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  • Pulling Your Crypto into Shape

    29 June 2022

    Alexander Wilson

    Alexander discusses ETC Tax’s experience of compliance work in the crypto space and considers some of the pitfalls and workarounds.

    Compliance in crypto most often means calculating the tax on the profits of buying and selling different cryptocurrencies.  There are various software packages around that claim to calculate the taxable profits and losses on crypto transactions and even split them between those chargeable to income tax or capital gains. 

    So, it’s as easy as uploading the data and downloading the report and plugging the figures on to a Tax Return?  Well, not quite.

    Weighing the Cost

    There is a myth that cryptocurrencies aren’t ‘real’ somehow and so that until one converts some BTC or ONE to fiat, there is no tax implication at all. We have seen many cases where crypto traders have operated in blissful ignorance for years.

    Of course, the reality is that the exchange of one asset for another will give rise to an event for CGT as a matter of basic principles. So, if ETH purchased at £10,000 is disposed of for something else (let’s say DOGE) worth £11,000 at the time of disposal, then there is a gain of £1,000.

    Moreover, the terms of the capital gains tax legislation mean that the share pooling rules (same day pool > 30 days pool > s.104 pool) apply to all fungible assets which includes BTC, ETH, DOGE et al.

    Unfortunately, the volume of trades often means that calculating the gains in accordance with the share pooling rules is impracticable without software (our record is 750,000 transactions). Thankfully, software tools have been developed to deal with this issue.

    Uploading data to the software is usually straightforward. You can download a spreadsheet of transactions (usually a .csv file) from your platform or blockchain explorer and upload that. Or you can give your software an API key for a Centralised Exchange (CEX) or the public key from the blockchain and the software will draw the data automatically and directly from the source.

    Services such as koinly.io, recap.io and cryptotaxcalculator.io and many others are all very good and available to provide reports for a fee. However, in our experience it is common for them to throw out errors or alerts for transactions that aren’t recognised. Further, transactions may be miscategorised without any indication.

    In one case, we were dealing with a client and the software we were using at the time calculated that they had a tax liability of over £200 trillion, enough to wipe-out the national deficit and more. Unfortunately for Hector, we spotted this small discrepancy and tracked down the problem; the software had identified BUNNY tokens as… BUNNY tokens. Searching various sources revealed that there were at least three different tokens using that code and each was worth a very different amount.

    Unregulated Choice

    As crypto technology has developed, more and more types of transactions are being developed, often by decentralised exchanges (DEX’s). DEX’s can be set-up by anyone who can write the code and deploy it on the blockchain. The makers could be anywhere in the World and their identity may not be known.

    This gives rise to an “interesting” variation in the amount of data provided and the format in which it is provided. This can present considerable difficulties in compiling the data (the pooling rules apply to all assets of the same class, whether held together or not). Ideally, your software will be able to recognise the data from different sources but with more exchanges and blockchains emerging all of the time, no platform can promise to recognise them all.

    Different Transactions

    As well as throwing-up many different data formats, DEX’s are throwing-up many different forms of transactions. An example of this is liquidity pool staking for cryptocurrency pairs. Let’s illustrate with a BNB/CAKE pool on PancakeSwap:

    A client would send some BNB and some CAKE (of equal US$ value) to a wallet used by the DEX’s smart contract. In return, the client would be sent some Pancake-LP tokens, representing that deposit. The BNB and CAKE top-up a pool of those assets so other people can exchange one for the other. The client would stake those LP tokens to earn a small cut of each exchange.

    When the client closes their position, they would unstake their LP tokens and then exchange them for some BNB and CAKE. However, the proportion of the BNB and CAKE in that pool has changed and so the proportion of those assets received back by the client will not be the same as those committed to it.

    Naturally, these utilities were designed with no thought at all to the accounting or tax compliance needs of the users!

    In any transaction of this type, consideration will have to be given to what is going on. Are there capital disposals and acquisitions? Do the LP tokens have a value? Can they be exchanged on the open market? Are there any income events? Does staking the LP tokens represent a disposal?

    Correcting Errors & Resolving Alerts

    Fortunately, software platforms such as Koinly allow you to change or edit transactions as needed. The software developers simply can’t write the software to correctly recognise every possible transaction, all of them are playing constant catch-up.  

    One of the selling-points of the blockchain is the transparency of the data. All transactions conducted ‘on-chain’ (e.g., anything on a DEX) is recorded on the publicly accessible ledger that is the blockchain. Every single one. (Transactions on CEX’s like Binance, are not done ‘on-chain’, these transactions are dealt with internally by the platform in the same way that a bank deals with your money).

    Most blockchains in use have one or more ‘explorers’ on which the publicly available data can be read. The explorer for the Ethereum blockchain is etherscan.io. These are simply websites that allow you to search for any public key (wallet address) or individual transaction. They are powerful (and free) tools which allow you to get ‘under the bonnet’ of clients’ transactions and work out what is going on if the software can’t.

    Likewise, there a many free-to-use services which give lots of historical data about different tokens, including historical trading data. These include coingecko.com and coinmarketcap.com. These can be very helpful in resolving issues such as identifying tokens which the software does not recognise or even recognises incorrectly.

    We have only touched on some of the issues that will arise when dealing with crypto compliance. We have found that ‘hands-on’ knowledge of crypto is invaluable in understanding the various transactions which can be seen. If you would like further advice or help with your crypto compliance problems, reach out to us!

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    Please provide as much detail as possible in regards to the reason for your enquiry so our tax advisers can prepare and tailor their response to reflect your needs. We will endeavour to - respond / call you back - to discuss your enquiry and you will not be charged for this time.

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