Yesterday we reported how the UK government was signalling its intent to embrace cryptocurrency in 2019 by cleaning up tax issues for investors.
HMRC (Her Majesty’s Revenue and Customs) issued the largest document of its kind anywhere in the world, detailing how taxation should be addressed for crypto assets.
Today, Coin Rivet brings you that guidance, in full, right here…
Cryptoassets are a relatively new type of asset that have become more prevalent in recent years. New technology has led to cryptoassets being created in a wide range of forms and for various different uses.
This paper sets out HMRC’s view – based on the law as it stands at the date of publication – about how individuals who have cryptoassets are taxed. It does not explicitly consider the tax treatment of cryptoassets held for the purposes of a business carried on by an individual.
HMRC will publish further information about the tax treatment of cryptoasset transactions involving businesses and companies.
The cryptoassets sector is fast-moving and developing all the time. The terminology, types of coins, tokens and transactions can vary. The tax treatment of cryptoassets continues to develop due to the evolving nature of the underlying technology and the areas in which cryptoassets are used. As such, HMRC will look at the facts of each case and apply the relevant tax provisions according to what has actually taken place (rather than by reference to terminology). Our views may evolve further as the sector develops.
Where HMRC considers that there is, or may have been, avoidance of tax, the analysis presented will not necessarily apply.
What cryptoassets are
Cryptoassets (or ‘cryptocurrency’ as they are also known) are cryptographically secured digital representations of value or contractual rights that can be:
- traded electronically
While all cryptoassets use some form of Distributed Ledger Technology (DLT) not all applications of DLT involve cryptoassets.
HMRC does not consider cryptoassets to be currency or money. This reflects the position previously set out by the Cryptoasset Taskforce report (CATF). The CATF have identified three types of cryptoassets:
- exchange tokens
- utility tokens
- security tokens
However the tax treatment of all types of tokens is dependent on the nature and use of the token and not the definition of the token.
This paper considers the taxation of exchange tokens (like bitcoins) and does not specifically consider utility or security tokens. For utility and security tokens this guidance provides our starting principles but a different tax treatment may need to be adopted.
Exchange tokens are intended to be used as a method of payment and encompasses ‘cryptocurrencies’ like bitcoin. They utilise DLT and typically there is no person, group or asset underpinning these, instead the value exists based on its use as a means of exchange or investment. Unlike utility or security tokens, they do not provide any rights or access to goods or services.
Utility tokens provide the holder with access to particular goods or services on a platform usually using DLT. A business or group of businesses will normally issue the tokens and commit to accepting the tokens as payment for the particular goods or services in question.
Security tokens may provide the holder with particular interests in a business, for example in the nature of debt due by the business or a share of profits in the business.
Which taxes apply
In the vast majority of cases, individuals hold cryptoassets as a personal investment, usually for capital appreciation in its value or to make particular purchases. They will be liable to pay Capital Gains Tax when they dispose of their cryptoassets.
Individuals will be liable to pay Income Tax and National Insurance contributions on cryptoassets which they receive from:
As set out in more detail below, there may be cases where the individual is running a business which is carrying on a financial trade in cryptoassets and will therefore have taxable trading profits. This is likely to be unusual, but in such cases Income Tax would take priority over the Capital Gains Tax rules. HMRC will publish separate information for businesses in due course.
HMRC does not consider the buying and selling of cryptoassets to be the same as gambling.
Financial trading in cryptoassets
HMRC taxes cryptoassets based on what the person holding it does. If the holder is conducting a trade then Income Tax will be applied to their trading profits.
Only in exceptional circumstances would HMRC expect individuals to buy and sell cryptoassets with such frequency, level of organisation and sophistication that the activity amounts to a financial trade in itself. If it is considered to be trading then Income Tax will take priority over Capital Gains Tax and will apply to profits (or losses) as it would be considered as a business.
As with any activity, the question whether cryptoasset activities amount to trading depends on a number of factors and the individual circumstances. Whether an individual is engaged in a financial trade through the activity of buying and selling cryptoassets will ultimately be a question of fact. It’s often the case that individuals and companies entering into transactions consisting of buying and selling cryptoassets will describe them as ‘trades’. However, the use of the term ‘trade’ in this context is not sufficient to be regarded as a financial trade for tax purposes.
