17 Nov 2021
In the fast-paced and rapidly evolving cryptoassets space, everyone is asking the same question; “Do I need to pay tax on my cryptocurrency profits?” Since the first substantive Bitcoin rally in 2018, the world has started to better understand the value and importance of ‘crypto’ (meaning all types of cryptoassets), and the taxing authorities have attempted to offer clearer guidance. That said, in the eyes of many, it’s still not clear cut and there is a real block between what crypto technologies represent, and how HMRC perceive it.
HM Revenue & Customs (HMRC) has quite straightforwardly advised that it considers crypto to be a type of property, like stocks and shares, gold, or antiques. Nothing is straightforward in the infant world of crypto however. In the UK, HMRC guidance means you are expected to pay tax on your profits from crypto activity. The type of tax you pay, will depend on how you trade your crypto, and the type of gains, profits or rewards receive (see my series of article ‘The Chain of Crypto Taxes’ for specific guidance).
Global taxing authorities are fighting hard to ensure the right amount of tax is paid at the right time, including demanding data from crypto exchanges about their users; HMRC recently struck a deal with Coinbase, eToro and cex.io, meaning anyone with activity in excess of €5,000 per year on the exchange protocols, will have their information shared with HMRC. This is a clear sign that HMRC are serious about crypto.
In all of this lies several contentious matters, none more so than the fact HMRC are only offering ‘guidance’ on how you should account for your crypto activity. There remains a lack of uncertainty around the tax treatment of crypto, simply because there is no specific crypto tax law. HMRC’s guidance is not legislation and is being contested by some major tax professionals, including the Society of Trust and Estate Practitioners (STEP). This is creating a very tricky situation for taxpayers and tax advisors, because those who really understand crypto and its’ technologies, take the opinion that HMRC are guiding all crypto actors to put square pegs into round holes. In other words, they are shoehorning new technology into tax legislation that’s been around for a very long time. Capital Gains Tax (CGT) has been around since the 1960s, a time when blockchain, distributed ledgers and crypto would have been thought of as science fiction; think Flux Capacitor from Back to the Future, that’s how far-out today’s crypto lingo would have seemed!
Block to the future
Many investors speak of going to ‘the Island’ one day, which is essentially any island, imaginary or not, where those with off-the-scale financial success can sail off into the sunset with their crypto millions, find their own block of land (or entire island) and live happily ever after. But tax authorities are also including data on crypto investors in the information they collect across borders. A freedom of information request by HMRC has been used to gather information about crypto investors in and outside of the UK for the tax years 2017/18 to 2019/20 inclusive. Details collected included names and addresses of investors and the value of crypto held. HMRC state that “the data is used to improve the integrity of the tax system and to identify those that have failed to declare their gains”.
Keeping up with crypto
Despite such data grabs, the world of crypto is moving so fast that tax authorities are currently being forced to play catch up. Do they understand the rules of the game, or will there always be a brain-block?
By treating crypto as property for tax purposes, the UK views it differently to how it views foreign exchange holdings, where gains do not become chargeable to CGT if they are used for personal expenditure outside the UK. Perhaps this is why no legal definitions for ‘virtual currency’ have been legislated for yet?
The rapidly advancing nature of crypto, has also seen the emergence of the outstandingly conceptualised Decentralised Finance (DeFi) industry. This is a whole new crypto sector that completely removes the banks and middlemen, replacing them with smart contracts, distributed ledgers and automated money markets (pre-programmed algorithms), therefore allowing anyone with an internet connection to buy, sell, lend and borrow crypto, but with real world utility at the heart of it.
The crypto industry will continue to test the boundaries of existing tax law and will no doubt push the lawmakers into places they had never even before imagined. In order to retain the anonymity afforded by the blockchain, many privacy chains are starting to emerge, along with so-called private coins. Without fair and proper tax law, it’s highly likely billions of pounds worth of funds will flow into private coins, meaning the world’s taxing authorities will no longer control its’ own money, and in turn taxing rights. The loss of tax revenues is a major concern for all governments, and is the biggest threat to how the modern world operates, ever.
