Introduction
Before we get into this subject in more detail, you may be interest to read that this subject is becoming more mainstream, and at an alarming rate!
The Financial Conduct Authority estimate that around 2.3 million adults in the UK hold cryptoassets i.e. around 3.5% of the population.
Apparently, the abbreviation NFT, meaning non-fungible token, has been made ‘word of the year’ for 2021 by Collins Dictionary. They say that the use of the abbreviation has increased by more than 11,000% in one year alone.
NFTs are digital certificates of ownership for digital assets like videos and images. They can be bought and be sold, just like traditional pieces of art.
Another of the new technology words that is included in the Collins Dictionary is ‘crypto’, which is short for cryptocurrency.
More people are now starting to talk about buying, holding or investing in cryptoassets. Some are even trading in cryptoassets. We take a look at the main taxation implications.
Think you are not affected - think again!
Holders of cryptoassets should consider the potential capital gains tax implications as this is the most likely tax to be due for those buying and selling of cryptoassets.
HMRC is keen to ensure that people fully understand that the following three common types of transactions are not tax exempt and may need to be reported on a Tax Return:
Selling cryptoassets for fiat money. A fiat money is a government backed currency, like £, € or $.
Exchanging one cryptoasset for another e.g. using some Bitcoins to buy another cryptocurrency , like Ether for example, is a disposal of Bitcoins for capital gains tax purposes and a purchase of Ether.
Paying for goods or services with cryptocurrency e.g. Every time you pay Microsoft for a software purchase, using crypto currency rather than pounds, is a disposal of crypto currency.
In all the above cases, these transactions will be disposals for capital gains tax purposes. Whilst the capital gain or loss may be small they each add up.
The amount of the capital gain will be the different between the sale proceeds from the disposal and the acquisition cost of the crypto asset i.e. sales price minus buying price. See the pooling rules below.
Please remember that if the aggregate capital gains in a tax year exceed your annual exemption, which is currently £12,300 for the next few tax years, or the aggregate disposal proceeds exceed four times the annual exemption, then the gain or loss must be reported on a Self Assessment Tax Return.
Quite simply, if you sold £50,000 worth of Bitcoins you would need to report it on your annual Tax Return. That is because the disposal proceeds, of £50,000, is more than four times the annual capital gains tax exemption, i.e. £49,200.
It would not matter if you left the £50,000 in a bank account, spent it or reinvested it into something else. It also would not matter if you generated a lost on the transaction. In fact, if you generated a capital loss, you may wish to claim the loss on your Tax Return if you want to use that loss to offset against future gains. If the capital loss is not claimed within the statutory (4 year) period then it is lost and cannot be used to offset against future gains.
Anyone who holds cryptoassets should consider whether or not they have anything to report or capital gains tax to pay.
Source
A large part of the following posted article has been extracted from selected sections from the HMRC Internal Cryptoassets Manual. We have expanded on some areas and given examples and some context to the HMRC text. As well as explaining the main taxation consequences of cryptoassets, the purpose of this article is also to explain some of the jargon and the main terminology used when discussing cryptoassets.
Overview
Profits and gains from the buying and selling price of cryptocurrencies are generally subject to tax.
Mostly, for individuals, this will be capital gains. Capital gains tax is paid on aggregate annual gains, less losses, which exceed £12,300 pa. Gains over £12,300 and gross proceeds over £49,200, even if the gain is less than £12,300, should be reported on a Self Assessment Tax Return.
In some circumstances buying and selling cryptocurrencies counts as trading income in which case the profit is subject to income tax or corporation tax rules and must be reported to H M Revenue & Customs.
Introduction
The terminology, types of coins, tokens and transactions can vary.
The tax treatment of cryptoassets continues to develop due to the evolving nature of the underlying technology and the areas in which cryptoassets are used. As such, the facts of each case need to be established before applying the relevant tax provisions according to what has actually taken place, rather than by reference to terminology.
The tax treatment of all types of tokens is dependent on the nature and use of the token and not the definition of the token. The views of HMRC may evolve as the sector develops and HMRC may publish amended or supplementary guidance accordingly.
On its own, owning and using cryptoassets is not illegal in the UK and does not imply tax evasion or any other illegal activities.
What are cryptoassets?
