With the new decade now upon us we take a look at the UK tax implications of cryptoassets following recent guidance released by HMRC for both businesses and individuals.
The guidance released covers cryptoasset ‘exchange tokens’, such as Bitcoin, but does not apply to other types like security tokens or utility tokens which will be looked at by HMRC in more detail in the future. The fact that the terminology, types of coins, tokens or transactions can vary should be accounted for when considering that their tax treatment will continue to develop in line with the evolving nature of the underlying technology and areas where they are used.
To start things off, cryptoassets, most commonly known as cryptocurrency, are cryptographically secured digital representations of value or contractual rights that are possible to be transferred, stored or traded electronically. A very important distinction that needs to be made is that HMRC will not consider cryptoassets to be currency or money for tax purposes. Nevertheless, they have identified 3 different types to be considered:
- Exchange tokens: they are intended to be used as a payment method, and their value exists simply based on their use as a means of exchange or investment.
- Utility tokens: they can provide the holder access to certain goods or services on a platform, where businesses will issue those tokens and accept them as payment for their goods or services.
- Security tokens: they can provide the holder with certain interests in a business, i.e. debt due by a business or share of profits in a business.
It is also worth noting that the tax treatment depends on their nature and use and not simply their definition.
Tax implications for businesses
When it comes to the tax treatment of exchange tokens from a business perspective, the first thing that needs to be determined is whether a ‘trade’ is being carried on or not. The buying and selling of exchange tokens may constitute trading based on the standard tests (commonly referred to as the badges of trade) which include, but not limited to, the following:
- a profit seeking motive
- degree and frequency of transactions
- the nature of the asset
- interval of time between purchase and sale
- method of acquisition
Where it is deemed that the activities do indeed amount to a trade, then any receipts and relevant expenses will form part of the trading profit calculations for the business. This also applies where exchange tokens are used as part of the trade where they are received as payment from customers or used to make payments to suppliers.
HMRC has specified that since cryptoassets are not deemed to be either money or currency, they must be then translated to pounds sterling at the transaction date before recognizing them in the trading profit calculations. However, this also implies that corporation tax legislation relating to money or currency would not apply to any cryptoassets and those would include:
- the foreign currency rules
- the Disregard Regulations relating to exchange gains and losses
- designated currency elections
When it comes to loan relationships, as exchange tokens do not constitute money or currency, the loan relationship rules would not apply, even where exchange tokens are loaned in place of traditional currency. This is because they do not represent an amount of money or currency, it logically follows that there is no money debt and no transaction for the lending of money, which sit at the core of the loan relationship rules. However, where they are provided as collateral security for an ordinary monetary loan, then a loan relationship does exist, and the normal rules apply. In such a scenario the accounting treatment would be an important consideration.
Intangible fixed assets
Where companies account for exchange tokens as intangible assets, they may be able to tax them under the corporation tax rules for intangible fixed assets. Briefly, intangible fixed asset rules can enable any sums written off to be tax deductible for calculating trading profits, allow for receipts arising from those assets to be treated as revenue and also allow for reinvestment relief available from the proceeds of the sale of intangible assets that are reinvested in other assets within the intangible fixed asset rules.
For exchange tokens to be taxed under the corporate intangible fixed asset rules, they have to be both an ‘intangible asset’ for accounting purposes and an ‘intangible fixed asset’, in the sense that they have to be created or acquired by a company for use on a continuous basis, and not simply held by the company even if they are held in course of its activities. In practice, this would be applicable for businesses that are involved in cryptocurrency mining activities, also called cryptomining.
Chargeable gains from investments
As exchange tokens are digital, they are automatically intangible assets. They could however count as chargeable assets where they are capable of being owned and where they have a value that can be realised. If a company holds exchange tokens as an investment, they would then be liable to pay corporation tax on any gains realised when they dispose of them.
In this situation, a disposal can include the selling of exchange tokens for money, exchanging exchange tokens for a different type of cryptoasset, using exchange tokens to pay for goods or services and giving away exchange tokens to another person. Similar to the usual rules on gifting chargeable assets, where they are given to someone outside the group, they are deemed to be transferred at market value.
There are certain costs that can be allowable as deductions in calculating whether a gain or loss arose, and those would include the consideration (in pounds) originally paid for the asset, transaction fees paid before the transaction is added to a blockchain, advertising for a purchaser or a vendor, professional costs to draw up a contract for the acquisition or disposal of the exchange tokens and costs of making a valuation or apportionment to be able to calculate gains or losses. Where there are any costs for mining activities, they would not be allowable costs for calculating a gain or a loss since they are not incurred wholly and exclusively for the acquisition of the exchange tokens.
It is also worth noting that HMRC believes that exchange tokens fall within pooling rules of assets, meaning they are to be dealt in without having to identify the particular asset disposed or acquired at each separate transaction. This prevents having to individually track gains or losses for each transaction, by keeping the relevant exchange tokens in a ‘pool’, with their total consideration used to acquire them forming the ‘pooled allowable cost’. In practice, this implies that any acquisitions in Bitcoins, Litecoin and Ethereum will result in having three different pools for allowable costs. When any of them are sold, they will be considered to be a part-disposal, and a proportionate amount of the pooled allowable cost is then deducted to calculate a gain or a loss.
Where exchange tokens are disposed for less than their allowable cost, a capital loss is created. Such losses can be used to reduce overall gains from other transactions, but losses must be first reported to HMRC. Also, similarly with other assets, where exchange tokens are deemed to have become worthless or of ‘negligible value’, the business can crystallise its losses through a negligible value claim. This will treat the exchange tokens as being disposed and reacquired at a negligible value, which allows for a capital loss to be realised and utilised by the business.
