Cryptocurrencies don’t seem to be going anywhere anytime soon. More and more investors are looking to cash in on these lucrative investments. However, when tax is concerned many aren’t sure what’s involved, especially in the UK.
To help you through the process we’ve created a digestible guide of what you need to know about tax and crypto.
A cryptoasset is another name for a cryptocurrency. There is a huge variety to choose from when investing, with new types being released all the time. They are officially described as cryptographically secured digital representations of value or contractual rights that can be:
- Traded electronically
Cryptocurrencies can be accessed and stored through the use of a virtual wallet. There are many ways to obtain a virtual wallet with different apps and websites offering them.
Crypto is unique compared to other currencies as it’s decentralised. That means there is no central bank or government that is in charge of managing it, even if issues arise. All transactions that are made are recorded in a public ledger or what is more commonly referred to as a blockchain.
The blockchain operates with the help of distributed ledger technology (DLT), which is a digital system designed to record the details of transactions in various places at once.
HMRC and Crypto
Unlike other governments, HMRC doesn’t consider cryptoassets as a currency. They have instead been categorised into 4 main sections:
- Exchange Tokens
- Utility Tokens
- Security Tokens
Exchange Tokens - These are classed as something that is supposed to be used as a type of payment. An example of this would be Bitcoin.
Utility Tokens - Utility tokens allow the holder to gain access to certain goods and services on a platform, typically through the use of DLT. Businesses are known to issue these types of tokens with the intention of accepting them as payment for services or goods, however, they aren’t usable outside the business. Although, they can still be traded on exchanges or between individuals, similar to exchange tokens.
Stablecoins - This type of cryptoasset is one that has a more stable value with it being connected to a government-backed currency such as The Great British Pound or a valuable commodity such as silver. Like the others, it still is primarily used for payment purposes.
Security Tokens - Security tokens provide a holder with certain rights or interests in a company. This could be a percentage of ownership, repayment of a particular amount of money, or the ability to claim a share of the company’s future profits.
Taxing Cryptoassets in The UK
Any individuals that live within the United Kingdom and own cryptoassets are taxed on the profit gained. This type of tax is known as Capital Gains Tax (CGT). Therefore, you’ll only be required to pay tax on the difference between the price that the cryptoasset was purchased at and how much it was sold for.
How Capital Gains Tax works
During the tax year, individual’s have a tax-free allowance, also known as an annual exempt amount. This allowance is subject to change but for 2020/2021 it currently stands at £12,300.
Let’s break this down a bit further - Say you bought cryptocurrency for £6,000 and then decided to use it to purchase an item. At the time of the purchase, the new value of the crypto was £10,000. You’ll be required to pay tax on £4,000 due to capital gains (unless you’re under the tax-free allowance). As this gain is under exempt amount, provided you have no further capitals gains, there will be no tax to pay. If your gains exceed the exempt amount you will pay tax. The actual amount of tax that should be paid depends on your current income.
HMRC requires people to report their gains through a self-assessment tax return when gains have been made on cryptoassets.
Will I be taxed on cryptoassets if I don’t trade them?
Short answer: No. The only taxable amount you’ll need to worry about when holding cryptoassets is the gains made when they are sold, from their original price. HMRC monitors exchanges and acquires information about trades taking place.
Keep in mind that if you swap one type of cryptocurrency for another this is seen as selling and you’ll be required to pay gains tax (unless you’re under the tax-free threshold).
What about income tax?
There are some instances where investing in crypto activities will require you to pay income tax. For example, HMRC has been known to see regular buying and selling of cryptoassets as trading. If this is the case, then any profits earned will be treated as additional income and may be subject to tax. An individual’s current income will determine if income tax will be applied along with the percentage charged.
What is known as cryptocurrency ‘mining’ and ‘staking’ are sometimes classed as generating income and will require individuals to pay income tax. However, this is uncommon.
Rules for Businesses
Businesses are taxed similarly to individuals when cryptoassets are concerned. They are required to pay tax if the following occur
- Buying and selling exchange tokens
- Giving goods or services from receiving exchange tokens
- Swapping exchange tokens for other assets including other cryptocurrencies
Keeping up-to-date with tax payments
Cryptoasset exchanges typically have limited access to transactional records, or in small cases, they cease trading and records are lost.
Therefore, individuals are advised to keep their own records when transactions are made. The following information should be kept:
- What type of cryptoasset is being traded
- The date the exchange occurred
- Whether it was a purchase or sale
- The exact units
- The pound sterling value (same date as the transaction took place)
- The cumulative total of cryptoasset units held
- Relevant bank statements and cryptowallet information
This information can also help individuals understand how much they may be taxed, preventing any nasty surprises when compared to the amount of gains actually received. Financial planning plays a big part in the investment process, that’s why it’s always recommended to speak to tax professionals to ensure you make the most out of your investment.
Government Nudge Letters
In the month of October 2021, HMRC announced that it plans to notify digital currency holders about declaring the correct amount of gains. This includes paying the necessary amount of income tax and capital gains tax if applicable.
Following HMRC cost basis methods
HMRC has important rules for cost basis methods when it comes to cryptoassets. The reason for this is to prevent investors from manipulating the ACB cost basis method. This occurs when assets are purchased and sold at a loss in a short period to show fabricated gains or losses.
3 different cost basis methods can be used for investors that reside in The UK. You’ll need to find the one that relates to your investment to determine which one must be applied.
Bed and Breakfasting Rule: Cryptocurrencies that are purchased and then sold within 30 days must be calculated with the cost basis of the coins/tokens purchased within the month to total the gains or losses accumulated. Although, if more are sold than purchased within the months, then the section 104 rule must be followed.
Same-Day Rule: Cryptoassets that have been purchased and sold on the same day must use cost basis on that specific day to evaluate the gains or losses made. However, if you’re selling a higher volume than purchase on a particular day, then the bed and breakfasting rule is applicable.
Section 104 rule: When the following two rules don’t apply, then an alternative cost basis method must be used. It’s similar to the ACB method which involves the average cost basis for a collection of assets to be calculated by tallying up the total amount paid for every asset then dividing them by the current amount in the investor’s possession.
Things to consider when using same-day and bed-and-breakfasting rules
Rules for both same-day and bed-and-breakfasting apply for both shares and cryptoassets. This is done to prevent wash sales. For example, trying to sell crypto and then buy it back with the intention of showing higher losses to lessen the amount of tax.
Same-day rule: Cryptocurrency that is of the same type which is sold and then bought on the same day must do the following: The cost basis of the sale will be the acquisition cost of the purchased amount on the same day. This is also relevant if the acquisition of the cryptocurrency is actioned before the actual sale (as long as it’s on the same day).
The bed-and-breakfasting rule: Similar to the same-day rule. All crypto that is obtained within 30 days of a sale is used in its cost basis.
If you’re wondering why these are in place, it’s to prevent investors from selling their holdings at the end of the tax year to produce losses that can be written off, even with them purchasing more straight after.
Talk to the experts
Understanding all the complex rules around taxation and cryptoassets can be challenging. For peace of mind, why not contact us to help guide you through the process. That way you won’t need to leave anything up to chance to prevent any fines ending up at your letterbox from HMRC.