By Ben Chernoff
The tech industry has been an early adopter of payments and transactions using cryptoassets, such as digital coins and NFTs.
Equally, many tech entrepreneurs have focused their own personal investments in this area to give themselves a brighter financial future.
However, many individuals and businesses may not be aware of the tax implications of their activity within the crypto markets.
In recent months, HM Revenue & Customs (HMRC) has been ramping up nudge letters and its investigation into crypto investments and transactions.
If you receive a letter from HMRC about cryptocurrencies, then it does not necessarily mean that you have made an error or failed to disclose income in your tax return.
However, you should not ignore the letter, and professional advice should be sought.
How does the UK tax cryptoassets?
HMRC does not consider cryptoassets to be currency or money. Instead, it views this digital currency as something more akin to investing.
HMRC has said that most individual investors will only be subject to Capital Gains Tax (CGT) on gains (profits) and losses on cryptoassets.
However, those ‘mining’ cryptoassets (e.g., those using a computer to complete complex computations to create coins and assets) could be considered a trading activity.
All ‘exchange tokens’, such as Bitcoin, although digitally located on computers and servers worldwide, are for tax purposes located wherever the beneficial owner is resident.
Capital Gains Tax
Most individuals investing in cryptoassets will only pay Capital Gains Tax (CGT) on gains they make when disposing of the digital asset.
It can be challenging to calculate gains from cryptocurrency as they are regularly traded on exchanges where they change hand for other cryptoassets rather than fiat currency.
With the crypto markets being so volatile, the value of these digital coins can frequently go up and down, sometimes in a matter of minutes or hours, which makes placing a value on the asset difficult.
Nevertheless, these trades are considered a disposal for CGT purposes, even where the trade leads to no actual income in traditional fiat currency.
In these cases, it is down to an investor to realise either a taxable gain or loss and dispose of the asset as actual currency to settle their tax obligations.
Taxpayers should be aware that gains on disposal are taxed as regular capital. This means that you will obtain tax relief on the direct costs of buying and selling the cryptocurrency investment and can use your annual CGT exemption of £12,300 if it is unused elsewhere to reduce the amount of tax due.
If HMRC decides that you are trading, rather than just investing, it may tax your profits as income instead of gains. This typically occurs where an individual is:
- Actively mining cryptocurrency
- Is considered a dealer due to the volume of trade they complete
- Validating transactions
- Staking and yield farming.
In all of these cases, a person is likely to be remunerated through the receipt of fees and/or further cryptoassets in return for their services. On this basis, these rewards may be subject to income tax.
One way to determine whether you are trading for tax purposes is to use the Badges of Trade test, which is based on previous legal precedents.
Some employers are also choosing to pay staff via cryptoassets. If an employer awards cryptoassets, they are taxable as employment benefits.
Recording and reporting tax
Due to the nature of this industry, cryptoasset exchanges only maintain records of transactions for short periods.
Therefore, it is down to the individual to keep records for each transaction in case of a HMRC review or enquiry.
As with income from other personal investments, it is down to the taxpayer to report their gains to HMRC through a Self-Assessment tax return submission.
For IHT purposes, the value of cryptoassets in an estate must be included within the standard IHT return which is handled during probate.
Time to seek help
Given the complexity of the tax arrangements surrounding cryptoassets, the offshore nature of some exchanges and the increased interest from HMRC in the gains made by some investors, now would be a good time to seek advice if you have greater than expected gains.
In some cases, if you have failed to previously disclose earnings from cryptocurrencies and other digital assets, a disclosure can be made to HMRC, which may reduce or entirely eliminate any financial penalties.
To find out how we can assist you with issues relating to cryptoassets, please speak to us.