Given the recent meteoric rise in the value of Bitcoin (currently over $50,000) and the spotlight that cryptoassets are receiving from high profile individuals and institutions including Elon Musk, Jack Dorsey and others; it is no surprise that HM Revenue & Customs (HMRC) is taking increasing notice.
Whilst loading up on over $1.5 billion of Bitcoin ('BTC') for Tesla's treasury reserves in Jan – Feb 2021, Elon couldn't help but share his love for the "Doge coin" fan club (along with Snoop Doggy Dog and Gene Simmons....!)
Despite this growing and widespread interest, many crypto investors and holders are still in the dark about crypto tax. This means that there are plenty of myths and misconceptions (on both sides of the tax fence) surrounding crypto tax, so let's take a look at the UK cryptoasset tax rules and some of the more common crypto tax myths to help you make the right choices when filing your crypto taxes.
What are Cryptoassets?
You will often hear crypto referred to as a kind of digital currency, virtual money, internet money, intangible money or alternative currency etc. The list goes on.
The world of crypto made the leap from being an academic concept to (virtual) reality with the creation of Bitcoin in 2009. Since then, numerous other cryptocurrencies have been created. These are frequently called 'altcoins', i.e. alternative coins to Bitcoin.
Despite the commonly accepted terminology of this asset class being a cryptocurrency, it is important to note that HMRC defines Bitcoin and the other 8,000+ altcoins as "cryptoassets" rather than "cryptocurrencies".
Before we go any further, HMRC has issued some helpful guidance on the taxation of cryptoassets for individuals and businesses that should be your starting point.
Which UK Taxes Apply to cryptoassets?
The short answer, unfortunately, is "all of them" need to be considered depending on the nature of the transaction.
The two main taxes to consider are Capital Gains Tax ('CGT') and Income tax, but we will consider how other taxes can apply in certain situations below.
When is there a taxable event?
There are a number of potential triggers for tax to be considered when dealing with Bitcoins and other cryptoassets:
- Sale of crypto for cash
This is the most obvious example: where a cryptoasset is sold or converted into cash for a profit or loss.
2. Exchanging from one crypto into another crypto
For example, transferring BTC into Ethereum.
This is a common misconception: many people incorrectly think that if they stay within the world of cryptos and don't "cash out" then there will be no tax due. This is wrong. It is the same principle with listed shares - you can't exchange the gains in your shares in Tesla to buy more shares in Apple without incurring a tax charge.
A further crypto myth-buster: many wrongly think that exchanging into a stable coin means that there is no taxable event.This is incorrect. HMRC sees no difference between exchanging from BTC to LTC and from BTC into USDT.
3. Use Bitcoin (or any other cryptoasset) to pay for goods or services
This will become increasingly prevalent as more and more debit cards are introduced that allow users to pay for goods and services using crypto.
Although that uplift in value of your LTC on your crypto card wallet might look like a "nice little windfall"; unfortunately, it's not 'free money' and needs to be tracked and taxed.
4. Gift cryptoassets (if not to spouse/civil partner)
Gifting cryptoassets to connected parties such as children, parents (or your business) must be conducted at arm's length market value and will constitute a CGT disposal for you for tax purposes.
HODL: Day-to-day fluctuation
The crypto market is currently highly volatile with shifts of 50% or more in value in a single day (up or down!) not uncommon.
For the avoidance of doubt, those that sit tight (and 'hodl') will not trigger a taxable event (and therefore no tax due) until such time as a cryptoasset is transacted in one of the four ways mentioned above.
How do I calculate the capital gains position?
Let's start with a simple example: John buys 1 BTC for £10,000 and sells it via an exchange for £40,000 several months later. John will be subject to UK capital gains tax on the £30,000 gain or profit on the disposal.
The same principle will apply if, rather than convert the BTC into cash, John transferred the £40,000 via an exchange into acquiring some Ethereum tokens. He would similarly be subject to UK CGT on the uplift in value of the BTC asset from its £10,000 acquisition cost to its £40,000 disposal value i.e. £30k gain.