Another aspect of crypto that remains unresolved, is that of jurisdiction and domicile. In a so-called virtual market, it’s difficult call to make, as crypto doesn’t officially have a single place it can call home. HMRC take the view that the location of the owner of the crypto or wallet is the answer. However, professional bodies such as STEP continue to argue that this stance is one of convenience, rather than tax law. What if the crypto is held by an exchange or another guardian? If the crypto is secured in smart contracts, that are stored in blocks held by nodes within a global distributed ledger network, how can there be a ‘home’? It seems the world’s leading tax authorities need to find an answer to this as soon as possible.
HMRC argues that its’ stance, that is, any crypto assets held by a UK resident are located in the UK, conforms with most transactions that take place. They also state that their detailed guidance is designed to help their customers apply tax law to crypto correctly. The reality is, the tax law they are trying to extend to crypto simply doesn’t work.
It shouldn’t be overlooked that HMRC can look into a taxpayer’s affairs by going back four years, increasing to six years if they feel an individual has been careless or negligent. In some instances, they can go back twenty years, if disclosure has been deliberately avoided.
In terms of record keeping, HMRC expect detailed records to be kept for each and every trade (see Article 1 in The Chain of Crypto Taxes series). This could be a significant task for day traders, or those who frequently move and exchange their crypto. Trading bots can perform thousands of transactions daily, so without proper reporting apps, this could make matters even harder. When activity falls within CGT, there are complex rules that should be used to cover gains, depending on whether assets are bought and sold on the same day, and/or within a 30 day period. Many investors will often rely on the exchanges for their records, but this could be risky, especially if an exchange fails, or if it doesn’t keep data for long enough.
The common talk between investors is that crypto gains should only be taxed on a ‘cash-in/cash-out’ basis, but HMRC’s current guidance means there are a variety of triggers that can cause a taxable event; gifting your crypto, selling it, exchanging one crypto for another, staking it and earning reflections (rewards). Staking is a fairly recent function that has turned the crypto world on its head, and will no doubt attract many more investors in a relatively short time. Yields earned from staking will certainly attract UK taxes too.
A major problem for investors is that a gain/profits could be made, with a CGT liability becoming payable, but with any newly held crypto as part of that transaction significantly falling in value or becoming worthless. This would mean there may not be enough crypto available to convert to fiat (GBP) to pay to the tax; imagine a 100x (10,000%) tax rate, that’s what you might get in crypto. Even if you held enough value in alternative crypto holdings, you may be required to sell these to pay your tax bill, this triggering another tax bill! Many investors would be at pains to sell their best performing crypto to pay tax, but this is where the amazing world of DeFi can help (see my article The ABC of DeFi).
This isn’t unthinkable in such a new, mis-understood, and volatile industry. It is unlikely however, that the usual sorts of property taxed within the CGT regime, would ever suffer such volatile market conditions, which is why trying to place crypto activity into the same regime is argued by many to be unfair or indeed helping to ensure taxpayers pay the wrong amount of tax at the wrong time. After all, HMRC do not accept crypto donations to charity for Gift Aid purposes, because they state it’s too volatile….hang on a minute!
It should be noted that any losses derived from crypto activity could be used to relieve future profits from being taxed, but this will require significant future activity and gains in such a scenario. With the abolition of self-assessment in the UK, and the advent of Making Tax Digital (MTD), surely now is the time for HMRC to introduce equitable crypto tax laws that marry up with the intended benefits of MTD?
Perhaps HMRC could be smart by taxing individuals on a cash-in/cash-out basis, until they are prepared to accept payment for taxes in crypto i.e. when they themselves see it as not being volatile?
HMRC run a real risk of not being able to keep up with the rules of the game and unless they introduce their own rules to make the game easier, there’s going to be a long road ahead, with many more blocks.
HMRC recently published the latest edition of their Trusts and Estates newsletter
From 6 April 2022 the dividend tax rate increased by 1.25%
You may want to consider making a salary sacrifice arrangement, whether you are an employer or an employee.
Our quick guide to the main tax measures announced by Rishi Sunak.
These increases will be ring-fenced to provide funding for the NHS, health and social care.