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The taxation of cryptocurrency

29 May 2023 | BY Claire Critchley

Cryptocurrency is a complicated concept and the following text gives HMRC’s view on the basic rules.

Modern cryptocurrencies were first described in 1998 but the concept fully emerged in 2008 with the release of a white paper explaining their foundations. The first cryptocurrency was Bitcoin but since 2008 the market has expanded to include other transferable tokens, including Ether, Litecoin and Ripple. Given the trade volumes now seen in the UK, it is no wonder that HMRC are taking a more active interest in cryptocurrency.

What is cryptocurrency?

A cryptocurrency has been defined as a ‘digital virtual currency that uses encryption technology to ensure the security of transactions involving its use‘ and can be transferred, stored or traded electronically. Each ‘coin’ is a computer file stored in a ‘digital wallet’ app on a smartphone or computer, every transaction being recorded in a public list called the ‘blockchain’. Computers use complex programmes to validate a ‘block’ before being added to a ‘blockchain’.

Tax position

Although no taxes apply specifically to cryptocurrency assets, HMRC have confirmed that, in the majority of circumstances, anyone holding them as a personal investment is subject to capital gains tax (CGT) on any profit; this is because HMRC see cryptocurrency as an exchange of tokens rather than a form of money. However, following the usual tax rules for the definition of a trade, there are some instances where transactions are either not taxable or subject to income tax (or corporation tax for a company).  

HMRC state that the disposal of cryptocurrency falls within one of three classifications:

  • short-term speculation – similar to betting and not taxable. However, loss relief is not available. Note that HMRC does not generally accept transactions in cryptoassets as being gambling.
  • buying and selling to make a profit – as with the usual rules under the definition of a trade being liable to income tax (or corporation tax) usually where there is a high volume of transactions in a short space of time.
  • occasional investments – any gains and losses made from buying and selling are within the scope of CGT under the usual rules.

‘Disposal’ has been defined by HMRC as:

  • selling crypto assets for money;
  • exchanging cryptocurrency assets for a different type of crypto asset;
  • using cryptocurrency assets to pay for goods or services;
  • gifting crypto assets to another person.
  • donating tokens to charity

Income tax

As well as the situation whereby, an employee is paid via cryptocurrency, HMRC detail the following scenarios as being liable for income tax (or corporation tax for companies):

‘Mining’

‘Mining’ is how new cryptocurrency units (‘coins’) are created. The reward is a coin which may be taxed as a trade receipt depending on the level of activity. Alternatively, if the activity does not amount to a trade, the coins will be taxed as miscellaneous income. HMRC consider Bitcoin mining as outside the scope of VAT.

‘Staking’

‘Staking’ is also the creation of a ‘coin’ but this time being determined by a user’s wealth in the crypto asset rather than via a computer. Transactions are verified and rewarded with fees rather than new tokens; such activities are generally taxed as miscellaneous income.

‘Airdrops’

An ‘airdrop’ is when an individual receives an allocation of tokens typically in exchange for carrying out a service, e.g., as part of a marketing or advertising campaign. Providing there is no trade or business involving cryptoassets, such tokens are taxed as miscellaneous income unless received without carrying out a service (in which case income tax does not apply).

‘Trading’

The level and sophistication required for the activity to be deemed a trade is high and profits could be taxed as income if trading is of regular large amounts.

Capital gains tax

CGT is relevant when investors pay for new coins or tokens in a cryptocurrency or company as yet unreleased using existing cryptocurrencies. The sale proceeds are the existing cryptocurrency’s market value on the date the exchange took place. This same market value is used as the cost basis for the new tokens received when calculating pooled costs, CGT being liable on any profit. CGT may also be due on any profits made on the purchase of goods and services and when one cryptocurrency token is swapped for another.

Partner note:

Policy paper – Tax on crypto assets

https://www.gov.uk/government/publications/cryptoassets-taskforce

HMRC – new cryptocurrencies guidance

https://www.gov.uk/government/collections/cryptoassets

https://www.gov.uk/hmrc-internal-manuals/cryptoassets-manual

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