The publicity surrounding Facebook and Tesla’s recent involvement with cryptocurrency has again placed cryptocurrencies in the limelight. With many individuals and companies realising significant profits from cryptocurrencies, a significant concern must be to consider how to treat these gains for tax purposes.
This Blog does not discuss the mechanics (or advisability) of investing and trading in cryptocurrency. Yet it does assume a basic understanding of cryptocurrencies and how they operate.
Where to start with cryptocurrencies
A cryptocurrency is a digital ‘token’, recorded using a ‘blockchain’ or distributed ledger infrastructure. The technology can encode a range of user rights. One of the simplest and best known aspects of a cryptocurrency is that can operate as a medium of exchange.
Is it a currency or an asset?
Before starting, it is important to identify what we are talking about. The reality is the moniker of ‘cryptocurrency’ is not an accurate one. For example, HMRC does not view cryptocurrency as a form of currency or money, even though individuals and businesses can use it as a means of exchange for products and service.
Why is this? The sheer volatility of cryptocurrency is a key justification for not recognising it as a currency. Yet this presents a barrier to using a cryptocurrency to store or measure value. Because volatility is not good in maintaining a stable currency, HMRC regards cryptocurrencies as assets (rather than as a currency). Welcome to the world of crypto-assets!
How should one approach the taxing of crypto-assets?
When deciding the tax treatment, the first point to consider is whether the taxpayer’s exposure to crypto-assets is for investment or trading purposes. This is assessed by reviewing the facts of the case (against the recognised Badges of Trade) to determine if, on balance, each activity qualifies as a ‘trade’. For example, a trade could exist where there is:
- a profit-seeking motive
- a repetition of similar transactions
- short lengths of time between each purchase and sale
A different way to approach this is to consider whether the crypto-asset owner is an ‘Active’ or ‘Passive’ investor. This is important because the potential tax liability differs. As a rough guide, if one makes a one-off purchase of a few coins in the hope of the value appreciating, HMRC will consider this to be passive investing. If multiple transactions take place, effectively buying and selling coins to maximise profit, HMRC will view this as active trading.
To make this still more complex, there are different tax implications for individuals and for companies.
There is an underlying assumption for individuals that most transactions are of an investment nature activity – unless carried out with such a frequency, degree of organisation and sophistication that the case for trading is indisputable.
|ACTIVE||Activities such as financial trading or the mining of new crypto-assets may be treated as trading. Profit or losses are taxable to income tax at rates of up to 45% plus NICs (from 2% – 9% depending on other income). Trading losses can be offset against other income and gains if the business has other activities or the losses can be carried forward against future trade profits.
Certain activities, such as using spare CPU power from your home computer to mine and sell a few coins are unlikely to meet the standard for trading. Income derived in this way may be taxed as ‘miscellaneous income’ instead. Profit or losses are still taxable to income tax at rates of up to 45% but NICs are not due. Note that ‘miscellaneous losses’ can only be carried forward against future ‘miscellaneous profits’.
|PASSIVE||Gains will be subject to Capital Gains Tax at up to 20%. One particularly important point is to maintain a detailed record of your transactions as this will impact on the profit you are taxed upon when they are sold.
Crypto-assets are digital assets and all transactions should be found in a ‘wallet’ which holds data of the transactions undertaken. The fiat currency will come from the point of depositing the currency into a bank, which will be the value to use for your Capital Gains Tax calculation.
All crypto-asset transactions must be looked at on a case-by-case basis and similar to individuals, the basis for the activity will determine the tax implication on the return generated.
|ACTIVE||If activities amount to a trade, the company must account for the resulting income and expenditure within their taxable trading profit or loss. Only expenditure incurred wholly and exclusively for crypto-asset trading will be deductible, such as mining equipment and electricity costs. An Exchange token will initially form part of trading stock until it is sold.
The accounts could treat crypto-assets as an intangible fixed asset (IFA) and tax rules will generally follow this treatment providing the IFA has been acquired or created for use on a ‘continuing basis in the course of a company’s’ activities”. Simply holding the asset will not be sufficient to meet this criteria as it must be used on a continuing basis in the course of the business. Crypto-assets treated as an IFA may be valued at amortised cost or revalued at the year-end, and are taxable on the profit or losses.
|If the company is not trading and the crypto-assets are not classed as IFA, then disposal of the crypto-assets will be subject to the Chargeable Gains tax rules.
By default, crypto-assets are treated as Chargeable Assets, meaning they are only taxed on disposal, with costs not relievable until they can be offset against proceeds (if any). Allowable deductions include the consideration paid for the crypto-assets, distribution ledger transaction fees and professional fees incurred during the acquisition and disposal stages.
If the company has losses before 1/4/17 it may be able to utilise these against crypto profits, but only if they are of the same type (chargeable loss, trading loss or IFA loss). It is also possible to carry back crypto trading losses against a company’s prior year profits.
HMRC charge Corporation Tax at 19% on all of the above types of profit or gain. However, further tax may be payable when an individual extracts such funds from a company. If this occurs, the tax rate applicable can rise to 45% (plus NICs) depending on an individual’s income. There is, of course, the option to manage the timing of the extraction of profits so as to minimise this.
If cash is not required in the short term, another possibility is to leave it in the company until the company winds up. At this point Business Asset Disposal Relief is usable to reduce the tax rate to 10%.
Future Tax Development
In recent years, HMRC has provided extensive guidance regarding the treatment of crypto-assets. The rapid pace of development across virtual currencies, however, leaves many questions unresolved, a point emphasised as new crypto-exchanges introduce new currencies and features.
To compound the challenges, most G20 nations are developing their views on crypto-assets independently. This produces differing tax treatments for trading or investing in crypto-assets.
That said, with crypto-asset miners (and similar operations) already operating worldwide, this currently creates opportunities for sophisticated taxpayers to develop schemes to mitigate tax liabilities in different countries. As crypto-asset trading matures, however, investors should expect moves to establish uniform tax rules between countries.
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