Tax on crypto is charged in the same way as any other financial asset. So it’s important to accurately calculate your tax on crypto and report on the earnings from various cryptocurrency exchanges. A recent clampdown has seen HMRC issue letters to thousands Coinbase users reminding them of their duty to report and pay tax on their crypto activities. That’s why we have taken a dive into cryptocurrency taxation here, to explain everything you need to know.
A Complete Guide to Tax on Crypto
The number of available cryptocurrencies has risen and cryptoasset transactions are becoming more commonplace due to financial innovation, accelerated further by the impact of Covid-19. Cryptoassets offer new ways to transact, invest and store funds and could serve to fulfil a diverse set of functions, ranging from the trading of digital collectibles to raising capital for new projects. However it is recognised that with a rapidly changing technological landscape, this also presents new challenges and risks. Bitcoin is the original and so far most successful cryptocurrency. It launched on the market in 2009. At the time of writing, there are over 17,000 cryptocurrencies and digital tokens flying about the market, with thousands pouring into the market all the time.This astonishing rate of growth is good cause for financial regulators to pay attention. In fact, the number of cryptocurrencies more than doubled between 2021 to 2022. Where there has been a rise in cryptocurrency, there has also been a rise in the number of people who are willing to sell, trade and invest. This isn’t surprising since the virtual currency is secure from hacks, provides fast trading options and some are incredibly valuable. Despite the fact that the currency is virtual, the taxes investors face are very real. Anyone who is interested in investing or trading any form of cryptocurrency should be aware of the taxes that can apply here. You also need to be aware of how they can declare these transactions on a self-assessment tax return.
What Is Cryptocurrency?
Cryptocurrencies provide a peer-to-peer method of transaction. The simplest way to think about crypto is as a virtual currency. Even though you cannot touch it, it can still be used to purchase goods. As well as not being physical, there is no central bank for this type of currency, and it is not supported by a government. Despite all of this, the currency does have value and can be used to make purchases if the seller accepts this type of currency. Cryptocurrencies are actually digital assets. They are created using computer software which enables secure trading and ownership.
Crypto is supported by a technology referred to as blockchain. This maintains a secure record of transactions and keeps track of who owns what. Public blockchains are decentralised, meaning that they operate without a central authority such as a bank or government. Some are intended to be units of exchange for goods and services, others to store value, and some are mainly designed to help run computer networks which process more complex financial transactions.
One common way cryptocurrencies are created is through a process known as mining, which is used by Bitcoin. Mining can be an energy-intensive process in which computers solve complex mathematical tasks to verify the authenticity of transactions on the network. Miners who are owners of those computers receive newly created cryptocurrency in return for volunteering their computational systems. Other cryptocurrencies use different methods to create and distribute tokens, and newer entrants to market have a lighter environmental impact. Currently there is no internationally agreed taxonomy or classification of cryptoassets in existence.
HM Treasury states “A cryptoasset is understood to be a digital representation of value or contractual rights that can be transferred, stored or traded electronically, and which may (though does not necessarily) utilise cryptography, distributed ledger technology or similar technology. In 2019 the Financial Conduct Authority (FCA) published its ‘Guidance on cryptoassets’ which described three broad categories of token in relation to how they fit within existing FCA regulation: e-money tokens, security tokens and unregulated tokens.” It defined these as follows:
E-money tokens meet the definition of electronic money in the Electronic Money Regulations 2011 (EMRs) – broadly, digital payment instruments that store value, can be redeemed at par value, at any time and offer holders a direct claim on the issuer
Security tokens have characteristics akin to specified investments, like a share or a debt instrument, as set out in UK legislation. Broadly, these are likely to be tokenised, digital forms of traditional securities. As with e-money tokens, these are already within the UK’s regulatory perimeter and therefore subject to FCA regulation
Unregulated tokens are neither e-money tokens nor security tokens and include utility tokens: tokens used to buy a service, or access a DLT platform – this could, for example, include access to online cloud storage; and exchange tokens: tokens that are primarily used as a means of exchange.
How Does Cryptocurrency Work?
The more complex explanation of crypto is that it is an encrypted and decentralised form of currency. All of the transactions will be made, and the relevant information will be stored on a public ledger. This ledger will keep the identities of the user secure and mostly anonymous, as well as their cryptocurrency balance and a record of genuine transactions. This is similar to how a bank would store information. However, there are some differences. A bank has the authority to access records of the financial transaction and the identity of the users of the involved. In contrast, with cryptocurrency, the transaction can be verified through a public ledger, but nobody has the authority to know the identity of the individuals involved. The blockchain is a very common public ledger that is used to record transactions. The details of the transaction are stored and added to the next block in the chain while being secured by cryptography.
Where Do Cryptocurrencies Come From?
