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Tax on Bitcoin
The Bitcoin story, and the value of the cryptocurrency, continues to rise. Whether this trajectory continues depends on which commentator you listen to. Some think this is only the beginning, whereas others think it is the beginning of the end.
However, us tax bores will just focus simply on the issues and opportunities raised by tax on Bitcoin and other cryptocurrencies.
According to the Revenue, one might hold Bitcoin (which we will use as shorthand to include other cryptocurrencies) with the following in mind
This seems fairly uncontroversial and also appears to cover most potential bases (for any Bitcoiners out there – please let me know if I have omitted anything). As such, the tax on Bitcoin will depend on precisely the activity being undertaken.
We now turn to what is Bitcoin?
What is Bitcoin?
Bitcoin is a type of cryptocurrency. Some might describe it as a ‘virtual’ currency or money, in that it has no physical existence. This is not perhaps as mind-bending as it might once have been.
Certainly, this author makes very few transactions in cash – even with ‘Ringo’ (other parking apps are available!) I now don’t have to keep any shrapnel in the car to pay for my parking. Of course, traditional money is no longer backed by a gold / silver standard and its value is largely determined by the confidence in the country or countries that support it.
It is unclear, certainly from my reading, as to why Bitcoin was invented though a number of theories abound. First of which is that it was created to allow individuals and businesses to operate without a State being able to track transactions and also to ameliorate bank charges which arise for the simplest transactions.
Bitcoin and other cryptocurrencies are stored in an electronic file (wallet) which provides an address between, say, the vendor and the purchaser.
Generally speaking, the currency can be used online. However, there are apparently now 86 Bitcoin ATMs in the UK! The Thirsty Pigeon pub in Douglas accepts Bitcoin for a pint. And recently, high profile entrepreneur Michelle Mone launched a property development in Dubai accepting Bitcoin as payment.
It is fair to say that cryptocurrency has caught Government’s around the world napping. HMRC produced a briefing in March 2014 setting out some of the basics regarding the tax on Bitcoin and there was also a wider ‘Call for Information’ published by the Government later the same year.
For the remainder of this article we discuss some of the issues that may be encountered where a person or company holds or transacts in Bitcoin. This article does not consider the taxation of Bitcoin exchanges or Initial Coin Offerings (“ICOs”). However, this latter activity is something which is of particularly of interest to global regulators.
So what is the position of tax on Bitcoin?
General points – tax on Bitcoin
Bitcoin is broadly treated as a foreign currency for UK tax purposes. Where the value appreciates then that profit is deemed to be a foreign currency gain.
That said, from a legal perspective, it seems that Bitcoin is not considered ‘money’ or currency’ in the legal sense. Certainly, both the Bank of England and the European Central Bank dismiss any claims that it is.
As such, when considering the tax on Bitcoin, a basic framework could be applied:
This should be the case with Bitcoin and perhaps other larger cryptocurrencies such as Ethereum.
But what about others? In theory, I could create Andy Wood Dollars, with my happy face on it? I could do this? I could call it a cryptocurrency and allow you to pay for my tax services with it?
Where Bitcoin is used for personal use as a means of currency, in other words to buy services and / or goods, then there are no gains on exchange gains or any allowable losses.
This is the same position as when you buy your Euros for your holiday to Benidorm. You do not pay tax on any exchange gains, and are not allowed any losses, on the fluctuations in the currencies.
If one uses (or receives) Bitcoin in exchange for goods and services then VAT is payable, or not, in the normal manner.
Holding Bitcoin as an investment
General – speculative holding v investment
In their Guidance, HMRC state that:
The relevant legislation and case law will be applied to determine the correct tax treatment. Therefore, depending on the facts, a transaction may be so highly speculative that it is not taxable or any losses relievable… For example gambling or betting wins are not taxable and gambling losses cannot be offset against other taxable profits.
There is therefore a fine dividing line. Where does one draw the line between purchasing Bitcoin speculatively (sometimes referred to as gambling):, which is not taxable, and holding the cryptocurrency with the intention of creating long term appreciation. This latter activity being within the capital gains regime and subject to Capital Gains Tax (“CGT”) for individuals and Trustees and corporation tax if a company.