Note that in this example, we are dealing with the sale of a single crypto coin/token; whereas the situation is slightly more complex where there is a holding of more than one of the cryptoassets acquired over time (e.g. common where adopting 'dollar-cost-averaging' strategies to build up a crypto position).
Fortunately, rather than having to track the purchase price of every single coin/token acquisition that is then disposed/exchanged as part of a single transaction, the same UK CGT tax rules are adopted as applied in relation to the acquisition and sale of listed shares.
This is the concept of 'pooling' as per HMRC:
Instead of tracking the gain or loss for each transaction individually, each type of cryptoasset is kept in a ‘pool'. The consideration (in pounds sterling) originally paid for the tokens goes into the pool to create the ‘pooled allowable cost'
This pooling approach requires sales to be matched with purchases in the following strict order:
- made on the same day (same day rule), then
- made in the next 30 days on a first-in first-out basis (bed and breakfasting rule), then
- the rest of the acquisitions are aggregated in the crypto pool (pooling rule)
The pool is an aggregate or average cost of all the cryptoassets which are not sold within the subsequent 30 days. This allows for a pro-rata cost to be deducted from disposals using the matching rules.
Example of crypto pooling
Eve purchases 5 Bitcoin for £200,000. A year later she makes a further purchase of 2 Bitcoin for £150,000. By pooling the transactions, the total cost is £350,000 for 7 Bitcoin.
If Eve disposes of say 4 Bitcoin for £400,000, the gain will be calculated as follows:
Disposal value: £400,000
Underlying base cost: £200,000 (Calculated as £350,000 x 4 / 7 per the crypto pool)
Gain of £200,000 subject to capital gains tax.
How much capital gains tax do I pay on crypto gains?
It depends on whether you are a basic rate tax payer or a higher rate tax payer.
Basic rate taxpayers will be subject to UK CGT at a rate of 10% on gains (after taking into account the annual exempt allowance - see below).
Higher rate taxpayers will, be subject to UK CGT at a rate of 20% on gains (after taking into account the annual exempt allowance - see below).
Put simply, assuming you made no other income this tax year, you would pay 10% on the first £50,000, and 20% on the remainder of any gain.
What tax allowances are available on the sale or exchange of cryptoassets?
Every UK tax resident individual has an annual capital gains tax exempt allowance (currently £12,300 in the tax year 2020-21). This means that if the total gain in the tax year to 5 April 2021 is less than £12,300 then there is no CGT due.
Note that if your total proceeds received are in excess of £49,200 in the tax year to 5 April 2021, you must still report the transactions to HMRC, even if your net gains are less than £12,300 and no CGT is due.
What are my allowable costs?
Aside from the underlying base acquisition cost that can be deducted from the disposal value (as explained above in relation to the 'pooling' rules etc), you can also deduct fees incurred in buying and selling cryptocurrencies - often referred to as 'incidental costs of acquisition and disposal' in tax parlance (in crypto parlance it would typically be called 'Gas' ;) ).
You can offset any current year or prior year (brought forward) capital losses against crypto gains.
How can I reduce or mitigate the tax on cryptoassets?
Transfer to a spouse or civil partner: Make sure that you use all available annual exempt allowances (AEA) for CGT purposes. So a transfer of cryptoassets with a market value of £12,300 before 5 April 2021 to a spouse/civil partner can be carried out with no CGT and then the spouse/civil partner can sell/exchange to use up their AEA. So potential of £24,600 of tax-free gains for a couple this tax year.
Loss harvesting: Similar principle to above, this involves utilising your AEA, even when you're not necessarily ready to fully exit your holding or position. The principle is that by selling just enough to use up your AEA, you can then repurchase the amount sold to rebase/uplift or write-off the gain on that tranche - tax-free. This is because the AEA is a "use it or lose it" relief.
But, unfortunately, it is not quite that simple! There are rules to prevent you selling on the 5 April (to 'bank' your AEA relief, as explained above) and then repurchasing the same amount on the 6 April - referred to as "bed and breakfasting". There is a 30-day rule that applies before you can re-enter your position. This can be risky in the fast moving crypto market; however, one planning approach could be to exchange into a complementary cryptoasset that might roughly mirror the asset volatility whilst you wait out the requisite 30 days.