Cryptoassets are digital assets which use cryptographic techniques to generate a medium of exchange of financial transactions. The currency is encrypted (secured) using cryptography to secure financial transactions, create additional units, and verify the transfer of assets.
The word crypto means hidden or secret i.e. reflecting the secure technology used to record who owns what, and for making payments between users.
Digital currencies are intangible e-money, sometimes regulated, sometimes unregulated by national governments or similar regulatory organisations.
There are various cryptoasset on the market. They are commonly known as cryptocurrencies such as Litecoin, Ripple, Bitcoin, and Ethereum. With cryptoassets, you will need to use cryptographic techniques to access digital assets. However, all cryptoassets are not currencies.
Valuation
HMRC does not consider cryptoassets to be currency or money.
Many cryptoassets, like Bitcoin, are traded on exchanges which do not use pound sterling, so the value of any gain or loss must be converted into pound sterling on the Self-Assessment tax return.
If the transaction does not have a pound sterling value then an appropriate exchange rate must be established in order to convert the transaction to pound sterling.
An exchange is an online platform where people who wish to own cryptoassets can exchange their fiat (government backed) ‘real’ currency for a token; exchange tokens; and/or convert tokens into fiat currency.
Fiat currency is government-issued currency that is not backed by a physical commodity, such as gold or silver, but rather by the government that issued it.
Individuals
In the vast majority of cases, individuals hold cryptoassets as a personal investment, usually for capital appreciation or to make particular purchases. They will be liable to pay Capital Gains Tax when they dispose of their cryptoassets.
Tokens are digital assets and therefore intangible, but count as a ‘chargeable asset’ for Capital Gains Tax if they are capable of both being owned and have a value that can be realised.
Individuals will be liable to pay Income Tax and National Insurance contributions on cryptoassets which they receive from their employer as a form of non-cash payment or mining.
There may be cases where individual run a business which is carries on a financial trade in cryptoassets and they will therefore have taxable trading profits. In such cases Income Tax trading rules would take priority over the Capital Gains Tax rules.
Trading by individuals
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 and subject to income tax rather than capital gains tax.
Whether any activity constitutes trading would depend on a number of factors and the specific circumstances. Whether an individual is engaged in a trading activity of buying and selling cryptoassets will ultimately be a question of fact. Whilst transactions may be describe them as ‘trades’ this goes not mean that an individual is trading for tax purposes.
An individual who is trading may be able to reduce their income tax liability by offsetting any losses from their trade against future profits or other taxable income.
Trading by businesses
If a business is carrying out [trading] activities which involve buying or selling of cryptocurrencies, exchange tokens etc, they are liable to pay tax on them.
Such activities include:
buying and selling exchange tokens
exchanging tokens for other assets, including other cryptoassets
mining
providing goods or services in return for exchange tokens
The type of tax will depend on who is involved in the business and the activities it carries out, including whether these activities count as a trade.
It is likely they will be liable to pay one or more of the following:
Capital Gains Tax
Corporation Tax
Income Tax
National Insurance Contributions
Stamp Duty
VAT
These must be declared annually to HMRC on a company or personal Tax Return.
What is trading?
Trading is not defined in any taxes acts. Instead, it is defined through case law, made by judges, as a result of past legal cases taken through the courts.
In tax circles, the body of rules used to determine if somebody is trading is normally referred to as the ‘badges of trade’. They are indications that an individual or business is trading, and therefore subject to income tax or corporation tax on profits, rather than investing, which is subject to capital gains tax.
We therefore need to focus on the following main badges of trade.
Profit-seeking motive
An intention to make a profit supports trading, but by itself is not conclusive.
The number of transactions
Systematic and repeated transactions will support ‘trade’.
The nature of the asset
Is the asset of such a type or amount that it can only be turned to advantage by a sale? Or did it yield an income or give ‘pride of possession’, for example, a picture for personal enjoyment?
Existence of similar trading transactions or interests
Transactions that are similar to those of an existing trade may themselves be trading.
Changes to the asset
Was the asset repaired, modified or improved to make it more easily saleable or saleable at a greater profit?
The way the sale was carried out
Was the asset sold in a way that was typical of trading organisations? Alternatively, did it have to be sold to raise cash for an emergency?
The source of finance
Was money borrowed to buy the asset? Could the funds only be repaid by selling the asset?
