What is cryptocurrency and how does it work?
This is a very complex question! For an in depth guide we highly recommend watching Grant Sanderson’s YouTube video on the topic on his channel 3Blue1Brown. For our purposes though we can think about cryptocurrency as follows:
Nature of the Asset – Despite the name, HMRC do not treat cryptocurrency in the same way as, say, US dollars or Euros. In many ways HMRC treat crypto as more akin to precious metals like gold or silver.
Types of Crypto – HMRC break down crypto assets into four sub-categorises:
- Exchange Tokens – These are the most currency like crypto assets. Exchange tokens are tokens principally designed as a means of paying for goods and services. Bitcoin is a quintessential exchange token.
- Utility Tokens – Kind of like store credit. Instead of Bitcoin, which can be used to buy anything, a utility token would be issued by a specific company, tradable through their platform, which can only be spent on the company’s goods.
- Security Tokens – Kind of like debt or preference shares. Holders of security tokens gain an interest in the business issuing the token, such as a right to profits, fixed sums of money, etc. Rights to ownership are sometimes known as equity tokens and are rare in practice.
- Stablecoins – These assets are pegged to another asset. So, one might say that 1 GoldCoin is worth 1g of gold. You can now trade the tokens rather than real gold. For this to work a backer needs to have sufficient reserves for people to cash out.
Derivatives – Not everyone who, “invests in crypto” actually buys crypto assets. It is also possible to enter into contracts which allow one to benefit from price increases and decreases without owning the underlying asset. These are treated in the same way as regular derivatives for tax purposes.
Isn’t gambling tax free?
Income from gambling is, normally, tax free unless one is a professional gambler. However, HMRC do not consider investing in cryptocurrency to meet the definition of gambling. See HMRC’s manual for more details.
So what tax do I need to pay?
This depends on a number of things:
- Trader – The first thing to consider is if HMRC might consider you to be a trader. In short, whether you are trading sufficiently often and professionally that it can be considered akin to a job. If this is the case HMRC will tax you as a self employed individual with Income Tax (IT) and National Insurance Contributions (NIC) due on the gains you make. For more detail on how to determine whether or not you are a trader you can refer to what are know as the, “badges of trade.”
- Investor – If you are not a trader then you are likely to be viewed as an investor. In other words, someone who puts a bit of money into crypto just as one might put some money into an ISA, into shares, bonds, etc. If one goes on to sell the crypto and makes a profit then the tax due is Capital Gains Tax (CGT).
- Miner/Staker – If you receive crypto via, “mining” or, “staking” but not as a trader, you will be subject to Income Tax but not NIC on the basis that this is Miscellaneous Income.
- Employee – If you are paid in cryptocurrency then you will be subject to Income Tax. The NIC position depends on whether the cryptocurrency can be readily converted to regular currency or not. If the crypto is then sold at a profit on what it was worth when granted, CGT will also be due on sale.
- Company – If a company sells currency at a profit it will be subject to Corporation Tax.
- Estate – If you die and leave crypto to your descendants, the estate will be subject to Inheritance Tax (IHT).
You can see that there are lots of different tax considerations when it comes to cryptocurrency!
Am I a Trader?
In the first instance we would advise reviewing the, “badges of trade.” These are a series of considerations you can use to help reach a decision.
HMRC have, however, stated that they will view individuals buying and selling exchange tokens as traders only in, “exceptional circumstances.” As such unless you are spending a significant amount of time buying and selling, making a lot of money, or carrying out a lot of trades each week, you are likely to be viewed as an investor.
When is Tax Due?
Say you buy and sell crypto through something like Coinbase. You buy some Bitcoin, trade it for Ethereum, trade that for Dogecoin and a few months later cash out for GBP. A few months after that you withdraw the GBP into your current account.
Is tax due only when you withdraw the GBP? Is it due when you transfer crypto into GBP? Or is it due whenever you trade one currency for another?
The bad news is that every time you exchange one currency for another, or sell it for fiat currency, or spend it, or give it away, Capital Gains Tax arises. So, if you traded Bitcoin for Dogecoin you need to work out what that Dogecoin was worth, at the exact moment you bought it, and that is considered to be your proceeds for CGT purposes.