A trade in cryptoassets would be similar in nature to a trade in shares, securities and other financial products. Therefore 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.
More information on the existing approach and case law for share transactions and financial traders can be found in the HMRC business income manual (BIM56800).
Cryptoassets can be awarded to ‘miners’ for verifying additions to the blockchain digital ledger. Mining will typically involve using computers to solve difficult maths problems in order to generate new cryptoassets.
Whether such activity amounts to a taxable trade (with the cryptoassets as trade receipts) depends on a range of factors such as:
- degree of activity
If the mining activity does not amount to a trade, the pound sterling value (at the time of receipt) of any cryptoassets awarded for successful mining will be taxable as income (miscellaneous income) with any appropriate expenses reducing the amount chargeable.
The other taxable income: HS325 Self Assessment helpsheet has more information about miscellaneous income.
If the individual keeps the awarded assets, they may have to pay Capital Gains Tax when they later dispose of them.
Fees from mining
Fees or rewards received in return for mining (for transaction confirmation) are also chargeable to Income Tax, either as trading or miscellaneous income depending on the:
- degree of activity
If the individual receives cryptoassets as payment for the services provided then any increase in value from the time of acquisition will either give rise to a chargeable gain on disposal for Capital Gains Tax purposes or, in the case of a trade, get taken into account in computing any trading profits
An airdrop is where someone receives an allocation of tokens or other cryptoassets, for example as part of a marketing or advertising campaign in which people are selected to receive them. Other examples of airdrops may involve tokens being provided automatically due to other tokens being held or where an individual has registered to become eligible to take part in the airdrop.
The airdropped tokens, typically, has its own infrastructure (which may include a smart contract, blockchain or other form of DLT) that operates independently of the infrastructure for an existing cryptoasset.
Income Tax will not always apply to airdropped cryptoassets received in a personal capacity. Income tax may not apply if they’re received:
- without doing anything in return (for example, not related to any service or other conditions)
- not as part of a trade or business involving cryptoassets or mining
Airdrops that are provided in return for, or in expectation of, a service are subject to Income Tax either as:
- miscellaneous income
- receipts of an existing trade
The disposal of a cryptoasset 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.
Income Tax losses
An individual who is trading may be able to reduce their Income Tax liability by offsetting any losses from their trade against future profits or other income. HMRC’s Losses: HS227 Self Assessment helpsheet has more information (including restrictions that apply).
If profits from activities are taxable as miscellaneous income, losses may be able to be carried forward to later years. More information on this can be found in helpsheet HS325: other taxable income.
Capital Gains Tax
HMRC would expect that buying and selling of cryptoassets by an individual will normally amount to investment activity (rather than a trade of dealing in cryptoassets). In such cases, if an individual invests in cryptoassets they will typically have to pay Capital Gains Tax on any gains they realise.
Cryptoassets are digital and therefore intangible, but count as a ‘chargeable asset’ for Capital Gains Tax if they’re both:
- capable of being owned
- have a value that can be realised
What constitutes a ‘disposal’
Individuals need to calculate their gain or loss when they dispose of their cryptoassets to find out whether they need to pay Capital Gains Tax. A ‘disposal’ is a broad concept and includes:
- selling cryptoassets for money
- exchanging cryptoassets for a different type of cryptoasset
- using cryptoassets to pay for goods or services
- giving away cryptoassets to another person
If cryptoassets are given away to another person who is not a spouse or civil partner, the individual must work out the pound sterling value of what has been given away. For Capital Gains Tax purposes the individual is treated as having received that amount of pound sterling even if they did not actually receive anything.
If Income Tax has been charged on the value of the tokens received, section 37 Taxation of Capital Gains Act 1992 will apply. Any consideration will be reduced by the amount already subject to Income Tax.