Interval of time between purchase and sale
Assets that are the subject of trade will normally, but not always, be sold quickly. Therefore, an intention to resell an asset shortly after purchase will support trading. However, an asset, which is to be held indefinitely, is much less likely to be a subject of trade.
Method of acquisition
An asset that is acquired by inheritance, or as a gift, is less likely to be the subject of trade.
When do you generate a capital gain?
Most people believe that a capital gain arises when something is sold at a profit to its original cost. This is largely true. However, an asset does not have to be sold to generate a capital gain.
What is important for capital gains tax purposes is whether an asset has been ‘disposed of’, not necessarily sold for money.
An asset could be gifted, exchanged or converted for something else, destroyed or become of negligible value. Compensation could be received where an asset has been stolen or destroyed e.g. insurance proceeds.
To work out a gain on a cryptoasset, or any other disposal of a capital asset, one needs to take the ‘disposal proceeds’ and deduct any directly associated costs to make the transaction, i.e. professional or exchange fees. This results in a capital gain/loss.
The disposal proceeds would include money received from a sale, insurance proceeds or other compensation from the destruction or inability to use as asset. If an asset is gifted or exchanged, the disposal proceeds would normally be the market value of the asset if sold for money through an arm’s length sale and purchase between unconnected parties.
As well as the amount originally paid for the asset, other costs can be deducted when calculating the gain or loss, including transaction fees, valuation fees and specifically incurred professional fees.
At times, similar assets may be bought or acquired, that are indistinguishable from each other. In this case they are ‘pooled’ and the average cost is used to calculate a partial disposal from the pool. When a dispose from the pool take place the deemed cost of the items disposed of would be the numerical proportion calculated by dividing the number of items disposed of by the total number of items in the pool and multiplied by the total cost of the sum of the individual items in the pool.
Each type of cryptocurrency should be set up in its own pool. The pooling rules follow the usual share pool rules. In particular, be aware of the 30 day rule for 'bed and breakfast' sales and repurchases.
There are exemptions and special reliefs available on the disposal of some types of assets or disposals. One such exemption and relief is the disposal of chattels.
Chattels are tangible movable property e.g. a painting. Whilst we are reviewing digital cryptoassets, which by their very definition are not tangible, as they are intangible and cannot be touched, certain digital assets, like Non-Fungible Tokens (NFTs) may still be subject to the chattels exemptions.
If chattels are purchased and sold for under £6,000, there is no reporting obligation. If the proceeds exceeded £6,000 but were not more than £15,000, the amount of the gain to return depends on the amount of the disposal proceeds and the actual gain. However, if a sale takes place over this amount it most probably would be taxed in full.
Is buying and selling cryptoassets gambling?
HMRC does not consider the buying and selling of cryptoassets to be the same as gambling. Gambling winnings are tax free.
Mining
Tokens can be awarded to ‘miners’ for verifying additions to the blockchain digital ledger. Mining will typically involve using computers to solve difficult mathematical problems in order to generate new tokens.
Whether such activity amounts to a taxable trade, with the tokens as trade receipts, depends on a range of factors such as level of activity, organisation, risk and commerciality.
If the mining activity does not amount to a trade, the sterling value at the time of receipt of any tokens awarded will be taxable as income with any appropriate expenses deducted.
Non-Fungible Tokens (NFTs)
A non-fungible token (NFT) is a unit of data stored on a digital ledger. NFTs are unique and therefore are not interchangeable.
An NFT provides proof of ownership for other asset, in any tangible or intangible form, whether the underlying asset is maintained within a blockchain or stored outside of a digital ledger.
NFTs can be bought and sold. NFTs are mostly used to prove ownership of digital assets, such as images, videos, and music, but could be applied to tangible assets too. Any copyright on the underlying asset remaining with the creator of the asset. The creator may create new NFTs for the same underlying asset, but each NFT is unique.
Example
David is a professional artist. He paints pictures of popular Yorkshire countryside scenes. He decides to create 10 NFTs. Each NFT provides the right to exclusively view the artwork in a local gallery for one year and for up to 10 people at a time. David could receive a commission for future viewings if the NFT is subsequently sold to somebody else. David retains all other rights associated with the artwork.