This will essentially be determined on a case by case basis.
However, for some individuals who have acquired Bitcoin over the last few years with little thought or awareness of the explosion in its value, it might in practice be difficult to convince HMRC that this was a ‘gamble’ – despite the fact that HMRC should not be applying hindsight when determining intention.
Clearly, the application of hindsight may also, incorrectly, come in to play if a late comer to Bitcoin feels the full effect of any future crash in value!
Generally, if this is an investment then the individual will be subject to capital gains tax on any increase in value on the same basis as if it was a foreign exchange gain.
In other words, where the value of a Bitcoin has risen then that profit will be subject to capital gains tax. If they make a loss, then this will be a capital loss that, broadly, may be offset against capital gains in the year or carried forward.
An area worthy of consideration is perhaps whether it is possible that there is an investment business?
Parallels could be drawn with, say, the property sector. Someone who buys and sells properties with a profit motive, perhaps after improving the property will generally be a land trader. However, someone who acquires a property with the aim of retaining for the longer term, harvesting the rents and hoping for an increase in the value over time will be an investor.
However, this investor may also have an investment business. This business is unlikely to be a trade, but can still be a business.
This can be an important distinction as some capital gains reliefs are dependent on whether an activity constitutes a business. Could one demonstrate that there was sufficient accompanying activity – eg researching other currencies and perhaps investing in those based on that research / researching potential Initial Coin Offerings (“ICOs”) – such that the activity was a business?
I think this would be a difficult sell to HMRC. The difficulty is that Bitcoin will not produce an equivalent to rental income as is the case for a property business. That said, with the capital appreciation that has been witnessed in cryptocurrency, could one have an investment business purely focussed on capital appreciation?
My view is, for now, is that HMRC will probably not seek to tax any gains as subject to CGT due to the fact that, if they do, they open the door to potential capital loss claims if the bubble burst in the future.
As such, my view is that most gains on Bitcoin are unlikely to be taxable unless the holder can be seen to bring a degree of organisation to their approach.
There should be no Bitcoin implications on turning Bitcoin in to traditional currency or vice versa.
Buying and selling Bitcoin – as trading activity
So what if our Bitcoin owner approaches matters in a very professional manner. She has given up her job, bought ‘Bitcoin trading for Dummies’, (perhaps a blog is more apropos to this activity?) bought a new desk and computer and is spending a few hours a day looking for opportunities.
Could this person be trading? If so, what are the implications in respect of the tax on Bitcoin?
From a tax perspective, what constitutes a trading activity is any age-old issue. This is because there is no useful statutory definition (trade is defined but in a ridiculously circular fashion at ITA 2007, s989). As such, and perhaps rather unsurprisingly, we have a large body of case law.
Is there a trade?
Many accountants, tax advisers and lawyers will be familiar with the Badges of Trade (entirely different to the Badgers of Trade – an imaginary organisation of large mercantile woodland creatures). These were factors drawn together in 1955 by the Royal Commission for the Taxation of Profits and Income based on previous case law decisions.
In a case which followed a number of decades later (Marson v Morton  STC 463), a total of nine badges were identified by the Court. It also stated that these “are in no sense a comprehensive list of all relevant matters, nor is any one of them so far as I can see decisive in all cases. The most they can do is provide common sense guidance to the conclusion which is appropriate”.
However, for the purposes of this article, I do not propose in setting the factors out in any detail. For a basic summary of the badges, then one could look at HMRC’s Business Income Manual for their opinion on this case law.
Probably the best parallels can be drawn from case law where there have been share / futures traders such as the relatively recent case of Manzur and Wannell v Rothwell before that. In these cases, it was found that the presumption will be that these will usually be investment in nature rather than one of trade.
It is worth pointing out that, generally speaking, as income tax is applied to trading profits rather than capital gains tax the case law has been taxpayers trying to negate a trading classification.
However, if the activities constitute a trade, then any trading losses will be available to offset against general income. In such circumstances, there would be the opportunity to carry back losses.