If an individual donates cryptoassets to charity, they will not have to pay Capital Gains Tax on them. This does not apply:
- if they make a ‘tainted donation’
- where the individual disposes of the cryptoassets to the charity for more than the acquisition cost so that they realise a gain
Certain costs can be allowed as a deduction when calculating if there’s a gain or loss, which include:
- the consideration (in pound sterling) 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 cryptoassets
- costs of making a valuation or apportionment to be able to calculate gains or losses
The following do not constitute allowable costs for Capital Gains Tax purposes:
- any costs deducted against profits for Income Tax
- costs for mining activities (for example equipment and electricity)
Costs for mining activities do not count toward allowable costs because they’re not wholly and exclusively to acquire the cryptoassets, and so cannot satisfy the requirements of section 38(1)(a) Taxation of Capital Gains Act 1992 (but it is possible to deduct some of these costs against profits for Income Tax or on a disposal of the mining equipment itself).
If the mining amounts to a trade for tax purposes the cryptoassets will initially form part of trading stock. If these cryptoassets are transferred out of trading stock, the business will be treated as if they bought them at the value used in trading accounts. Businesses should use this value as an allowable cost in calculations when they dispose of the cryptoassets. More information can be found in the HMRC capital gains manual (CG69220).
Pooling under section 104 Taxation of Capital Gains Act 1992 allows for simpler Capital Gains Tax calculations. Pooling applies to shares and securities of companies and also “any other assets where they are of a nature to be dealt in without identifying the particular assets disposed of or acquired”. HMRC believes cryptoassets fall within this description, meaning they must be pooled.
Instead of tracking the gain or loss for each transaction individually, each type of cryptoasset is kept in a ‘pool’. The consideration (in pound sterling) originally paid for the tokens goes into the pool to create the ‘pooled allowable cost’.
For example, if a person owns bitcoin, ether and litecoin they would have three pools and each one would have it’s own ‘pooled allowable cost’ associated with it. This pooled allowable cost changes as more tokens of that particular type are acquired and disposed of.
If some of the tokens from pool are sold, this is considered a ‘part-disposal’. A corresponding proportion of the pooled allowable costs would be deducted when calculating the gain or loss.
Individuals must still keep a record of the amount spent on each type of cryptoasset, as well as the pooled allowable cost of each pool.
Victoria bought 100 token A for £1,000. A year later Victoria bought a further 50 token A for £125,000. Victoria is treated as having a single pool of 150 of token A and total allowable costs of £126,000.
A few years later Victoria sells 50 of her token A for £300,000. Victoria will be allowed to deduct a proportion of the pooled allowable costs when working out her gain:
|Less allowable costs||£126,000 x (50 / 150)||£42,000|
Victoria will have a gain of £258,000 and she will need to pay Capital Gains Tax on this. After the sale, Victoria will be treated as having a single pool of 100 token A and total allowable costs of £84,000.
If Victoria then sold all 100 of her remaining token A then she can deduct all £84,000 of allowable costs when working out her gain.
Acquiring within 30 days of selling
Special pooling rules apply if an individual acquires tokens of a cryptoasset:
- on the same day that they dispose tokens of the same cryptoasset (even if the disposal took place before the acquisition)
- within 30 days after they disposed of tokens of the same cryptoasset
If the special rules apply, the new cryptoassets and the costs of acquiring them stay separate from the main pool. The gain or loss should be calculated using the costs of the new tokens of the cryptoasset that are kept separate.
If the number of tokens disposed of exceeds the number of new tokens acquired, then the calculation of any gain or loss may also include an appropriate proportion of the pooled allowable cost.
Melanie holds 14,000 token B in a pool. She spent a total of £200,000 acquiring them, which is her pooled allowable cost.
On 30 August 2018 Melanie sells 4,000 tokens B for £160,000.
Then on 11 September 2018 Melanie buys 500 token B for £17,500.
The 500 new tokens were bought within 30 days of the disposal, so they do not go into the pool. Instead, Melanie is treated as having sold:
- the 500 tokens she has just bought
- 3,500 of the tokens already in the pool
Melanie will need to work out her gain on the 500 token B as follows:
|Consideration||£160,000 x (500 / 4,000)||£20,000|
|Less allowable costs||£17,500|
Melanie will also need to work out her gain on the 3,500 token B sold from the pool as follows:
|Consideration||£160,000 x (3,500 / 4,000)||£140,000|
|Less allowable costs||£200,000 x (3,500 / 14,000)||£50,000|
Melanie still holds a pool of 10,500 token B. The pool has allowable costs of £150,000 remaining.
