Crypto asset tax : The New HMRC Guidance Update…
In December 2018, HMRC released their long-awaited policy paper on the appropriate tax treatment of cryptoassets. This being HMRC’s second paper on this, the first being published in 2014.
The paper goes some way in undertaking the difficult task of marrying the creaking anachronistic tax system with the complexities of the uber modern system of cryptoassets.
This is one of a number of modernising operations HMRC have undertaken in recent years. Notably, also in relation to the taxation of tech giants, such as Google, Amazon and Airbnb, who exploit movable, high value and intangible assets, such as intellectual property, to low tax jurisdictions to pay less tax.
Importantly, this policy paper was published just over a month before the 31st January 2019 deadline for submitting a self-assessment tax return for tax years 2017-18. With the most significant surge in cryptoassets’ value falling within the 2017-18 window, most notably in relation to Bitcoin where the value reached over $19,000 per coin, it is important that those who are taxable in this year, submit an accurate and timely return.
What’s new at HMRC with Cryptocurrencies & Cryptoassets?
Here, I will highlight and address the tax treatment forwarded by the policy paper, with particular reference to the relevant taxes and the taxable events that these apply to. I will also highlight key substantive changes in tax treatment between the current and previous policy papers, which also exemplifies how HMRC may change their guidance as they see fit.
Definition of Cryptoassets… HMRC define cryptoassets as,
“cryptographically secured digital representations of value or contractual rights that can be:
• Stored; and,
• Traded Electronically”
In express contrast to its 2014 guidance, HMRC now state that cryptoassets are not currency or money, whereas previously, HMRC specified that it was to be treated as such. HMRC now align its categorisation of cryptoassets with the Bank of England, European Central Bank and other leading financial institutions. As a result, emphasis is placed on the name cryptoassets, rather than cryptocurrency.
Taxing Assets & Currencies
Generally, there are two taxes that may be applicable to individuals who hold and trade cryptoassets.
Firstly, the overall majority of taxpayers will be taxable to capital gains tax (CGT) on the disposal of their cryptoassets. This is because the cryptoassets are predominantly held as investment property and therefore, these will be given comparable treatment to assets, such as shares.
If taxable to CGT, a taxpayer will pay tax at the rates of 10% or 20%, dependent upon the taxpayers’ level of income.
In the alternative, instead of CGT, a taxpayer will be chargeable to income tax (IT) and national insurance (NI) in circumstances where cryptoassets have been:
• Received as earnings;
• Airdropped; or,
IT is chargeable at the rates of 20%, 40% and 45% and NI is chargeable to 12% and 2%.
If income tax is applicable, HMRC state that IT treatment will take priority over CGT treatment.
In stark contrast to its 2014 guidance, HMRC expressly rules out the possibility of falling within the remit of gambling. HMRC fail to offer any reason or justification for this significant change. However, do note that this is HMRC guidance and therefore, if someone does fall within the gambling characterisation, albeit this is likely to be very few people and taxpayers may have significant difficulty in justifying this classification, current legislation provides for this to be tax exempt.
Crypto Currencies & Assets vs. Capital Gains Tax
Taxpayers will be chargeable to CGT on the disposal of cryptoassets in a number of circumstances, these include:
• Selling cryptoassets for money;
• Exchanging cryptoassets for a different type of cryptoasset;
• Using cryptoassets to pay for goods or services; and,
• Giving away cryptoassets to another person.
The value attached to the cryptoasset on each taxable event, detailed above, is the pound sterling value attributable to the cryptoasset at the point of the taxable event.
This may add a level of complexity as not all cryptoassets have a direct pound sterling value.
For example, some cryptoassets must be exchanged to another cryptoasset first, in order to realise a fiat currency value, which will then provide a pound sterling value. Therefore, it is advisable that those buying and selling cryptoassets should keep a record of all relevant values at each taxable event, that directly or indirectly give each cryptoasset a pound sterling value.
When calculating whether there is a gain or a loss, the following are allowable costs:
• The consideration (in pound sterling) originally paid for the asset;
• Transaction fees paid before the transaction is added to a blockchain;
• Advertising for a purchaser or a vendor;
• Professional costs to draw up a contract for the acquisition or disposal of the cryptoassets;
• Costs of making a valuation or apportionment to be able to calculate gains or losses;
However, the following will not be allowable in calculating whether there is a gain or a loss:
• Any costs deducted against profits for Income Tax;
• Costs for mining activities (for example equipment and electricity).
As is applicable for shares, s.104 pooling is applicable, which provides a methodological way to calculate taxable gains.