SEIS/EIS: SEIS rules allow for 50% of gains to be exempted or "washed-out" if invested into a qualifying SEIS company. This is in addition to the 50% income tax relief, therefore, resulting in a potential 60% overall tax saving. EIS reliefs also include the potential for capital gains to be rolled over into a qualifying EIS company.
Pensions: Personal pension contributions increase the basic rate band and provide potential, therefore, for more of your gains to be subject to CGT at 10% rather than 20% (watch out for pensionable earnings cap).
Crypto Loans: You can expect to see the market increasingly opening up to allow holders to borrow against their crypto (with the crypto used as collateral). There are already platforms that provide this facility. Although a potentially risky strategy, for those who would like to access cash from their crypto portfolio without selling their holdings or incurring a tax charge, this could be a useful planning tool.
Hard forks occur where a particular cryptoasset e.g. BTC, splits into two and crypto holders receive crypto from the new fork e.g. BCH, based on their holding in the original (forked) cryptoasset (BTC).
Post Fork, the new cryptoasset has to be treated as having its own pool for tax purposes. This impacts on the pooling base cost for tax purposes. HMRC has yet to issue specific guidance, other than it should be conducted on a 'just and reasonable basis'.
The generally accepted practice is for the cost of the original crypto to be apportioned between the two assets in line with the market values of both assets on the day after the fork.
Mining and Staking
Income from mining will typically be subject to income tax, unless the mining activities amount to a trade (which goes beyond the scope of this post).
Income up to £1,000 per tax year can be covered by the miscellaneous income annual allowance (currently £1k) with the remainder subject to income tax at your marginal rate of income tax.
You would then be subject to UK CGT on the ultimate sale or exchange of these cryptoassets using the market value at the date received as your underlying base cost (see above for CGT calculations).
HMRC has yet to issue formal guidance in relation to staking, but we expect it will be treated as a capital gain or subject to income tax.
An airdrop is the term used when a cryptocurrency project distributes free tokens or coins to the holders of existing tokens or coins, often as a form of advertising.
If you receive an airdrop simply by holding another token, you should not be subject to income tax. Capital gains tax treatment will apply when you later sell these coins which will have £nil base cost.
The position will be different if you receive an airdrop in return for performing a service or similar - in this case it will likely be subject to income tax and reportable as miscellaneous income.
De-Fi and NFTs
Decentralised Finance ('De-Fi') refers to a new and emerging crypto exchange business model that applies the FinTech approach to trading the digital assets market. With no centralised bank or other institution, smart contracts are deployed, primarily via Ethereum but new De-Fi smart contracts platforms are constantly emerging e.g. BNB.
Both De-Fi and NFT accounts are created via decentralised exchanges that allow users to buy and sell digital assets from the pool of available assets on the exchange - comprising financial instruments such as liquidity pools, farming etc, in the case of the former and tokenised digital art, property and in-game assets etc, in the case of the latter.
We await HMRC guidance on the tax treatment of these potentially complex areas.
Tax treatment of cryptocurrency - VAT rules
Broadly speaking, activities in cryptocurrencies that are similar to Bitcoin 'mining' fall outside the scope of VAT, whilst trading in cryptocurrencies are exempt supplies for VAT purposes.
Note that if, as a business, you charge customers in crypto then you must remember to apply VAT (if you are VAT registered).
Any gifts of cryptoassets will be subject to the normal rules around potentially exempt transfers (more commonly referred to as 'PETs') meaning that they will fall outside the deceased's estate only after seven years.
Cryptoassets held at the time of death will form part of the estate and will be valued for the purposes of calculating any IHT due.
PAYE - if paid in crypto
If you are paid in crypto as a salary or a bonus, this must be accounted for in the normal way via RTI HMRC reporting and the PAYE and NIC paid over to HMRC within the normal time-limits.
This is a constantly evolving area and therefore you should reach out if you require specific professional advice. It is for guidance purposes only.
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