The rapid growth in cryptocurrency and distributed ledger technology has seen an influx of new cryptocurrency business, traders and investors which has attracted significant attention from HMRC and other tax authorities worldwide. As a result, HMRC are actively enquiring into crypto businesses, traders and investors to ensure that all individuals and businesses involved in cryptocurrency pay their fair share. Ensuring cryptocurrency businesses, traders and investors are structured properly is paramount to keeping tax efficient and remaining compliant with HMRC.
This is article is based on the assumption that the individuals and businesses referred to below are UK based and it does not cover the UK corporate tax consequences for companies.
Cryptoassets are not considered to be currency or money by key financial institutions. Within the tax context, according to HMRC cryptoassets are synonymous with other assets such as shares and will be taxed accordingly.
HMRC recognizes that most individuals hold crypto as personal investment, and they will pay capital gains tax when they “dispose” of the crypto.
Tax follows the underlying activity in which cryptocurrency is being acquired or sold. As such, crypto investors and traders must consider the wide degree of transactions ranging from basic purchase and sell orders to hard forks, airdrops, staking and the like.
HMRC defines three types of crypto assets: exchange tokens (currency coins like bitcoin), utility tokens (tokens issued by a business with utility uses), and security tokens (tokens that represent a form of equity in a business).
HMRC has released fairly comprehensive guidelines for filing taxes on cryptocurrency in the U.K
The report’s guidelines apply to all forms of crypto, but it also acknowledges that for utility and security tokens, “different tax treatment may need to be adopted.” However, they have not clarified yet that these different kinds of tokens are treated differently.
Individuals are liable for income tax for crypocurrency received via mining, airdrop, and confirmation rewards as well as crypto received as salary from an employer. Furthermore, if an individual runs a business making profit from trading cryptocurrency, income tax rules take priority over capital gains.
For example, the most obvious would be the ‘day-trader’ who is actively buying and selling cryptoassets with the view to realising a short-term profit. Even in these circumstances, it is generally difficult to fall within the description of a ‘trader’ and HMRC generally accept that individuals will be subject to the more favourable rates of capital gains tax.
In order to fall within the description of trading, individuals will need to buy and sell cryptoassets with such frequency, level of organization, intention and sophistication that the activity amounts to a financial trade in itself. If the threshold of trading is met, the net profits will be subject to income tax at 20%, 40% and 45% and national insurance at 12% and 2%.
In most circumstances, a person who trades on their own account is unlikely to meet the description of a ‘trader’ for income tax purposes and will more than likely fall within the capital gains tax regime.
In most cases, an individual buying, holding and selling cryptocurrency on their own account will be deemed to carry on an investment activity and subject to capital gains tax.
HMRC defines a disposal as selling crypto for fiat, exchanging one cryptocurrency for another cryptocurrency, and giving away crypto to another person (as a gift or in exchange for goods or services).
The disposal of cryptoassets will result in a taxable event, with the value of any disposal proceeds matched against purchases in a specific order:
Cryptoassets acquired on the same day;
Cryptoassets acquired in the following 30-days
The average cost of any unmatched cryptoassets (known as the ‘pool’)
The amount of the capital gain is the difference between the value of the disposal proceeds and the value of the acquisition cost per the matching rules.
Allowable costs can be deducted when calculating a gain or loss, such as the original purchasing amount, transaction fees, and professional costs (i.e. cost of drawing up trade contracts or appraisal costs) in relation to buying or selling the assets.
Capital losses from crypto transactions can be taken into account for the cryptocurrency tax liability. If crypto is disposed for less than its allowable cost (i.e. sold at a loss), then the loss can be deducted to reduce the overall capital gain. The loss must be reported to HMRC.
Regarding giving away crypto: if the recipient is not the spouse or civil partner of the giver, the pound sterling value must be calculated and then treated as capital gains for the recipient, even if the crypto is not converted to fiat. Crypto assets donated to charity are not applicable to capital gains tax, unless the donation is more than the acquisition cost or unless the donation is a tainted donation.
An individual pays capital gains tax on the total gains above an annual tax-free allowance which is currently £12,300. Any gains realised above this allowance will be taxed at 10% up to the basic rate tax band (if available) and 20% on gains at the higher and additional tax rates.
Airdrops – Where an individual has participated in a crypto airdrop, they are deemed to have acquired the asset at a ‘nil’ cost which will then be matched against a disposal or added into the pool. If the person is ‘trading’ and subject to income tax, the value of the airdrop will be subject to income tax.
Hardforks – Where a fork results in a new cryptoasset being created, the individual must allocate a share of the cost of the original cryptocurrency to the newly acquired or created cryptoasset. This does not create a tax liability but does ‘split’ the cost of the old asset, so that a future disposal may result in a greater liability. If the person is trading, the value of the received cryptoasset will be assessable to income tax.
Staking – Staking is akin to investment income and will be deemed to be subject to income tax regardless of whether a person is trading or not.
In the event that a cryptocurrency becomes worthless and/or untradeable, a negligible value claim can be filed in order to treat the asset as disposed of, and thus losses can be claimed.
If you lose your private key, a negligible claim can be filed only if it can be proven that there is no chance of recovering the key.
In the instance of theft or fraud, one cannot claim a capital loss. The only instance where the HMRC states a loss can be claimed is in the instance of being sold a cryptocurrency that then becomes worthless. In which case, a negligible value claim can be filed.
As stated above, if you are tax resident in the UK, and you make gains of over your CGT annual exemption (£12,300 for 2021/22) you will need to report and pay CGT via a UK annual self-assessment tax return.
If your gains fall within your CGT annual exemption, you may still need to report the gains where the proceeds exceed four times the annual exemption (i.e. £49,200 for 2021/22), or where you have other capital gains or losses.
HMRC now receives information direct from UK crypto exchanges/platforms and so not disclosing transactions will most likely result in a HMRC enquiry and could lead to HMRC imposing penalties and costing you more.
For example, in 2020 Coinbase, the digital currency exchange, confirmed that it had shared with HMRC details of UK resident users who have used its platform with Crypto transactions of £5,000 or more in the 2019/20 tax year.
It is always preferable to make a voluntary disclosure to HMRC to correct errors or omissions rather than wait for HMRC to make contact. This will likely lead to lower financial penalties (if due) and may also reduce how far back the disclosure covers.
Whilst the appropriate route to disclosure will turn on the specific circumstances, HMRC do have online disclosure facilities which are likely to be appropriate in most cases where a correction is required.