Although HMRC has not released legislation specifically addressing the tax treatment of cryptoassets, it has published detailed guidance setting out its approach to exchange tokens. There are however many complexities in the rapidly evolving area of cryptoassets, which may result in unexpected tax implications.
Investments or trading
In the majority of cases, cryptoassets are held as investments. Profits realised on sales will be subject to capital gains tax and losses will be available to offset against other capital gains.
In exceptional cases, an individual could be treated as carrying on a financial trade in cryptoassets and, if this is the case, any trading profits would be subject to income tax instead of capital gains tax. The tests to determine whether or not an individual is deemed to be ‘trading’ in an asset are complex and are based on the interaction of a number of factors, including the source of financing, the frequency of transactions, the method of acquisition and the interval of time between the purchase and sale of the asset.
Trading losses can be offset against other income which is more attractive than the capital loss treatment. HMRC is, however, likely to challenge a taxpayer who reports a cryptoasset related loss as a trading loss because there is a high hurdle to clear in order to meet the trading criteria.
In addition, individuals may be liable to pay income tax and, in some circumstances, national insurance contributions, on cryptoassets that they receive from:
- their employer as a form of non-cash payment, in return for services provided; and
- mining, staking, transaction confirmation or airdrops received in return for a service.
Calculating capital gains and losses
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’ includes:
- exchanging cryptoassets for cash or for a different type of cryptoasset;
- using cryptoassets to pay for goods or services; and
- giving away cryptoassets to another person, in which case the proceeds received are deemed to be the market value of the holding in sterling.
Capital gains tax will not be due on transfers between spouses or civil partners or on most gifts to charity if the transfer is direct.
As well as the amount originally paid for the asset, other costs can be deducted when calculating the gain or loss, including transaction fees, valuation fees and specific other professional fees.
Costs for mining activities do not count toward allowable costs for capital gains tax but it is possible to deduct some of these costs against trading profits for income tax. HMRC requires share pooling rules to be applied when calculating gains and losses realised on disposals of cryptoassets.
Cryptoassets received as employment income count as ‘money’s worth’ and are subject to income tax and national insurance contributions on the value of the asset.
Cryptoassets are ‘readily convertible assets’ (RCAs) if trading arrangements exist, or are likely to come into existence, for the asset. Where exchange tokens can be exchanged for fiat currency or other cryptoassets on one or more token exchanges, it is HMRC’s view that trading arrangements exist.
If the asset is an RCA then an employer with a UK tax presence must operate PAYE to withhold income tax and class 1 national insurance contributions from the payment via the employer’s payroll.
Any subsequent disposal of the cryptoasset may result in a chargeable gain for capital gains tax on the increase in value between receipt and sale.
The location of cryptoassets
The location, or situs, of cryptoassets is particularly relevant to non-UK domiciled individuals who are able to use the remittance basis and for related inheritance tax purposes.
HMRC's published view is that existing statutory situs rules do not apply to exchange tokens in most cases. HMRC has instead determined that a "clear, logical, predictable and objective rule" is that the situs of the exchange tokens should be determined by the residence of the beneficial owner.
As a result, HMRC considers that while an individual is UK resident, the exchange tokens they hold as beneficial owner will be located in the UK. The person will therefore be liable to UK tax if they are a UK resident and carry out a taxable transaction with their tokens. This view could also mean that holdings of security tokens may give an inheritance tax exposure for non-UK domiciled individuals living in the UK. Furthermore, any new purchases could give rise to taxable remittances unless due care is taken.
It should be noted that this position is HMRC’s view and is not necessarily supported by existing case law or legislation given the very different nature of cryptoassets. It also contrasts with the views held by tax authorities in other jurisdictions. Ireland, for instance, look to the location of the server on which the wallet is held. There may well be litigation through the courts in the future, or supervening legislation, which would help provide clarity to non-UK domiciled individuals going forwards.
Keeping complete records in order to calculate the tax implications of cryptoasset transactions accurately can be a challenge for many taxpayers. 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;
- the date of the transaction;
- the number of units bought or sold;
- the value of the transaction in pound sterling;
- the cumulative total of the investment units held; and
- bank statements and wallet addresses, if needed for an enquiry or review.
Non-fungible tokens (NFTs)
Non-fungible tokens (NFTs) are a type of cryptoasset that provide proof of ownership for other assets, maintained by the blockchain. They can be bought and sold. NFTs often only prove ownership of the token, with any copyright remaining with the asset’s creator. The creator can create new NFTs of the same asset, but each token is unique. NFTs are mostly used to prove ownership of digital assets, such as images, videos, and music, but can theoretically be applied to tangible assets as well.
HMRC is yet to provide any specific guidance on the taxation of NFTs.
How can S&W help?
Our team can help you calculate your taxable gains or losses on your cryptoasset transactions, and assist with your filing obligations with HMRC.
If you are a non-UK domiciled individual, it is important that you consider the latest guidance from HMRC before making any trades of exchange tokens. We can confirm the impact that any purchases or sales may have and, where appropriate, advise you on how to best manage that impact.
If you would like any further details please contact your usual Smith & Williamson adviser, or one of the advisers named on this page.