Cryptocurrency was first introduced as an alternative to traditional currency. Bitcoin was the very first cryptocurrency and it was introduced in the wake of the 2008 financial crisis. Many of those affected were upset with both banks and governments alike, and they felt that having lost their trust, as well as their money, there should be an alternative type of currency allowing citizens to hold control over their own financial assets independently. The founder(s) of Bitcoin believe that the power of a person’s money should lie with the person who earned it instead of the bank that keeps it or governments which have the power to seize it. Transactions are generated, secured, and verified thanks to cryptography, which is really just code. Cryptocurrencies have some benefits over traditional fiat currency. Fiat currency is issued by the government and it is not backed by a physical commodity, such as gold or silver, but rather by the government that issued it. The value of a fiat currency is derived from the relationship between supply and demand and the stability of the issuing government, as opposed to the worth of a commodity backing it. Cryptocurrencies do not need the backing of the government, and transactions are processed entirely without financial institutions. This allows traders anywhere in the world to transfer funds quickly, at low cost, without the need for any payment services.
Why Are There So Many Cryptocurrencies?
Since the introduction of Bitcoin, many many more cryptocurrencies have been introduced to the market. The simplest reason for this is that there is practically no barrier to entry. Since cryptocurrency is independent of banks and the government, anyone can create their own. Even without any technical knowledge, you can simply hire someone else to make a cryptocurrency for very little cost as it is really just code.
This is why so many altcoins can be introduced, from anywhere. Any cryptocurrencies other than Bitcoin are referred to as ‘Altcoin’. The most popular altcoin is Ethereum. Users refer to the broader blockchain network by its full name Ethereum, but use the term Ether (ETH) when talking about the currency itself. Bitcoin accounts for nearly half of the total crypto market and Ethereum nearly a quarter. The remaining market is made up of all other altcoins. The majority of early altcoins were intended to improve Bitcoin’s performance. Many developers create cryptocurrencies with hopes to solve real-world problems with blockchain technology. However because it is so easy to create a cryptocurrency, this also attracts users seeking to make a quick buck.
Users can buy and sell cryptocurrencies but trading of cryptocurrency derivatives is banned in the UK. Since the Cryptoassets Taskforce’s 2018 report the government has undertaken to strategically assess new and emerging risks as this market continues to mature. At present no agency is directly responsible for the regulation of crypto assets. However the government plans to strengthen the rules on potentially misleading cryptoasset advertisements. The Financial Conduct Authority (FCA) is so far only empowered to regulate cryptoassets if there is a danger of their breaching money laundering or terror laws.Currently a large proportion of cryptoassets fall outside the regulatory perimeter. This means they may not be subject to the same consumer protections or safeguards that apply to other financial services and payments. In their March 2020 Budget HM Treasury outlined two measures as part of the UK’s response to cryptoassets.
- consulting on bringing certain cryptoassets into scope of financial promotions regulation to enhance consumer protection; and
- consulting on the broader regulatory approach to cryptoassets, including new challenges from so-called ‘stablecoins’
An airdrop is where someone receives an allocation of tokens, for example as part of a marketing or advertising campaign in which people are selected to receive them. Income Tax will not always apply to airdropped tokens received in a personal capacity. Airdrops that are provided in return for, or in expectation of, a service are subject to Income Tax. The disposal of a token received through an airdrop may result in a chargeable gain for Capital Gains Tax, even if it’s not chargeable to Income Tax when it’s received. Where changes in value get brought into account as part of a computation of trade profits Income Tax will take priority over Capital Gains Tax.
How Tax on Crypto is Charged
Tax on crypto is charged in the same way as any other financial asset. Tax avoidance was never part of the design process in developing the first cryptocurrency. Neither was it intended for purchases of illegal goods or services. Any business that is carrying out activity involving exchange tokens, is liable to pay tax on them. This could be buying and selling exchange tokens, exchanging tokens for other assets (including other types of cryptoassets), ‘mining’ or providing goods or services in return for exchange tokens. The type of taxation depends on who is involved in the business and whether these activities count as a trade.
Dealing in cryptocurrencies will be subject to the following taxes, depending on the conditions:
- Capital Gains Tax (CGT)
- Corporation Tax (CT)
- Corporation Tax on Chargeable Gains (CTCG)
- Income Tax (IT)
- National Insurance Contributions
- Stamp Taxes
Each exchange of cryptocurrency is a taxable event. If you exchange Bitcoin for Ether for example, HMRC will treat this as a sale of Bitcoin at the market price of the Ether you received. The amount of tax liability depends on the businesses income, expenditure, profits and gains. These must be declared annually to HMRC in the usual way, either via self-assessment tax return (for individuals); or your company tax return (for companies). Since cryptocurrencies are independent of government backing, they do not hold a value in pound sterling, so the amount that is tax liable must be converted into pound sterling on the Self-Assessment tax return. If the transaction does not have a pound sterling value, for example if bitcoin is exchanged for an altcoin, then an appropriate exchange rate must be established in order to convert the transaction into pound sterling. HMRC expects reasonable care to be taken to arrive at an appropriate valuation for the transaction using a consistent methodology. Details of the valuation methodology should be kept. Prestige Business Management will acc calculate your cryptocurrency taxes and report on the earnings from various crypto exchanges. This will keep your business and your taxes streamlined, and your taxes low. Even if you have only made losses you still have to report this in your tax return. In fact, it is in your best interest to report your losses as this is one way in which you can reduce your crypto tax liability.