The proceeds of the initial NFT sale would be assessable as business profits on David. Any commissions received by David would also be treated as business profits.
As David is a professional artist then he will most probably be trading when he created the original artwork and the associated NFTs. Similarly, any income or profits that arise from the sale of the underlying artwork would be trading income.
However, if John, a private individual, were to buy the artwork, or any of the NFTs, for his own personal use then any subsequent profit arising on the sale of the artwork or the NFTs would probably be a capital gains tax profit. This is because John is not trading, but investing.
If the artwork or the NFTs were bought by a dealer or business owner who intended to buy them and sell for a profit then this would be a trading profit which would be subject to income tax or corporation tax.
As can be seen from the above examples, it is the ‘badges of trade’ (the intention to make a quick trading profit) and whether to keep the artwork for the longer term, for investment purposes, which determines whether income tax/corporation tax or capital gains tax is payable on the sale/disposal.
Distributed Ledger Technology and Blockchain
Distributed Ledger Technology (DLT) is a digital system that records details of transactions in multiple places at the same time. Unlike traditional databases, distributed ledgers have no central data store or administration functionality. The ledger acts as an immutable record of all the transactions that have happened within the network previously.
Due to its secure nature, the concept of DLT is generating interest in many sectors including banking and fintech. A well-known application of DLT is the Bitcoin blockchain, which acts as a public record of all the transactions that have ever taken place.
Wallets and public and private keys
Encryption keys are a vital aspect of cryptography. They make a message, transaction or data value unreadable for an unauthorised reader or recipient, so it can only be read and processed by the intended recipient.
Exchange tokens rely on a public and private key system:
The private key is a randomly generated string and is used to authorise a transaction involving tokens held at a public address.
A public key is mathematically generated from the private key, linking the two keys cryptographically.
For all practical purposes, a private key cannot be generated from a public key.
The public address is shared across the Distributed Ledger (DL). Anyone who knows that address can look at the DL and see all transactions to and from the public address. Any person who knows the public and private keys can authorise transactions involving tokens held at the relevant public address.
If a private key is lost, the tokens will continue to exist at the public address. However, the ‘owner’ would be unable to undertake any transactions in respect of those tokens. If private key details were kept only on a computer which was subsequently destroyed, then the tokens would be unreachable, although they would continue to exist.
A cryptoasset wallet is a user interface where a private key is stored. The key gives the owner of a cryptocurrency / token etc access to their assets.
While a digital wallet can contain different types of cryptocurrencies, each cryptocurrency is a separate CGT asset.
Record keeping
Keeping good records for tax purposes, in order to calculate the profit or gain, can be a challenge for most potential taxpayers. When those records are in digital format it can make the process more difficult.
Cryptoasset exchanges may only keep records of transactions for a short period, or the exchange may no longer be in existence when an individual completes a tax return.
The onus is therefore on the individual to keep their own records for each cryptoasset transaction and these must include:
the type of cryptoasset
date of the transaction
if they were bought or sold
number of units involved
value of the transaction in pound sterling on the date of the transaction
bank statements and/or wallet addresses
Records of cryptoassets can be:
paper wallets containing the individual’s public and private keys
electronic wallets on devices
other records of transactions and balances such as downloads of wallet activity from a cryptoasset exchange
hardware wallets like a USB drive that containing the individual’s public and private keys.
Cryptoassets are digital assets and as such all records in a wallet should show balances and transactions, either in full or via reference to a public blockchain.
Records should be kept of cryptocurrency. They form part of the audit trail from acquisition to disposal and therefore provide evidence of any gains, profits or losses made.
Cryptoasset transactions usually occur on a public blockchain and so can be viewed digitally and checked using records obtained from a wallet.
Cryptoassets are obtained, administered, exchanged, used and linked to fiat (‘real’ government backed) currency, mostly in electronic or digital format. It is therefore reasonable to keep electronic records which show full details of transactions and any supporting valuations for the buying and selling of such assets.
Stamp duty
Stamp Duty is charged on instruments that transfer stocks or marketable securities. At the time of writing, HMRC’s view is that existing cryptoassets would not be likely to meet the definition of ‘stock or marketable securities’ or ‘chargeable securities’.
Inheritance Tax
Cryptoassets will be property for the purposes of Inheritance Tax.
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