The Taxation of Cryptocurrency & Tax Efficient Cryptocurrency. One Year On…
The cryptocurrency boom of autumn 2017 saw an explosion of interest in cryptocurrencies, blockchain and related technologies and has even resulted in the emergence of “crypto-millionaires”.
Many financial advisers have been left scratching their heads as they turn to the tax implications of the resulting profits (and in some cases, losses!) for their clients’ 2017/18 tax returns.
HMRC’s Cryptocurrency Tax Position
HMRC have exercised caution in stating their view in the taxation of profits and losses deriving from cryptocurrency activities.
Their first published comments in 2014 clarify the VAT position, concluding that in most cases VAT is not chargeable. In respect of direct taxes – income tax and capital gains tax – HMRC in the same note indicated that while cryptocurrencies might appear to be exotic and unfamiliar, existing tax principles developed through case law over the decades should apply to the treatment of profits and gains.
HMRC also put forward, perhaps surprisingly, the possibility that certain transactions might be exempt from taxation on the basis that they were akin to ‘gambling’.
Cryptocurrency Trading or Investing?
As for any activity, one must consider whether it is ‘trading’ or ‘investing’. Generally, one would need to consider the ‘badges of trade’ to determine whether an activity is trading.
The badges of trade include considers the frequency of transactions, the length of ownership and the intentions of the taxpayer in entering into any transactions.
For example, an individual who acquires an asset with the intention to dispose of that asset in the short-term to realise a profit with the view to repeating this again and again would more likely be considered a trader.
When considering the badges of trade, it is crucial that all of the factors are weighed up and considered as a whole, as opposed to a simple box ticking exercise. Indeed, it is possible for a single transaction to be considering a trading transaction.
The key tax implications for a ‘trader’ are that any profits are subject to income tax up to at 45% and Class 2 & 4 National Insurance Contributions whilst if the activity is not trading, any gains would be subject to capital gains tax at up to 20%.
HMRC’s Updated Capital Gains Tax (CGT) Manuals
While there is a body of case law relating to trading and investment, and cryptocurrency activities should be considered in relation to this established case law, HMRC have recently amended their capital gains tax manuals to include further guidance on the taxation of cryptocurrency.
That they have updated this manual, but not the Business Income Manual, might be taken as some indication as to where HMRC is attempting to push cryptocurrency activities; that is, toward being treated as investment and therefore subject to capital gains tax, rather than trading and subject to income tax.
Perhaps the most significant reason for pushing the treatment of cryptocurrencies toward being investment rather than trading is the potential implications of losses. If in the eyes of financial institutions, regulators and HMRC, cryptocurrencies are bubble, then it is anticipated that participants in the market will realise losses and, in some cases, significant losses, particularly for those that entered the market at the height of the boom.
The reliefs available to loss making individuals are much more generous where they are trading losses rather than capital losses.
Where an individual makes a capital loss, relief may only be provided against other capital gains in that year, or in future years. If, however, it is a trading loss, the options available to the taxpayer include the ability to carry losses back for up to three years and the ability to offset these losses against other income such as employment income and rental income. That is, a trading loss is much more flexible and, given the difference between income tax and capital gains tax rates, potentially more valuable.
Practicalities for tax compliance & cryptocurrency tax efficiency
Those who took advantage of the cryptocurrency ‘boom’ or entered the market at that time will now need to be considering their filing obligations. Any capital gains or trading profits will need to be reported on their 2017/18 tax returns and the liabilities paid by 31st January 2019.
Given the uncertainties regarding the tax position, taxpayers should take particular care with their filing positions. This is particularly important if they decide to take a position which is not aligned with HMRCs published view. For example, if the view is taken that one’s cryptocurrency transactions are so highly speculative that they are akin to gambling, it would be strongly recommended to make a white space disclosure in a tax return setting out the basis of that filing position.
Such disclosures would act as a preventative measure against discovery and penalties should HMRC successfully a contrary position.
While record keeping systems for cryptocurrencies are improving, filing an accurate return where there are (significant) cryptocurrency activities can prove challenging.
Other investors may rely on well-presented broker packs to summarise their investment activities for the previous tax year, and simplify their tax compliance requirements, but cryptocurrency investors may need to piece together records from miscellaneous coin exchanges and wallets, if the information is available at all. Some cryptocurrency investors will have undertaken many thousands of transactions which further complicate matters including how the “share pooling” rules, which HMRC consider to apply to cryptocurrencies, should be applied to work out the base cost and the gains arising in respect of any particular disposal.
For historic disclosures, there are further challenges. The penalty regime applying to UK and offshore jurisdictions differs which raises the question as to just where cryptocurrency activities take place.
Regardless of these difficulties, ignoring the issue is not an option. HMRC was quick to recognise cryptocurrency as a potential issue in 2014, and while it has been slow to provide further, definitive guidance on the taxation of activities, the signs are that it is clearly aware of the potential liabilities that could arise.
Professional advisers should certainly review their client’s tax position, or make them aware of their obligations, seeking the appropriate advice where necessary to help make full disclosures.
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