Some cryptoassets are not controlled by a central body or person, but operate by consensus amongst that cryptoasset’s community. When a significant minority of the community want to do something different they may create a ‘fork’ in the blockchain.
There are two types of forks, a soft fork and a hard fork. A soft fork updates the protocol and is intended to be adopted by all. No new tokens, or blockchain, are expected to be created. A hard fork is different and can result in new tokens coming into existence. Before the fork occurs there is a single blockchain. Usually, at the point of the hard fork a second branch (and therefore a new cryptoasset) is created.
The blockchain for the original and the new cryptoassets have a shared history up to the fork. If an individual held tokens of the cryptoasset on the original blockchain they will, usually, hold an equal numbers of tokens on both blockchains after the fork.
The value of the new cryptoassets is derived from the original cryptoassets already held by the individual. This means that section 43 Taxation of Capital Gains Act 1992 will apply.
After the fork the new cryptoassets need to go into their own pool. Any allowable costs for pooling of the original cryptoassets are split between the pool for the:
- original cryptoassets
- new cryptoassets
If an individual holds cryptoassets through an exchange, the exchange will make a choice whether to recognise the new cryptoassets created by the fork.
New cryptoassets can only be disposed of if the exchange recognises the new cryptoassets. If the exchange does not recognise the new cryptoasset it does not change the position for the blockchain, which will show an individual as owning units of the new cryptoasset. HMRC will consider cases of difficulty as they arise.
Costs must be split on a just and reasonable basis under section 52(4) Taxation of Capital Gains Act 1992. HMRC does not prescribe any particular apportionment method. HMRC has the power to enquire into an apportionment method that it believes is not just and reasonable.
An airdrop is when an individual receives an allocation of tokens or other cryptoassets. For example, tokens are given as part of a marketing or advertising campaign.
The airdropped cryptoasset, typically, has its own infrastructure (which may include a smart contract, blockchain or other form of DLT) that operates independently of the infrastructure for an existing cryptoasset.
The tokens of the airdropped cryptoasset will need to go into their own pool unless the recipient already holds tokens of that cryptoasset, in which case the airdropped tokens will go into the existing pool. The value of the airdropped cryptoasset does not derive from an existing cryptoasset held by the individual, so section 43 Taxation of Capital Gains Act 1992 does not apply.
Capital Gains Tax losses
If an individual disposes of cryptoassets for less than their allowable costs, they will have a loss. Certain ‘allowable losses’ can be used to reduce the overall gain, but the losses must be reported to HMRC first.
There are special rules for losses when disposing of cryptoassets to a ‘connected person’.
Claiming for an asset that’s lost its value
As with other types of assets, individuals can crystallise losses for cryptoassets that they still own if they become worthless or of ‘negligible value’.
A negligible value claim treats the cryptoassets as being disposed of and re-acquired at an amount stated in the claim. As cryptoassets are pooled, the negligible value claim needs to be made in respect of the whole pool, not the individual tokens.
The claim will need to state the:
- asset which is the subject of the claim
- amount the asset should be treated as disposed of (which may be £0)
- date that the asset should be treated as disposed of
The disposal produces a loss that needs to be reported to HMRC. Negligible value claims can be made to HMRC at the same time as reporting the loss.
More information about negligible value claims can be found in the HMRC capital gains manual (CG13120P).
Losing public and private keys
If an individual misplaces their private key (for example throwing away the piece of paper it is printed on), they will not be able to access the cryptoasset. The private key still exists as part of the cryptography, albeit it is not known to the owner any more. Similarly the cryptoassets will still exist in the distributed ledger. This means that misplacing the key does not count as a disposal for Capital Gains Tax purposes. More information can be found in the HMRC capital gains manual (CG13155).
If it can be shown there is no prospect of recovering the private key or accessing the cryptoassets held in the corresponding wallet, a negligible value claim could be made. If HMRC accepts the negligible value claim, the individual will be treated as having disposed of and re-acquiring the cryptoassets they cannot access so that they can crystallise a loss.
If an individual invests in cryptoassets, there’s a risk of becoming a victim of theft or fraud. HMRC does not consider theft to be a disposal, as the individual still owns the assets and has a right to recover them. This means victims of theft cannot claim a loss for Capital Gains Tax.