Capital Gains Tax
Tax on crypto in exactly the same way as Gold and real estate. When you either sell or trade in crypto, you will be tax liable on the difference between the sale price and how much it cost you, minus exchange fees. This is known as a Capital Gains Tax. In most cases, individuals hold cryptoassets as a personal investment, usually for capital appreciation or to make particular purchases. In this case you are liable to pay Capital Gains Tax when you dispose of your cryptoassets. Individuals will be liable to pay Income Tax and National Insurance contributions on cryptoassets which they receive from their employer as a form of non-cash payment and mining, transaction confirmation or airdrops. There may be instances whereby an individual is running a business which is carrying on a financial trade in cryptoassets and they will therefore have taxable trading profits in this case Income Tax would take priority over the Capital Gains Tax rules. A trade in exchange tokens would be similar in nature to a trade in shares, securities and other financial products. The approach to be taken in determining whether a trade is being conducted or not would also be similar, and guidance can be drawn from the existing case law on trading in shares and securities. Typically a loss or profit for a currency contract outside of trading of profiles or existing in the loan relationship would be taxed or marked as a loss for both corporation tax and capital gains tax. With cryptocurrency, things are slightly different. These are allowable and chargeable under CGT if they are received by an individual and under corporation tax if they are received by a company.
VAT will be due as normal from anyone who supplies goods or services that are sold in exchange for any sort of cryptocurrency. The VAT that will be due will be determined by the sterling value of the cryptocurrency at the time of the transaction.
Income Tax and Corporation Tax
All profits and losses from Bitcoin transactions must be shown in account records and will be taxable under normal income tax rules. This is true for any non-incorporated business. Whether the income received from, and any charges that are made in connection with the activities involving bitcoin will be subject to CT, IT or CGT taxes will depend on the activities. Cases will be looked at on an individual basis to see whether any profit is chargeable and if any loss is allowable. The correct legislation will be applied to each case to determine the right amount of tax. The general rules for foreign exchange apply for the tax treatment of virtual currencies. The government has not set specific rules or separate rules for paying tax on crypto as the general consensus in government is that it is not necessary. This means that the profits and losses on exchange movements between various currencies are and will be taxable. Exchange movements are usually determined by the business’s functional currency and the other currency. The profits and losses of any company that enters into a transaction that involves Bitcoin would be shown in their account records and taxable under regular CT rules.
Cryptocurrency has high volatility compared to other currencies. This is because it is untethered from government worth or value if a commodity. It is ungoverned and responds to supply and demand and behaviour within the market. Bitcoin surged in value throughout 2021 reaching a new record high in November, breaking surpassing £50,000. Volatility creates winners and losers and it has nothing to do with skill in investing. Long-term investors or those who want to hold bitcoin as a store of wealth may find it difficult to predict its future performance, so it’s practically impossible to invest in cryptocurrency strategically.
Stablecoins bridge the worlds of cryptocurrency and everyday fiat currency because their prices are pegged to a reserve asset like pound sterling or gold. This dramatically reduces volatility compared to something like Bitcoin and results in a form of digital money that is better suited to everything from day-to-day commerce to making transfers between exchanges.
If you are operating in a way where it can not be classified as either speculative or personal use, it must be considered an investment. In this case, expect a tax of 10% or 20% for CGT as an individual and a CT of 19% for business. Since this is an investment and not a trade, then you can expect certain levels of business relief to be available.
How are Mining & Hard Forks Taxed?
Bitcoin mining is the process whereby new bitcoins are entered into circulation. It is also how the network confirms new transactions. It is a critical component of the blockchain ledger’s maintenance and development. Mining is performed by sophisticated hardware that solves extremely complex computational maths. The first computer to find the solution receives the next block of bitcoins and the process begins over again. The bitcoin reward, although small compared to the outlay, is an incentive that motivates people to assist in the primary purpose of mining which is to legitimise and monitor Bitcoin transactions, ensuring their validity. Cryptocurrency is totally decentralised because many users all over the world share these responsibilities. Mining crypto is taxed the same way as any regular income. E.g. If you receive 10 USD as a result of the Bitcoin Cash fork then you will need to declare this as additional income, using the fair market value of the USD at the time you received it. A hard fork is when the existing code of a single cryptocurrency is changed, so it splits in two: an old and new version.
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At Prestige Business Management we can help you understand how to report and pay tax on crypto. Find out what we can do for you. Call us today on 0203 773 2927.