They say the only certain things in life are death and taxes, and while we can’t help you with your mortality, we can offer a little advice about the other thing. When you’re dealing with cryptocurrency, it’s best to get in front of your tax liabilities sooner rather than later because penalties for not doing so can add up quickly.
With cryptocurrency transactions, tax rules can get slightly complicated, and you could incur several different liabilities, like income and corporation tax, stamp duties, and – depending on transaction types – VAT. Whether you get classed as a business or individual will define how you pay tax and how much. The good news is, HMRC provides a lot of information that makes getting your head around crypto rules a little easier, and we’re going to look at that here.
Firstly, it’s important to remember that HMRC may decide to treat you as a business rather than an individual if your activity level is comparable to a company. So, how does HMRC determine whether your crypto is an investment or you qualify as a crypto trader? Well, that depends on several factors, such as:
The number and frequency of transactions
The time you devote to the activity
The length of time you hold instruments - whether they’re bought and sold within minutes or retained for longer
Related: Tax and NIC thresholds for 2021/22
If mining is classified as a business based on those criteria, then any resulting income will be added to trading profits and become subject to income tax. Fees or rewards for any staking activity will also get added, although reasonable expenses will be deductible.
Remember, while disposing of mined cryptocurrency, any gain in value from the time of acquisition will get added to trading profits. You’ll also have to pay National Insurance Contributions for such a transaction.
Read More: Profit And Loss Forecast Template & Guide
It’s worth saying here that this is a grey area because there’s no reporting guidance from HMRC. The best approach is to declare this in the same way as you would mining. That’s to say you’d pay income tax on any staking or lending income at your regular income tax rate. If you received payment in a cryptocurrency, you’d need to calculate the fair market value of the coins based on when you received them.
If you get classed as an individual and hold crypto as an investment, you’ll be liable to pay capital gains tax upon disposal. ‘Disposal’ has been defined by HMRC as:
Selling crypto assets for money
Exchanging crypto assets for a different type of crypto asset
Using crypto assets to pay for goods or services
Giving away crypto assets to another person
Naturally, the amount of capital gains will be the difference between the sales proceeds from the disposal and the crypto asset’s acquisition cost – in other words, the sale price minus the buying price.
The answer to that question will depend on your income tax bracket:
If you’re a higher or additional rate taxpayer, your capital gains tax rate will be 20%
If, on the other hand, you’re a basic rate taxpayer, your tax rate will depend on your taxable income and the size of the gain (after any allowances get deducted)
There are some special rules for high-frequency traders or businesses, and we’ll look at those later on.
In essence, a capital gain is any difference between the selling price and an asset’s purchase cost. The former is usually readily apparent but calculating the latter requires some accounting expertise.
HMRC uses a share pooling method calculation. With the pooling method, you basically end up averaging the acquisition cost of all the crypto you’ve purchased so you can calculate the purchase cost of the coins being sold.
Natalie bought one BTC for £1,000. Six months later, she bought 0.5 BTC for £2,000. Her total pool of bitcoin is 1.5, and total allowable costs are £3,000.
Let’s say Natalie sells 0.5 BTC some years later for £3000. The following is what her capital gains calculation would look like:
Post this sale, Natalie will have a remaining pool of 1 BTC with an allowable cost of £2000
The Same-Day and 30-Day rules that apply to shares also come into play with cryptocurrency. That’s to prevent wash sales, which basically refers to selling crypto and repurchasing it in an attempt to realise losses so you can reduce your tax burden.
So, let’s look at the Same-day rule first. Let’s say you sell a cryptocurrency and buy another of the same kind on the same day. In that case, the cost basis for your sale will be the acquisition cost of the crypto you purchased that day. Remember that’ll still be the case, even if the acquisition happens before the sale, as long as both transactions happen on the same day.
Ok, so the 30-day rule is quite similar, but – as the name suggests – the timeline changes and any crypto you acquire within 30 days of a sale will be used to calculate its cost basis. The rules are in place for a reason. They exist to ensure you don’t sell your holdings at the end of the tax year, just to create losses that you can then write off before repurchasing them immediately.
