Investment in cryptocurrencies and cryptoassets have become a popular choice for many individuals, even amateur investors who have tried to cash in on the incredible surge in the value of some digital currencies.
In most cases, investors purchase, trade and eventually sell their cryptocurrency via online exchanges, agencies or platforms that allow regular (fiat) currency to be turned into an individual’s preferred cryptoasset.
These platforms, such as Coinbase, Binance, Kraken and even PayPal, are expected to disclose any individuals with holdings above £5,000, with a UK address to HM Revenue & Customs (HMRC).
While many of these exchanges are often located offshore, as an individual you are taxed based upon where you reside, and with HMRC having a clear idea of your income from cryptocurrencies they have started to become more proactive where they believe tax is due.
An increasing number of crypto investors are beginning to receive nudge letters from HMRC asking them to report their income to the tax authority.
Often, they are only given 30 days or so to respond to HMRC and disclose their dealings on exchanges and crypto platforms.
If you receive a letter from HMRC about cryptocurrency then it does not necessarily mean that you have made an error on your tax return or failed to disclose income, but you should not ignore the letter, and professional advice should be sought.
Failing to disclose this information, when requested, could lead to an investigation or a potential financial penalty, which could be equal to between 100 – 200 per cent of any tax owed.
To figure out how much tax may be due, or if anything is owed at all, investors must typically first calculate their gains.
The rules around cryptocurrencies and taxation are complex and depend on your activities within this market, but here are the basics.
When is tax due on cryptoassets for UK taxpayers?
HMRC does not consider cryptoassets to be currency or money. Instead, it views this digital currency as something more akin to investing.
HMRC has said that most individual investors will only be subject to Capital Gains Tax (CGT) on gains (profits) and losses on cryptoassets.
However, those ‘mining’ cryptoassets (e.g., those using a computer to complete complex computations to create coins and assets) could be considered a trading activity.
All ‘exchange tokens’, such as Bitcoin, although digitally located on computers and servers worldwide, are for tax purposes located wherever the beneficial owner is resident.
Capital Gains
Most individuals investing in cryptoassets will only pay Capital Gains Tax (CGT) on gains they make when disposing of the digital asset.
It can be challenging to calculate gains from cryptocurrency as they are regularly traded on exchanges where they change hand for other cryptoassets rather than fiat currency.
With the crypto markets being so volatile, the value of these digital coins can frequently go up and down, sometimes in a matter of minutes or hours, which makes placing a value on the asset difficult.
Nevertheless, these trades are considered a disposal for CGT purposes, even where the trade leads to no actual income in traditional fiat currency.
In these cases, it is down to an investor to realise either a taxable gain or loss and dispose of the asset as actual currency to settle their tax obligations.
Taxpayers should be aware that gains on disposal are taxed as regular capital. This means that you will obtain tax relief on the direct costs of buying and selling the cryptocurrency investment and can use your annual CGT exemption of £12,300 if it is unused elsewhere to reduce the amount of tax due. This is only possible where assets are pooled.
Income Tax
If HMRC decides that you are trading, rather than just investing, it may tax your profits as income instead of gains. This typically occurs where an individual is:
- Actively mining cryptocurrency
- Is considered a dealer due to the volume of trade they complete
- Validating transactions
- Staking and yield farming.
In most of these cases, a person is likely to be remunerated through the receipt of fees and/or further cryptoassets in return for their services. On this basis, these rewards may be subject to income tax.
One way to determine whether you are trading for tax purposes is to use the Badges of Trade test, which is based on previous legal precedents.
Some employers are also choosing to pay staff via cryptoassets. If an employer awards cryptoassets, they are taxable as employment benefits.
Inheritance Tax
HMRC will consider cryptoassets within an estate when calculating its value for Inheritance Tax (IHT. Digital currencies and NFTs (non-fungible tokens) should, therefore, be taken into account when determining a person’s assets.
While an individual is resident in the UK, HMRC will treat any cryptocurrencies or assets as being based in the UK, which may affect non-UK domiciled individuals who are resident in the UK and believe their assets are offshore. According to the tax authority, it still considers these to be within the scope of UK IHT.
For IHT purposes, cryptoassets are treated the same as many similar investments, such as shares, and their value will be determined at the market value at the date of death in pounds sterling. Given the volatility of the cryptomarkets, this can make determining value challenging and may mean that if there is a fall in value from the date of death to the disposal of the assets, it may not be possible to reclaim the IHT.
Recording and reporting tax
Due to the nature of this industry, cryptoasset exchanges only maintain records of transactions for short periods.
Therefore, it is down to the individual to keep records for each transaction in case of a HMRC review or enquiry.
As with income from other personal investments, it is down to the taxpayer to report their gains to HMRC through a Self-Assessment tax return submission.
For IHT purposes, the value of cryptoassets in an estate must be included within the standard IHT return which is handled during probate.
Time to seek help
Given the complexity of the tax arrangements surrounding cryptoassets, the offshore nature of some exchanges and the increased interest from HMRC in the gains made by some investors, now would be a good time to seek advice if you have greater than expected gains.
In some cases, if you have failed to previously disclose earnings from cryptocurrencies and other digital assets, a disclosure can be made to HMRC, which may reduce or entirely eliminate any financial penalties.
To find out how we can assist you with your tax arrangements surrounding cryptoassets, please get in touch.