Cryptocurrency has entered by public consciousness comparatively recently, but its ongoing growth means business advisers, the general public, investors (and of course HM Revenue and Customs!) now need to take it seriously.
Tax Tuesday this week looks at this area, where constant use of unfamiliar terminology can cause even the most enthusiastic of observers’ eyes to glaze over.
What is cryptocurrency?
In essence, it is a type of digital asset, the most famous example of which is Bitcoin. It is designed to be a decentralised medium of exchange (in many ways like a traditional currency) although the only government around the world to date which has embraced a cryptocurrency as legal tender is El Salvador with Bitcoin.
By de-centralised we mean rather than being managed by a central authority (the central bank and banking network) like traditional currencies, cryptocurrencies are managed on a ‘peer to peer’ basis i.e. users of a cryptocurrency manage the network themselves.
By ‘cutting out the middleman’ the idea is that efficiency and speed of transaction is increased and transaction cost is reduced.
Cryptocurrency is managed through the ‘blockchain’, a highly secured database which constantly records relevant transactions or ‘blocks’.
Whenever a transaction using the given cryptocurrency is made, a number of users of the network must verify its authenticity and once this has happened, the transaction is ‘locked’ within the blockchain and so cannot be modified.
What about the tax treatment?
Like other governments around the world, HMRC’s response was initially slow but in recent years they have ploughed more resource into this growing area and have now issued more detailed guidance on their views of the tax treatment of cryptocurrency.
Cryptocurrency held for investment purposes is likely to be dealt with under the capital gains tax regime for individuals (chargeable gains for companies).
A disposal will be triggered if one cryptocurrency is swapped for another, is sold for ‘fiat’ currency (e.g. sterling), is gifted or is used as a medium of exchange e.g. is used to purchase an item which a UK individual would normally use sterling for.
Very broadly, cryptocurrency which is fungible (i.e. where each ‘coin’ is identical to the others like a specific class of shares in a company) will be treated in a similar way to shares for CGT purposes.
Losses made on cryptocurrency are treated in the same way as other capital losses for instance, for an individual, they can be used against other gains made in the year or carried forward to set against gains made in future tax years.
There are more complex rules applying for capital gains tax purposes for those UK taxpayers who may be non-UK resident/non-UK domiciled which are beyond the scope of this article (although please do contact us for more information on this point if required).
Cryptocurrency owners can sometimes receive ‘staking rewards’ akin to interest from a traditional bank account from the blockchain network.
These are taxed as income and become part of the capital gains tax base cost (for the purposes of calculating a gain on a future disposal) for those coins acquired.
‘Airdrops’ occur when newly ‘minted’ crypto-coins are issued to existing holders, often as part of a marketing or advertising campaign. Normally these are not subject to income tax (unless the holder is deemed to be trading – see below).
If profits made on cryptocurrency are deemed to be trading profits rather than capital gains, then income tax (generally higher than capital gains tax) will be due on the profits.
HRMC have confirmed that only in exceptional circumstances would they expect the buying and selling of cryptocurrency to be carried out with the frequency, organisation and sophistication that would deem a trade to exist.
As mentioned above, the integrity of a blockchain network is crucial and those users who help to verify and update the digital ledgers are often rewarded with further currency tokens. Tokens received from such ‘mining activities’ will be treated as taxable income.
Whether such income is trading income or just miscellaneous income (both subject to income tax but each with slightly different rules mainly to do with the ability to deduct expenses) depends on the scope and nature of the activities.
How can we help?
This is a broad overview of the tax rules applying in the complex and fast changing area of cryptocurrency. Please contact your relationship principal or email firstname.lastname@example.org.
The author takes every care in preparing material to ensure that the content is accurate and up to date. However no responsibility for loss occasioned to any person acting or refraining from acting as a result of this material or from making use of this material can be accepted by the author.