Cryptocurrencies are virtual but individuals trading or investing in cryptocurrency – and their tax advisers – need to consider the very real taxes that could apply and how to report those transactions on self-assessment returns
It is now almost ten years since the public launch of Bitcoin. Once a niche area, there are now over 1,600 different cryptocurrencies or digital tokens and increasing numbers of individuals prepared to explore the possibilities of using digital currency. While the coins are virtual, individuals trading or investing in cryptocurrency – and their tax advisers – need to consider the very real taxes that could apply and how to report those transactions on self-assessment returns. This article focuses on the position of those individuals.
A cryptocurrency such as Bitcoin can be described in a number of ways. The more technical explanations tend to take the approach that a cryptocurrency is a public ledger which operates on a peer-to-peer network (i.e. there is no central server). The network handles the creation and processing of transactions which are recorded in a blockchain. This blockchain is secured by cryptography and each transaction made is recorded and incorporated into the next block added to the chain.
For the layperson, a more comprehensible explanation is to view Bitcoin and similar cryptocurrencies as a virtual currency. Despite their lack of physical form or the support of a government or central bank, the digital coins or tokens have a value and can be exchanged for goods and services. While Bitcoin is the most well-known cryptocurrency, it is only one of a huge number of different types of similar virtual currencies. It is possible to exchange Bitcoin for other cryptocurrencies or for pounds sterling and other legal tender or fiat currencies. Users hold their virtual currencies in a digital “wallet” either in the cloud or on their computer.
There is no specific legislation which deals with the taxation of cryptocurrencies or digital tokens that use similar technology. In order to determine the tax treatment, it is necessary to draw analogies to more familiar assets. There is some guidance available in the form of HM Revenue and Customs Brief 9 (2014), which highlights that it is important to look at the specific facts to determine the position in each case.
For the individual, there are various ways that they could be using cryptocurrencies. These include:
Increasing numbers of shops and service providers will accept Bitcoin and other cryptocurrencies as payment for goods and services. Coins acquired for personal expenditure would not generally be expected to have a tax consequence. This is similar to the position when foreign currency such as Euros are acquired to spend on holiday.
This is the process of generating new coins. This is a specialised activity which requires the miner to dedicate a large amount of computing power to solving cryptographic puzzles which result in adding a block to the blockchain. The miner who solves the puzzle first creates a new coin and earns coins (or fractions of coins) in payment. This article does not address the tax issues of this type of participation, where there is as yet little authoritative guidance.
The most likely activity that agents may be asked for advice on is the buying and selling of cryptocurrencies with a view to making short or long term gains or profits. A number of exchanges exist where individuals can trade between various cryptocurrencies and/or fiat currency. Prices of many of the cryptocurrencies, particularly the more recently launched offerings, can be very volatile.
The first question is whether or not such an activity amounts to gambling. This is raised as a possibility in Brief 9 (referred to above), which states that “a transaction may be so highly speculative that it is not taxable or any losses relievable. For example gambling or betting wins are not normally taxable and gambling losses cannot normally be offset against other taxable profits“. However, for this to be the case, the acquisition of the coin or token would have to meet the definition of a bet. A bet generally consists of an individual winning or losing based on some future event. In most cases this is unlikely to be the case for a cryptocurrency and HMRC may not look favourably on this line of argument.
If the individual’s activities are not gambling, the next question is whether or not they amount to a trade. This will depend on the usual badges of trade tests. The case of Salt v Chamberlain (1979) may also be helpful here. There it was held that the initial presumption where an individual was engaged in speculative dealings in securities was that they were not trading. This presumption can though be displaced on the facts.
If the profits or losses are not those of gambling or trading, are they then subject to Capital Gains Tax? Brief 9 sets out that cryptocurrencies are intangible assets and, provided that the digital coin or token is something which is capable of being owned, and has a value which can be realised, that “gains and losses incurred on Bitcoin or other cryptocurrencies are chargeable or allowable for CGT if they accrue to an individual”.
Like shares, where individual units of currency are not identified on sale, then the purchases can be pooled and disposals or part disposals are made out of the pool. The usual rules for the cost of acquisition and disposal should apply, with transactions needing to be translated into sterling using the exchange rate applying at the time of the transaction.
There are a number of areas of complexity where detailed guidance is urgently needed. HMRC is aware that there are issues and we understand that HMRC is currently in “listening mode”.
Where an individual has large number of transactions, record keeping may well be an issue. Investors will need to consider whether they have a sufficient record of every transaction in order to calculate their tax position. Transaction volumes can be large, with one member reporting to us a client making 1,600 transactions in a year.
The position for Initial Coin Offerings (ICOs) can also be unclear. ICOs can be used to raise money for new ventures. In this case the individual may be investing in something which is more of a token with certain rights, than a coin that could act as currency. In these cases, an understanding of the nature of the rights that the individual has acquired will be needed to determine the correct tax treatment.
The EU is considering increasing regulation on cryptocurrency platforms, exchanges and wallet providers to require them to carry out identity checks on those transacting. This has had an impact on prices in recent months and may mean that individual investors will be seeking advice on whether or not there will be real tax relief for their digital losses in the near future.
From the perspective of the tax adviser faced with a client involved with cryptocurrency transactions, the above demonstrates that there is still a great deal of uncertainty about the tax position and it is difficult for advisers to provide definitive advice. Full and upfront disclosure of the position to HMRC is likely to be a sensible approach, with each client’s position considered individually.
Helen Thornley is a technical officer at the ATT.