As such, it could be the case that if there was a crash in the value there might be some Bitcoiners who seek to argue that they were actually trading. Again, HMRC would seek to resist any such submission. However, the tax on Bitcoin would ultimately be determined on a fact by fact basis.
Income / corporation
As alluded to above, it is likely that the activities are likely to seen as speculative (no tax) or, if there is more organisation to the holdings, then taxed as an investment.
As such, an individual is likely only to be subject to capital gains on any return (and as mentioned, most holders of Bitcoins are likely merely to be speculators – in which case will not be subject to tax).
Where the Bitcoin is held by a company then any gains will be subject to corporation tax. One will also need to consider the loan relationship rules.
Again, there should be no VAT implications from changing in to or out of Bitcoin.
Mining of Bitcoin
I grew up in a mining village – albeit one where the mine had long since disappeared. I must say that Bitcoin was probably the furthest thing from their minds in those days.
Bitcoin mining adds transactions to the Blockchain and acts to release new Bitcoins in to circulation. The ‘mining’ process involves compiling recent transactions into blocks and then attempting to solve a computationally difficult puzzle.
The first participant who solves the puzzle gets to place the next block on the block chain and claim the rewards. The rewards incentivize mining and include both the transaction fees (paid to the miner in the form of Bitcoin) as well as the newly released Bitcoin.
Income / corporation
As to whether the ‘profits’ of such an activity are taxable will depend on the organisation of the operations.
If someone wakes up one day, purchases the equipment, has a bit of a stab at being a Bitcoin miner and gives up after a few months then it is unlikely that this will constitute a trade. Clearly, on this fact pattern, it is likely that our deterred Bitcoiner is looking to offset his losses, from the purchase of equipment and energy bills. He may find an unsympathetic ear from HMRC.
However, the same type of rationale should apply to someone who makes a profit from what could be termed a hobby. This is particularly relevant for Bitcoin where any profit is likely to be derived from the increase in the value of the Bitcoin itself.
Clearly, where a full time professional operation was set up, with specialised equipment, perhaps staff and a clear business plan then this might be more akin to a trade and taxable as such.
Again, there is extensive case law on when a hobby might become a trade.
The case of Patel is instructive. Here, the taxpayer was a social worker and he was a full-time employee of the local authority.
He began a business in 2004, supplying cooking ingredients and running catering workshops. He also set up another business three years later to sell Indian art and photography.
Neither made a profit. In fact, he made a loss and tried to claim those losses against his employment income (as he would be able to do had they been trading losses).
HMRC refused on the ground he had not run his businesses on a commercial basis. Mr Patel appealed.
The First-tier Tribunal (“FTT”) found that both concerns began as hobbies and never grew beyond such. Factors indicated a commercial approach, including the creation of professionally designed websites, but the taxpayer had no clear idea of levels of sales, nor was he seriously interested in profit. Instead, it was stated that his aim was to pursue his interests and share his love of Indian culture.
The only way he could have made them profitable would have been by reducing his hours of employment as a social worker, but he did not do that.
But what if, aping what has happened in Bitcoin, Mr Patel’s uncommercial operation in Indian art made huge profits purely on the basis that there was an international bubble in the value of Indian art? Well, the same analysis should apply and his profit should not have been taxable in the same way his losses were not allowable in this case.
Again, the taxation of Bitcoin mining will depend on the circumstances of a particular case.
If the activities are such that it would constitute a trade then any profits that arise to an unincorporated business (I.e. sole trader or partnership) would be subject to income tax.
Where activities were run through a company then profits would be subject to income tax.
It is stated in HMRC’s guidance that Bitcoin is not a form of economic activity. As such, these transactions are not subject to VAT.
Conclusion – tax on Bitcoin
We trust that you found the above overview of the tax on Bitcoin (and all things crypto) of interest. Clearly, this is a fast-developing area internationally and trade is no different.
As Regulators and Governments come to grips with cryptocurrency then so must advisers and their clients. We hope this acts as a useful starting point in understanding the position of tax on Bitcoin activity.
We are currently advising individuals and companies holding and transacting in cryptocurrencies.
If you have any queries on the tax on Bitcoin or other cryptocurrencies then please get in touch.