Transfers between spouses or civil partners are deemed to take place at no gain, no loss so will not trigger CGT. Donations to charity will also not usually trigger a CGT charge though we suspect Oxfam is not yet geared up to accept Dogecoin donations!
Can I Deduct Expenses?
Yes, but probably not all of them. HMRC have published a detailed list of what they will and will not allow. So, for example, the original cost of buying the asset is definitely deductible. Fees for withdrawing money as GBP, however, are not deductible. We suggest carefully looking through this list to ensure you don’t get caught out in claiming expenses.
How do I Work Out How Much CGT is Due?
Let’s take an example:
Adam makes the following purchases:
- 30 April 2021 – 100 ExampleCoin for £10,000
- 31 May 2021 – 75 ExampleCoin for £15,000
- 30 June 2021 – 80 ExampleCoin for £30,000
Adam then sells 50 Example coin on 31 July 2021 for £40,000. Transaction fees for converting the ExampleCoin into GBP were £250. There was a withdrawal fee of £75.
The first question is, what did Adam pay for the 50 shares he sold? Did he sell from the first tranche purchased, in which case he paid £100 per share. Or was it from the last tranche, in which case £375 per share?
The answer under UK law is the concept of, “pooling.” The is really just a fancy term for working out the average. Pre-sale Adam has 255 ExampleCoin and has paid £55,000. As such the price per share is £215. If he sells 50 the purchase price is therefore deemed to be £10,750 (50 x £215).
So, proceeds of £40,000 and cost of £10,750 gives us a £29,250 gain. One can deduct the transaction fee but not the withdrawal fee to get down to £29,000. The first £12,300 of gains one makes in a tax year are CGT free. The balance, £16,700, is subject to CGT at either 10% or 20% depending on one’s other income and gains.
If Adam decided to cover the transaction fees using an ExampleCoin instead of GBP that would still be an allowable expense. However, in that case, spending that ExampleCoin on the transaction fee would itself be a disposal on which CGT is due. To avoid an infinite loop, it may be administratively easier for investors to pay transaction fees in GBP.
Note that pooling can be more much more complex where there are lots of purchases and sales during a year. There are also special rules if assets are bought and sold in the same day, or if assets are sold and repurchased within 30 days of selling. If in doubt, seek advice before submitting your tax return.
What Happens if I Lose my Private Key?
Strictly speaking your crypto still exists on the blockchain. It hasn’t been destroyed and, in some sense, you still own it. However, if you can prove to HMRC that you really can’t access the asset then it should be possible to submit what is called a, “negligible value claim” in order to crystallise the loss.
Is Crypto a UK or a non-UK Sourced Asset?
This is likely to be relevant for, say, non-domiciled individuals filing on the remittance basis who are only subject to UK tax on UK sourced income or gains and foreign income/gains which is remitted (brought into) to the UK.
The rules here depend on the type of crypto currency in question. For security tokens one looks at the pegged asset. So if 1 AppleCoin is pegged to 1 Apple Share, you look at where Apple are incorporated and that is deemed to be the location of the AppleCoin.
For exchange tokens, HMRC argue the crypto itself doesn’t really have a location. Instead, they will treat crypto as UK sourced if the owner is UK resident. If two people co-own a wallet then, bizarrely, HMRC argue the asset can simultaneously be a UK sourced asset for the UK resident and a non-UK sourced asset for the non-resident co-owner.
It’s worth flagging that the above is simply HMRC’s position. As at today’s date, there is no specific legislation regarding the sourcing of cryptocurrency. Longer term we hope that the Government will update the Tax Code to give clearer guidance regarding this question. HMRC may well be making up rules here but, to be fair, what else are they meant to do if no rules have been written for them to rely on?
Do I really need to submit a tax return?
Not necessarily. If your gains do not exceed the annual allowance (£12,300 for 2021/22) and your gross proceeds do not exceed £49,200 (4x the annual allowance) you may not need to file. You should, however, still maintain records as purchases and disposals made this year will impact pooling calculations for future years – years where returns may need to be filed.
If you have to file a return anyway for some other reason, gains should be reported even if they are under the annual allowance.
If you are a trader, making income, you are very likely to need to file. If in doubt, HMRC release a tool each year allowing you to check if you have a filing requirement or not. This year’s tool can be found here – Check if you need to send a Self Assessment tax return – GOV.UK. We suggest consulting this at the end of the year and following the instructions.