Those who do not receive cryptoassets they pay for may not be able to claim a capital loss.
Those who pay for and receive cryptoassets, may be able to make a negligible value claim to HMRC if they turn out to be worthless.
More information can be found in the HMRC capital gains manual (CG13155).
Cryptoassets received as earnings
Cryptoassets received as employment income count as ‘moneys worth’ and are subject to Income Tax and National Insurance contributions on the value of the asset.
Cryptoassets provided in the form of Readily Convertible Assets (RCAs)
Cryptoassets are RCAs if trading arrangements exist, or are likely to come into existence, in accordance with section 702 of the Income Tax (Earnings and Pensions) Act 2003.
Exchange tokens like bitcoin can be exchanged on one or more token exchanges in order to obtain an amount of money. On that basis, it is our view that ‘trading arrangements’ exist, or are likely to come into existence at the point cryptoassets are received as employment income.
If an employer has a UK tax presence they must deduct and account to HMRC for the Income Tax and Class 1 National Insurance contributions due through the operation of PAYE, based on the best estimate that can reasonably be made of the cryptoasset’s value.
More information on readily convertible assets can be found in the HMRC employment income manual – (EIM11900).
If an employer cannot deduct the full amount of Income Tax due from employment income they must still account to HMRC for the balance. This is called the ‘due amount’. The employee must reimburse their employer for the ‘due amount’ within 90 days after the end of the tax year. If they do not, then a further Income Tax charge and National Insurance contributions liability will arise on an amount equal to the ‘due amount’ under section 222 ITEPA 2003.
More information about PAYE: special types of payment can be found in the HMRC employment income manual – (EIM11954).
Cryptoassets which are not RCAs
Cryptoassets received as earnings from employment, which do not meet the definition of RCAs in section 702 ITEPA 2003, are still subject to Income Tax and National Insurance contributions.
Employers do not have to operate PAYE on payments of earnings that are not RCAs. The individual must declare and pay HMRC the Income Tax due on any amount of employment income received in the form of cryptoassets (using the employment pages of a Self Assessment return). More information on filing a Self Assessment tax return is available.
The employer should treat the payment of cryptoassets, which are not RCAs, as payments in kind for National Insurance contributions purposes, and pay any Class 1A National Insurance contributions to HMRC.
Cryptoassets provided by a third party in connection with employment
Where cryptoassets are provided by a third party, in connection with employment, an Income Tax charge may arise under Part 7A ITEPA 2003. A Class 1 National Insurance contributions liability may also arise under Regulation 22B and paragraph 2A of Schedule 3 to the Social Security (contributions) Regulations 2001.
Employers must account to HMRC for the Income Tax and National Insurance contributions due through the operation of PAYE, based on the best estimate that can reasonably be made of the cryptoassets’ value.
More information on Part 7A ITEPA 2003 can be found in the HMRC employment income manual – (EIM45000).
Subsequent disposal of tokens
Any disposal of the cryptoasset received through employment may result in a chargeable gain for Capital Gains Tax.
Cryptoasset exchanges may only keep records of transactions for a short period, or the exchange may no longer be in existence when an individual completes a tax return.
The onus is therefore on the individual to keep separate records for each cryptoasset transaction, and these must include:
- the type of cryptoasset
- date of the transaction
- if they were bought or sold
- number of units
- value of the transaction in pound sterling
- cumulative total of the investment units held
- bank statements and wallet addresses, if needed for an enquiry or review
Self Assessment tax returns
Many cryptoassets (such as bitcoin) are traded on exchanges which do not use pound sterling, so the value of any gain or loss 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 ripple) an appropriate exchange rate must be established in order to convert the transaction to pound sterling.
Reasonable care should be taken to arrive at an appropriate valuation for the transaction using a consistent methodology. They should also keep records of the valuation methodology.
The amount of tax due depends on the individual’s personal circumstances including their residence and domicile status.
HMRC does not consider cryptoassets to be currency or money so they cannot be used to make a tax relievable contribution to a registered pension scheme.
More information on contributions can be found in the HMRC pensions tax manual PTM044100.
Cryptoassets will be property for the purposes of Inheritance Tax.