Faced with clients who have been buying and selling cryptoassets such as Bitcoin, how do you advise them on the real tax consequences of their virtual assets?
For many of us, the world of cryptoassets is a very strange place indeed. It is a world in which very real fortunes have been made, and lost, on transactions based on encrypted computer code.
What has been bought or sold?
The first challenge is to establish the nature of the cryptoasset in which the individual has been transacting. Cryptoassets are digital assets, underpinned by distributed ledger technology (DLT), or blockchain, which is a cryptographically secured digital record of all the transactions that occur.
Such assets can be known as digital tokens or coins. Users hold their tokens in a digital wallet either in the cloud or on their computer.
There are three main categories of token:
These are commonly referred to as cryptocurrencies, such as Bitcoin and Litecoin. These tokens can be used to pay for goods or services.
One or more businesses will issue tokens using a DLT platform which they agree to accept as payment for goods or services in the future.
These can provide the holder with certain rights or interests in a business, for example a share of profits.
A good place to start when faced with a query from an individual who has transacted in cryptoassets is HMRC’s collection of guidance and policy papers on the taxation of cryptoassets for individuals.
The key policy paper on taxation has been reviewed and commented on by an informal working group comprising experts in the field and professional bodies. While that paper only specifically provides guidance on the taxation of exchange tokens held by individuals, it does provide a starting point for the principles which may apply to other types of tokens.
No more gambling
The new HMRC guidance, referred to above, supersedes the earlier positions largely set out within Revenue & Customs Brief 9 (2014). This suggested that HMRC might be willing to consider that highly speculative transactions were gambling, which would mean that any profits (or losses) would effectively fall outside the scope of tax.
Given that values of cryptoassets can fluctuate significantly (as much as 65% up and 25% down in a single day) this was potentially valuable for those who made profits having invested in new and untested cryptoassets.
However, in its latest guidance HMRC indicates that it doesn’t consider the buying and selling of cryptoassets as the same as gambling.
Not a currency
Despite their name, cryptocurrencies are not, in fact, considered to be equivalent to currency or money. Therefore, the current rules surrounding forex gains and losses are unlikely to apply.
CGT or income taxes?
In the majority of cases, HMRC expects that an individual will be holding cryptoassets as a personal investment. In this case, CGT will apply to any gains or losses.
Some individuals may consider that they are transacting with such frequency, level of organisation and sophistication that they are trading. This is a question of fact and HMRC says that guidance can be drawn from existing case law on trading shares and securities. One of the classic cases here is Salt v Chamberlain (a loss relief claim), which sets a very high bar for when an individual can be considered to be trading in securities.
Capital Gains Tax
Where the individual is subject to CGT, the approach is comparable to normal CGT rules for the disposal of shares and securities. Each type of token should be pooled and the usual rules for part disposals and for bed and breakfasting should apply.
It is important to note that, for CGT purposes, disposals will occur not just when a token is exchanged for sterling (or another fiat or legal tender currency such as dollars) but also when one cryptoasset is exchanged for another.
Particular issues are likely to arise with:
Volume of transactions
Since trades can be automated, it is possible for an individual to carry out a large number of transactions during the year (even if they are only acting in their spare time). One CIOT member has a client who had made in excess of 16,000 transactions in a tax year. I am not aware of any software which can calculate the gains and losses on all these transactions for UK tax purposes.
Valuation of transactions
All gains and losses need to be reported in sterling. Where one cryptoasset is converted to another there is not always a sterling exchange rate readily available. It may be necessary to convert the transaction into another fiat currency such as dollars and from there into sterling.
HMRC’s guidance does not address the problem of where cryptoassets are considered to be located for legal and tax purposes. HMRC has indicated that this is an issue that will be addressed in future updates.
Income tax even when not trading
Even if an individual is not trading, it is possible that they may receive miscellaneous income in connection with their interest in cryptoassets.
Such income might include the receipt of cryptoassets as payment for mining – solving complex problems to generate more cryptoassets – or from airdrops.
An airdrop is an allocation of cryptoassets which might occur, for example, during a marketing campaign. Where the airdrop is provided without the individual having to do anything in return then the receipt is not taxable. If the individual must do something in return, such as make a posting on a message board, the value of the cryptoassets received is taxable as miscellaneous income.
In both cases, such miscellaneous income may be eligible for the £1,000 trading/miscellaneous income allowance.
Updates to guidance
The HMRC guidance currently only applies to individuals, with separate guidance for businesses and companies due to be issued later in 2019.
In the meantime, if you have clients who have transacted in cryptoassets in 2017-18 there is a very short window to consider whether they have any taxable gains or income to report by 31 January 2019.
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Helen Thornley has a focus on personal and capital taxes. Initially training as an accountant before moving to tax, she worked in practice until her appointment as a technical officer in 2017. She also has an interest in the history of tax.