Employee remuneration through cryptoassets
If an employer remunerates their staff with exchange tokens, those exchange tokens are deemed to be ‘money’s worth’ and subject to income tax and NIC. Whilst fairly obvious this confirmation is welcomed and will hopefully make it clear that such assets cannot be used to disguise remuneration. The employer will have to apply a valuation on those exchange tokens using their best estimate and it would then be subject to PAYE accordingly. However, when the exchange tokens received are not readily convertible assets, the employer does not have to apply PAYE on them. It is then on the employee to declare any amounts received as exchange tokens on the employment pages of the self-assessment tax return form and pay any income tax liability arising to HMRC themselves. Even though the employer doesn’t have to operate PAYE, they would still have to treat it as a benefit in kind for NIC purposes.
The VAT treatment of cryptoassets has been a topic of particular interest in the industry. Currently, HMRC has provisionally stated that any exchange tokens received by miners for their mining activities will generally be outside the scope of VAT. This is on the basis that the activity does not constitute an economic activity for VAT purposes because there isn’t a sufficient link between any services provided and any consideration and also because there is no customer for the mining service. Moreover, using exchange tokens for goods and services will not incur any VAT for the supply of the token itself.
The VAT treatment that will in practice be more important is the fact that it was confirmed by HMRC (and also backed by a relevant decision by the Court of Justice of the EU) that any financial services supplied by exchanging exchange tokens for legal tender or vice versa, are exempt from VAT.
Tax implications for individuals
Individuals holding cryptoassets will normally do so as a form of personal investment, expecting a capital appreciation in its value in order to make a profit or use them to make certain purchases. Usually, an individual will be liable to pay capital gains tax when their cryptoassets are disposed of for a profit.
Income tax liabilities
As noted above, where they are received from their employer as a form of non-cash payment, an individual will be liable to pay income tax and NICs on the cryptoassets received. Where assets are subsequently disposed of, consideration as to why they were held will need to be given, but in most cases a chargeable gain calculation will be required for capital gains tax purposes.
HMRC will only tax the disposal of cryptoassets by an individual to income tax rates where they deem the individual is conducting a trade. In order for an individual to be conducting a trade, the badges of trade mentioned earlier have to apply. HMRC do state that they only expect this to be the case in exceptional circumstances. Therefore, the specifics of each situation need to be examined on a case by case basis, in order to determine whether a trade exists when an individual buys or sells cryptoassets or when they are involved in mining activities. In the rare case where a trade is conducted, income tax will be given priority over capital gains tax, which would be an unfavourable treatment for the individual considering the higher rates.
An individual who is trading in cryptoassets, is also able to offset any losses from that trade against future profits or other income or use other trading losses to offset their profits from their cryptoasset trade.
Capital Gains tax liabilities
HMRC would commonly expect that an individual that buys and sells cryptoassets is involved in an investment activity, and thus they would have to pay capital gains tax on any realised gains from their cryptoasset investments. A cryptoasset, that is digital and intangible in nature, will count as a chargeable asset for capital gains tax purposes if it is both capable of being owned and has a value that can be realised.
In order to calculate the gain realised on the holding of cryptoassets, the individual needs to determine whether there was a disposal for capital gains tax purposes and deduct any applicable allowable costs. In this case, the rules around disposals, allowable costs, pooling, capital losses and negligible value claims will apply in the same way as they do for businesses, which were discussed earlier.
With cryptoassets, it is important for individuals to keep their private key safe, which enables them to access their virtual wallets containing their exchange token investments. If it is lost, the cryptoassets still exist, albeit inaccessible to the individual, but HMRC will not count that as a disposal for capital gains tax purposes. Where it can be shown that there are no prospects of recovering the private key or accessing the cryptoassets in any way, then the individual could make a negligible value claim and if accepted by HMRC, a loss can be crystallised.
Where an individual who purchased cryptoassets is found to be a victim of theft or fraud, HMRC would not consider this to be a disposal, since the individual still legally owns them and has a right to recover them. Therefore, in situations where the cryptoassets are either stolen or an individual pays for them but does not receive them, they cannot claim a capital loss for them. While unfortunate, this should signify the importance of cybersecurity in today’s era of extreme technological dependency.
HMRC has confirmed that cryptoassets will be deemed as property for inheritance tax purposes so they will form part of an individual’s estate. Cryptoassets would therefore be vesting in the personal representatives of the deceased, but in practice, there are a few issues that may occur. The main issue is that they may not have access to them, and in the case of exchange tokens, that can only be done by knowing the ‘private key’ needed to access the virtual wallet holding them. Being unable to access them, renders them unusable and as mentioned, it may prove difficult to claim losses on the lost exchange tokens, as the required information may not be readily available. Investments in cryptoassets is a relatively recent trend and for estate planning purposes, suitable measures may not be taken. Therefore, the importance of having appropriate processes in place for passing such digital properties for inheritance tax purposes should be noted.
The need for legislation and regulations of cryptoassets is becoming more and more important as time passes. With the increasing speed that they are becoming part of ordinary day-to-day activity, governments and regulatory bodies are having a hard time keeping up. In the US alone, it is estimated that just for 2019, cryptoasset thefts, frauds and scams are in excess of $4billion, which prompted them to introduce rules around identification and information sharing on customers and businesses involved in cryptoasset exchanges, which is something that could be expected for the UK as well.
The released guidance by HMRC on the tax treatment of exchange tokens is a step in the right direction but affected individual and businesses should keep an eye out as this area will surely continue to evolve and change in the coming years.