‘Crypto’ has been used as a name to capture non-conventional electronic currencies, but actually refers to a wider spectrum of virtual assets.
With the creation and rapid evolution of crypto assets such as Bitcoin, Ethereum and XRP, understanding and evaluating them for tax purposes is not straightforward. Cryptoassets are by and large unregulated, with no single regulatory body underpinning them and importantly, HMRC do not consider cryptoassets to be currency or money.
So how are virtual assets such as Bitcoin treated for tax purposes in the UK?
HMRC in their early analysis identified three principal types of cryptoasset:
- Exchange tokens such as Bitcoin.
- Utility tokens – rights to future services or goods from a platform.
- Security tokens – similar to shares or bonds.
How these digital assets are treated for tax purposes depends on a number of issues. HMRC issued guidance on 19 December 2018 covering some of the areas of complexity, for example:
- Whether the taxpayer is actively trading in cryptoassets – where the hallmarks of ‘trading’ are met, the trading profit or loss would be subject to income tax.
- If an individual holds the cryptoasset for personal investment, they would be liable to Capital Gains Tax (CGT) if disposed of for a gain, or trigger a capital loss if disposed of at a loss.
- If individuals receive cryptoassets in lieu of salary or benefits relating to employment, they would be liable to income tax and National Insurance Contributions (taxable on receipt).
- HMRC do not consider the purchase and sale of cryptoassets to be gambling, despite what some commentators may think generally about Bitcoin and the possible inherent risks.
Interestingly, HMRC has formed a view on what constitutes a disposal of cryptoassets and is not limited to a straightforward sale. It includes: an exchange, payment for goods and services and gifting to another person. However, there is no disposal where the individual simply moves ‘tokens’ or parts of a ‘token’ between different ‘wallets’ owned by the same person.
HMRC has stated that the tax exposure associated with a disposal would need to be calculated in sterling and the taxpayer would be treated as having received the equivalent amount in sterling regardless of how much they actually received.
Allowable acquisition costs can be deducted when calculating a gain or loss (each type of cryptoasset will have a separate tax pool representing the deductible cost of the respective cryptoasset, so that disposals can be matched to cost). This means that each type of cryptoasset has its own pool and is treated as a single asset. When a proportion of the cryptoassets held within the pool are disposed of, the value of the pool of cryptoassets is apportioned to determine the base cost of the cryptoassets being disposed of.
Please bear in mind that the normal (equivalent share) matching rules will continue to apply to cryptoassets:
- Assets bought and sold on the same day.
- Assets acquired within the 30 days following the sale (on a ‘first in, first out’ basis).
- The “Section 104” holding (any other of the same type of asset held).
The residence and domicile of the taxpayer disposing of the cryptoasset is critical for the tax analysis and determining how any gain or loss might be treated for UK tax purposes. For example, a UK resident non-domiciled individual may wish to claim the remittance basis of taxation and provided proceeds from cryptoasset sales are not directly or indirectly remitted to the UK, UK CGT should not apply (please note different rules apply to trading).
HMRC identify that the tax treatment of cryptoassets continues to develop as the sector does. HMRC assert that rather than focusing on terminology, they will seek to look at the facts of each case and apply the relevant tax provisions according to what has actually taken place; i.e. first principles basis.
Mining: individuals who are involved in ‘mining’ for cryptoassets, common with Bitcoin for example, are usually awarded units in the asset for solving complex maths problems. In many circumstances these awards will be treated as income in the hands of the ‘miner’ at the appropriate sterling value.
Airdrops: where an individual receives an allocation of cryptoassets either as part of a marketing campaign or in performance of a service, the value associated with the airdrop may be subject to income tax.
Forks: when a minority of the cryptoasset community want to do something different or follow a different path there can be a ‘fork’ in the asset. These are more commonly known as ‘soft’ or ‘hard’ forks. A soft fork is adopted by everyone whilst a hard fork can result in new tokens coming into existence. If the assets are held via an exchange, it will be up to the exchange whether or not to recognise the new asset. Original costs of acquisition should be split between the original cryptoasset and the new cryptoasset on a just and reasonable basis. Forks do not constitute disposals for CGT purposes.
Loss of a security key: where an individual loses the personal key to their wallet and they can no longer access their cryptoassets. If it can be proved that there is no prospect of recovering the key or assets, a negligible value claim could be made. This means that a loss would be crystallised for income tax or CGT purposes.
Smart contracts: Smart contracts are decentralized, anonymized, blockchain-coded agreements that facilitate the exchange of cryptocurrencies (e.g. Bitcoins) or tokens (e.g. Ethers) for goods or services. When the preprogrammed terms and conditions of an agreement are met, the smart contract executes automatically, enabling the exchange of the payment for a given good or service. A single smart contract could have thousands of anonymous transactions associated with it.
Smart contracts raise further tax issues. The underlying transaction in which the cryptocurrency is exchanged for goods or services may result in taxation at different levels:
- Profits/gains (or losses) made on the cryptocurrencies’ change in value;
- Income generated by fees associated with the transaction; and
- VAT on goods or services sold.
Where does this leave an individual who has been involved with cryptoassets?
The individual must keep adequate records and this should include, but not limited to: bank statements, exchange statements, details of acquisition costs, number of units of the cryptoasset, value of each transaction in sterling etc. It is more important to have adequate records as it may be difficult to subsequently track and reconstitute details later on.
Transparency, visibility and the future?
Under self-assessment in the UK, the responsibility and obligation is placed upon the taxpayer to report and disclose taxable gains and losses as appropriate. The taxpayer must take reasonable care when arriving at a valuation or undertaking any computational analysis.
Whilst these types of asset may not yet be regulated, where they interact with the conventional banking or financial services system, they leave an audit trail. It is this footprint that may eventually lead to an information enquiry and/or information exchange by a foreign government.
Our advice is that individuals should always seek professional tax advice on such complex matters. Particularly in relation to relatively new subjects such as cryptoassets. At Edwin Coe we understand the needs of clients who have acquired and/or disposed of cryptoassets and would be delighted to assist.
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