50 of her token A for £300,000. Victoria will be allowed to deduct a proportion of the pooled allowable costs when working out her gain:
|Less allowable costs||£126,000 x (50 / 150)||£42,000|
Victoria will have a gain of £258,000, and she will need to pay Capital Gains Tax on this. After the sale, Victoria will be treated as having a single pool of 100 token A and total allowable costs of £84,000.
If Victoria then sold all 100 of her remaining token A, then she can deduct all £84,000 of allowable costs when working out her gain.
Acquiring within 30 days of selling
Special pooling rules apply if an individual acquires tokens of a crypto asset:
- on the same day that they dispose tokens of the same crypto asset (even if the disposal took place before the acquisition)
- within 30 days after they disposed of tokens of the same crypto assets
If the special rules apply, the new crypto assets and the costs of acquiring them stay separate from the main pool. The gain or loss is calculated using the costs of the new tokens of the crypto asset that are kept separate.
If the number of tokens disposed of exceeds the number of new tokens acquired. Then the calculation of any gain or loss may also include an appropriate proportion of the pooled allowable cost.
HMRC Example 2
Melanie holds 14,000 token B in a pool. She spent a total of £200,000, which is her pooled allowable cost.
On 30 August 2018, Melanie sells 4,000 tokens B for £160,000.
Then on 11 September 2018, Melanie buys 500 token B for £17,500.
The 500 new tokens were bought within 30 days of the disposal, so they do not go into the pool. Instead, Melanie is treated as having sold:
- the 500 tokens she has just bought
- 3,500 of the tokens already in the pool
Melanie will need to work out her gain on the 500 token B as follows:
|Consideration||£160,000 x (500 / 4,000)||£20,000|
|Less allowable costs||£17,500|
Melanie will also need to work out her gain on the 3,500 token B sold from the pool as follows:
|Consideration||£160,000 x (3,500 / 4,000)||£140,000|
|Less allowable costs||£200,000 x (3,500 / 14,000)||£50,000|
Melanie still holds a pool of 10,500 token B; then, The pool has allowable costs of £150,000 remaining.
VAT on Crypto Currencies
In 2014 HMRC produced a tax guide, Revenue & Customs Brief 9 (2014) Bitcoin and other cryptocurrencies. This is out of date and in need of a rewrite. It mainly considers VAT aspects.
Suppose you are buying or selling cryptocurrency on the regular web through popular platforms. HMRC’s data-gathering powers may well extend to your broking platform, and if the platform is in the UK, your details and gains are capable of being reported to HMRC.
HMRC’s data-gathering powers extend to other countries, and there are data-sharing agreements with over 100 other countries.
There are difficulties for tax authorities is in keeping up with new technology and new online platforms. It looks as if there may major challenges in data sharing when the type of data is constantly evolving.
If you have used cryptocurrency to purchase software or gaming points, it’s unlikely that you have made a profit, and HMRC will not be worried about you. You could claim tax relief on the cost software if it used in your business.
If you have used cryptocurrency to buy on the dark web, it seems unlikely that you will have made a profit on cryptocurrency.
It is difficult for authorities to check your transaction made through blockchain. There is a concern on some forums that people will who have used mixing when sending cryptocurrency could be targeted by HMRC. It seems unlikely that HMRC is going to be concerned about what you purchase; what you sell and who you sell to is another matter.