Tax Talk: Cryptoassets mean cryptic tax liabilities
What counts as a taxable event for cryptoassets? Will HMRC consider you a trader or an investor? We help you to prepare for being crypto accountable.
The growth of cryptoassets has brought many into direct contact with the UK tax regime for the first time. Most people, employed on payroll with investments limited to ISAs and pensions, will not need to consider a tax return in their lives. But those who hold cryptoassets will almost certainly need to file tax returns, as any taxation event cannot be dealt with at source.
In the early days of crypto, this position was misunderstood and HMRC didn’t help. Its very limited initial guidance in 2014 could have been interpreted as saying there were no tax risks. More recently, particularly in 2021, HMRC has been far clearer in its guidance and expectations of tax events. Specifically, HMRC has requested information from exchanges to target individuals who it believes have not reported their crypto activities in a ‘nudge campaign’.
Although crypto is still very new in terms of investment and trading activities, tax legislation is definitely not. Crypto activities and events are therefore matched against pre-existing tax treatments to determine tax outcomes. There is very little new legislation in this field. But the language of crypto changes and develops very quickly, so care will always be needed.
When does a taxable event arise?
The key triggers that give rise to a taxable event are when someone disposes of a cryptoasset in exchange for something else. These are the main examples:
- Sale of crypto for fiat currency, e.g. GBP or USD. The disposal value is the value of the currency received.
- Exchange of crypto for a different crypto type, e.g. converting Bitcoin to Ethereum, or using Ethereum to buy a non-fungible token (NFT). The disposal value is the GBP equivalent of the crypto disposed.
- Using crypto as a means of payment, e.g. using £5,000 worth of Bitcoin to place a deposit on a Tesla. The disposal value is £5,000.
The mere acquisition of a cryptoasset in exchange for cash isn’t a taxable event. It will, though, give rise to an acquisition cost for computing any profits on a later disposal. Equally, an airdrop of new coins would not usually give rise to taxable income. But if you receive cryptoassets in exchange for services provided (or if some or all of your salary is paid in crypto), those services are taxed in the normal way. The fact that crypto, rather than cash, is the payment mechanism does not change that underlying presumption. What’s more, if you’re receiving crypto in return for services, you’ll also need to consider VAT.
It’s important to note that, to be taxable, cryptoassets need to be exchanged for something else. If, for example, you move Ethereum between wallets or exchanges (you start and end with the same number and value of ETH), there is no disposal to consider. But you should still keep records of these transactions so that you can prove to HMRC, if challenged, that this is what you did.
Income or capital?
Many people investing in crypto will describe themselves as traders. If this is correctly established for tax purposes, it means they are subject to Income Tax in respect of their profits. But to be truly considered a trade, there must be serious organisation and time commitment to the activity, which can often be difficult to demonstrate. The reality for many is that, however they describe their activities to friends, they will be considered investors and subject to the Capital Gains Tax (CGT) regime.
In good times, being in the CGT regime is no bad thing. The rate of CGT for UK individuals is 20%, with an (often unused) exemption for the first £12,300 of gains in the current tax year. For small investors, this may mean no, or low, tax liabilities. But if they are treated as trading, the rate of Income Tax is as high as 45%.
Trading (and therefore Income Tax) status may be beneficial where losses arise, as there is scope to use those losses against income (such as salary) at the higher income tax rates. On the other hand, capital losses can only be used against current year or future capital gains. But beware. Given the number of first-time crypto speculators who have been badly burnt this year, HMRC is likely to strongly challenge any individuals who claim a trading status and an Income Tax loss offset in their first tax return.
Why is fungibility relevant for tax?
It was amusing for me as a tax advisor to see the word ‘fungible’ appear in daily use when NFTs became mainstream. I’d only heard it years ago when studying for my tax exams. Broadly, something fungible is something where all items of that class are identifiable. For example,
- if you buy a Red Ape NFT and a Blue Ape NFT, and then sell the Blue Ape, you can clearly track the Blue Ape purchase and sale, and know you are left holding a Red Ape.
- But if you buy 2 Bitcoin, and then sell 1 Bitcoin, you neither know (nor mind) which Bitcoin you have remaining.
Why these matters from a tax perspective are in determining how you calculate your profit on disposal. With the NFT example, your gain arises solely from the Blue Ape transactions. In the Bitcoin scenario, your Bitcoins form a pool. When you make your 50% disposal, the cost of disposal is 50% of the acquisition costs of your total Bitcoin holding. Again, you’ll need detailed records to track these accurately and support your calculations.
As an aside, and regardless of whether an asset is fungible or not, where you incur gas fees to buy or sell crypto these will be considered either costs of acquisition or disposal and will allow you to reduce your taxable gains.
HODL and losses
As we’ve said, there’s nothing new or unique about the taxation of crypto. It just involves the application of pre-existing tax concepts to new language. This is also the case where assets become of negligible value. Because of extreme price changes in the market, crypto investors often Hold On For Dear Life (“HODL”) to their cryptoassets.
Where an asset (normally shares) falls in value so dramatically with no prospect of recovery, it’s often possible to agree with HMRC that it’s of negligible value. This means it can be written off to give rise to a capital loss.
On a basic level, this could be appropriate for coins that have crashed in value recently, such as Luna. But even if all indicators lead the investor to conclude that the investment is a write off, the asset can still be traded. So, arguably, the prospect of recovery is greater than nil (even if only fractionally so). In such cases, if the availability of a capital loss to shelter current period gains is fundamental then, having considered the remaining investment potential, it may be best to dispose of the asset to crystallise an actual loss, rather than relying on negligible value claims.
If the loss derives not from a collapse in value, but from a theft or fraud, Andrew McCready has considered this in more detail here.
Be ready for HMRC
Although crypto is still a novel means of investing, the tax consequences are well established. HMRC is aware of significant non-compliance in the past. That’s why it’s actively pursuing taxpayers who it believes have not reported some (potentially sizeable) investment gains in recent years.
Even if you believe you have reported correctly, you cannot rule out HMRC raising questions regarding your crypto dealings. Having detailed evidence to support your transactions and tax treatments will be fundamental for resolving such enquiries quickly.
For further advice on any of the issues raised in this article, please contact Chris Riley.