HMRC makes it quite clear that exchanging one crypto for another also constitutes a taxable event. That means you’re basically disposing of one asset that’s subject to capital gains tax and then acquiring another one. The market value of the crypto you receive is considered as the sales price for that transaction. If this crypto cannot be valued for some reason, you can still use the market value of the crypto you sold.
Related: How is Bitcoin taxed in the UK?
From an HMRC perspective, using crypto to pay for goods or services is the same as selling crypto, so it’s subject to capital gains tax. Remember, though, the market value of the crypto you use to pay for something will be counted as the sales proceeds.
While there’s no tax liability created when you move crypto between your own different wallets, it’s important to remember you still need to keep track of such movements. Be warned, if you don’t do that, HMRC might assume they’re disposals and tax them.
Initial Coin Offerings (ICOs) or Initial Exchange Offerings (IEOs) refer to the practice of purchasing tokens or coins in a yet-to-be-released cryptocurrency or company. In such a case, investors pay for the new token using existing cryptocurrencies like Bitcoin or Ethereum.
In other words, it works like a crypto-to-crypto exchange. You’ll have to pay capital gains tax on the crypto you exchange for the ICO token. The “sale proceeds” here will be the market value of the existing crypto – not the new token – on the date that the exchange took place. In addition to that, this same market value will also serve as the cost basis for the new token you receive from the ICO, which you can use to calculate pooled costs.
It’s not all bad news, however. Like with most things HMRC-related, you can still protect yourself from incurring unnecessary tax liabilities if you pay close attention to the rules around cryptocurrencies and tax. Here our small business accountants give a guide on what you can claim and what you can’t claim.
Don’t forget about your allowance. Capital gains tax only has to be paid if you made over £12,000 (increased to £12,300 for tax year 2020-2021) in profits. That means you calculate your capital gains, and if the result is below the limit, you don’t need to pay any capital gains tax.
If an individual sells cryptocurrency for less than the cost basis, they’ll create a capital loss. That loss can be offset against any overall gains, but you’ll need to report it to HMRC first. Losses can be notified by letter or on your tax return. Capital losses can be claimed any time within four years, starting from the end of the tax year in which they occurred.
Remember, if the disposal of the crypto is to a connected person, the actual sales price is not considered the same as the sales proceeds, and the market value of the crypto on the date of the transaction gets used instead.
When crypto-assets are subject to wild fluctuation, it’s not unusual for someone to own currency that’s become worthless or of ‘negligible value.’ In such a case, the owner of the asset can file a negligible value claim. In filing that claim, the crypto assets get treated the same way as when they’ve been disposed of, then re-acquired for the amount stated in the claim. That allows you to write off a major loss for an asset that is now illiquid.
Don’t forget that a negligible value claim only needs to contain the name of the asset that’s now worthless, the amount at which the asset should be treated as disposed of (usually £0), as well as the date of the deemed disposal. Filing such a claim results in a loss you can offset against gains once it’s been reported to HMRC. You can make both the loss and negligible value claim to HMRC at the same time.
It’s worth knowing – when calculating a gain or loss, there are certain allowable costs you can deduct from the sales proceeds, as follows:
The consideration (in pounds sterling) originally paid to acquire the crypto asset
The transaction fees paid before the transaction was added to a Blockchain
Any exchange fees related to trades
Professional costs for drawing up the contract for both acquisition and disposal of the asset
Costs related to advertising for a purchaser or vendor
Costs of making an apportionment or valuation in order to calculate the gains or losses
Remember that the following costs are not allowable for capital gains tax purposes:
Any costs that have already been deducted against profits for income tax
The costs of mining activities, such as electricity and equipment. That’s because, in cases of individuals mining crypto as a hobby, electricity and equipment costs are not wholly attributable to mining crypto. However, some costs are deductible when the mining equipment get disposed of
Finally, it’s well worth noting that in a case where mining is a business activity, the crypto assets will form part of trading stock. If the assets get transferred out of trading stock, the business will be treated as if they bought the crypto at the trading accounts’ value. That value can then be used as an allowable cost upon disposal.
We hope you found this guide useful! If you are cryptocurrency trading as a business or as an individual, our experienced accountants and online accountants can ensure you get it right when it comes to tax. Please get in touch to find out more on 0207 043 4000 or firstname.lastname@example.org.