Article written by Moira McKeown and featured in Chartered Accountants Ireland, TaxPoint magazine (December 2021 edition).
When the price of Bitcoin soared to nearly $20,000 in 2017 it sparked increased hype in cryptocurrency. Since then Bitcoin has generated enormous amounts of publicity and its continued exorbitant price rise has attracted worldwide interest and investors. Many have made large gains and interest in cryptoassets continues to grow and develop. This resulted in HMRC publishing their views on the tax treatment of cryptoassets. This article provides a general overview of the UK tax position although there are many facets of crypoassets not covered herein.
Firstly, what are Crypoassets?
Crypoassets are assets or items of value that exist digitally and created by software. They can be transferred, stored and traded electronically. The main types of crypoassets recognised by HMRC are: Exchange tokens (better known as cryptocurrencies or coins); Utility tokens; Security tokens and Stablecoins. This article focuses on Exchange tokens. The two most common cryptocurrencies are Bitcoin and Ether. All transactions relating to these coins and tokens including their creation and change of ownership are recorded on blockchains – effectively databases that act as the books and records on the digital network.
In general, HMRC take the view most individuals hold cryptocurrency as a personal investment to profit from the purchase, on disposal. In those circumstances when the cryptoasset is sold the gain will be subject to capital gains tax. The actual tax treatment will depend on the fact pattern. In some situations, the profit will be subject to income tax or PAYE if received as remuneration for employment. The main scenarios are outlined below.
The starting point will be that the purchase and sale of cryptocurrency is by way of investment unless the taxpayer can demonstrate otherwise. HMRC do not consider cryptoassets to be money or currency. Cryptoassets fall within s21 (1) TCGA 1992. Therefore, HMRC view them as chargeable assets for CGT. Exchange tokens can be owned and have a market value that can be realised on an exchange or market place. Gains arising on the disposal of cryptocurrency will be subject to CGT at normal rates. A disposal will arise when tokens are sold; exchanged for a different type of token; used to pay for goods/services or gifted with the exception of transfers between spouses. The allowable costs to arrive at the chargeable gain are listed at s38 TCGA 1992. However, HMRC only allow some exchanges fees (see CRYPT022150).
Cryptocurrencies satisfy the definition of securities at TCGA 1992, s104 and therefore the special pooling rules that apply to calculate the capital gains on the disposal of shares will apply to cryptocurrencies. This means disposals of cryptocurreny will be matched with purchases in a particular order as follows:
- Same day purchase and sale rules
- Sale and purchase of cryptocurrency occurring within 30 days
- General pooling rule
Losses arising on disposal will be available to offset against capital gains in the same year or carried forward and offset against future gains.
Whether the profit is a trading gain or investment will be determined based on the activities carried out. Each case will be based on its own fact and circumstances. There is no clear dividing line. Trade is unhelpfully defined in ITA 2007 s989 as including “any venture in the nature of trade”. Deciding whether the activity amounts to a trade means resorting to the ‘Badges of Trade’ derived from case law. They are summarised as follows:
- Nature of the subject matter.
- Frequency of the transactions.
- Is the transaction related to the trade which the taxpayer otherwise carries on.
- Intention of the taxpayer at the time of purchase.
- Length of ownership of the asset.
The intention of the taxpayer has been observed to be relevant in case law when considering if trading exists or not. The intention should be matched with the taxpayer’s actions. The list above is not comprehensive; it will be necessary to look at the whole picture having regard to what the taxpayer did.
HMRC view trading in exchange tokens to be like trading in shares. Therefore, it is useful to consider the decisions in case law on trading in shares. In most cases the decision concluded trading did not exist. We can draw on the principles identified in such cases. Common themes included:
- The greater the number and size of the purchases and sales of marketable securities and the greater the frequency the more likely it will point towards trading.
- Intention of deliberate profit-making scheme.
- There is a degree of organisation.
If the taxpayer wants to demonstrate they are trading in cryptocurrency they will need to show:
- They have a deliberate trading strategy.
- They conduct transactions based on their strategy
- The maintain some basic book-keeping
- They have a business plan – preferably a written one.
If a trade exists, the profit will be subject to income tax. If losses arise they will be available to offset against future trade profits or other income. The principles outlined above will apply to corporates.
Some taxpayers may be of the view they are gambling in cryptocurrency in which case any profits should be tax free (loss relief is denied). Factually it is likely to be difficult to sustain this argument. This is mainly because the crypoasset market has become more sophisticated and the taxpayer would have to show they are transacting in the market blindly. To date there hasn’t been any tax case where the taxpayer successfully argued the profits made from the sale of shares (the closet comparison to the sale of cryptocurrency) were gambling and therefore tax free. Besides HMRC state in their manual they do not consider the buying and selling of cryptoassets to be the same as gambling. However, they do say whether a transaction can be characterised as gambling will be a question of fact, each case will be considered individually.
Non UK Domiciled
The above also applies to individuals who are UK resident but not UK domiciled (RND). The main difference will be the application of CGT and Inheritance tax (IHT) for non UK situs assets. RND can claim the remittance basis for gains arising on the disposal of foreign assets and the excluded property rules will apply for IHT meaning the gains or asset can escape UK tax.
Cryptoassets are digital in nature and therefore don’t have a physical location. Determining the location for tax purposes can be complex. HMRC’s current view is cryptocurrency is located where the beneficial owner is resident under the UK statutory residence test. They claim this gives a clear, logical, predictable and objective rule that can be easily applied. HMRC’s view may change in the future. Therefore, Bitcoins owned by an individual/company resident outside the UK will be a non UK asset. Whereas a Bitcoin held by a non-domiciled UK taxpayer will be a UK asset for IHT and CGT.
STEP issued guidance in September 2021 outlining an alternative view to the location of cryptocurrency noting HMRC’s view is one view that does not appear to be based on any legal principle. It was suggested a likely approach would build on existing principles of control, ability to deal and by extension, enforceability based on law governing the proprietary aspects of rights. This is because normally law governing property rights regarding an asset is the law of the jurisdiction in which the asset is located. Therefore, the location would not be linked to the beneficial owner but to the participant in the relevant cryptocurrency system who will be the person who has control over the private key (key to authorise cryptocurrency transactions).
In situations where cryptocurrency is not held directly by the beneficial owner but is instead held by a third party such as a cryptocurrency exchange or trading platform on the owner’s behalf it would be the residence of the third party that would determine the location of the asset.
In the absence of any statutory rules it will ultimately be a matter for the courts. In the meantime, it will be for the taxpayer and their agent to decide on what approach to take.
Finally, in relation to Stamp Duty HMRC’s current view is that existing cryptocurrency is unlikely to fall within the definition of stocks and marketable securities to which SD applies. Therefore, SD is unlikely to be charged on cryptocurrency. However, Stamp Duty Reserve Tax (SDRT) may apply if exchange tokens are given as consideration.
In summary, the tax position of crypocurrency is considered an investment and the profits, offset by losses, will be subject to capital gains tax unless the taxpayer can demonstrate they are carrying on a trade. Non UK domiciled taxpayers may be able to structure the ownership of their cryptocurrency using an offshore company or trust to ensure the cryptocurreny/assets are non UK situs assets. HMRC’s current view is the situs of crypocurrency is based on the residence status of the taxpayer although some professional bodies and legal authorities take a different view. If the taxpayer deviates from HMRC’s view it is likely to be challenged.
If you would like to discuss anything from the article further, please don't hesitate to contact Moira or a member of the team.