If a taxable disposal occurs and a loss is made, this will be relievable against any other gains made in the current year and any excess losses may be carried forward to relieve future gains.
Crypto Currencies & Assets vs Income Tax
As noted above, in the majority of cases CGT will apply and therefore, taxpayers will not be chargeable to IT on the disposal of cryptoassets. However, where IT does apply it will take precedence. There are a number of circumstances where IT will apply, these are:
• Trading in cryptoassets;
• Cryptoassets received as earnings.
Taxes & Trading in Cryptoassets
HMRC note that the substantive conduct and intention of the taxpayer may determine their tax treatment. In particular, an individual may,
“buy and sell cryptoassets with such frequency, level of organisation and sophistication that the activity amounts to a financial trade in itself.”
Currently, in order to establish whether someone falls into the remit of trading, their activity is assessed against the badges of trade. The relevant badges are,
• Frequency and number transactions;
• Connection with another existing;
• Whether and how the transactions are financed;
• Length of the ownership of the cryptoassets;
• The organisation and sophistication of the operation;
• Reason for the purchase and/or sale.
Notably, there is no magic number that must be satisfied to amount to trading. Instead, an assessment is undertaken pragmatically in consideration of all of the relevant factors.
If a taxpayer is trading, the profit will be taxable to IT and NI.
Taxes & Mining Coins/ Crypto-Assets
Mining activity is taxable to income tax on either one of two grounds:
• A taxpayer who has undertaken mining activity will be taxable to IT and NI if their activity falls within the badges of trade detailed above, i.e. if mining activity forms part of an overall trade; or,
• In the alternative, if the mining does not amount to trading activity, the pound sterling value of the mined cryptoassets will be taxable to income tax as miscellaneous income at the point of mining.
Notably here, if taxable to miscellaneous income, losses are restricted to miscellaneous income only and therefore, if a loss has been made, particularly due to costs from mining, such as electricity, these cannot be offset against any other non-miscellaneous income in that respective tax year.
Taxing crypto currencies & assets in the real world. Some examples…
Cryptoassets are new and unique and therefore, the relative tax treatment is difficult to draw comparisons with other areas of asset taxation. In particular, the taxation of mining activity to miscellaneous income is not comparable to the taxation of any other activity and therefore at face value, HMRC appear to be levying an additional taxable event, without any legislative base.
Here, I will attempt to draw on two examples to explore broad comparisons, which highlight that this treatment, if correct, is unique to cryptoassets.
Firstly, let us imagine that someone creates jam for a hobby, from fruit they have grown in their garden and later sell at a local farmers market from time to time. The sale of the jam would likely be chargeable to miscellaneous income; however, this would be taxable to miscellaneous income at the point of selling the jam at the farmers market. By comparison, in relation to cryptoassets, mining activity is chargeable to miscellaneous income at the point of mining and CGT at the point of sale. Therefore, an additional tax is being levied as a result of the cryptoassets being cryptoassets, which would not be levied on other assets in (loosely) comparable circumstances, such as in the case of someone making and selling jam for a hobby.
Secondly, let us imagine a professional services firm, such as an accountancy firm, who provide professional reports to clients. Often, these reports may take many months to produce. However, during this time, the client may be billed in part or in full and this work may be taxable (depending on accountancy treatment) as part of work in progress (WIP) for the firm. Firstly, ignoring the fact that this will be chargeable to trading income, WIP will still only be subject to tax once, i.e. subject to income tax on the overall cost of the report, whether that is paid in one go or instalments. There will be no further tax charge, whether IT or CGT, as the work will be complete, the client will have their report and the professional services firm will not have retained anything that they can later sell (asset or stock). By comparison, HMRC suggest mining activity will be subject to IT (miscellaneous income) at the point of mining and then CGT when the asset is later sold. Again, this clearly adds another tax to another loosely comparative circumstance.
HMRC’s guidance offers no legislative authority for this additional charge to tax, as a result it is difficult to understand on what legislative basis HMRC are seeking to levy this additional tax, unique to cryptoassets. As a result, this is something that requires further clarification, or subsequently it may challenged by a taxpayer.
Following the mining and selling of cryptoassets, taxpayers will be subject to one of two paths to taxation. This will depend upon whether the taxpayer falls within the trading or miscellaneous category.
The taxable paths are as follows:
(1) Mining activity (Trading Income). If a taxpayer was mining as part of a trade, the cryptoassets form part of the trading stock. Whether the cryptoassets were sold soon after mining, or several years later, the tax effect of this depends upon the treatment of the stock. If sold as trading stock, the profits of any sale of cryptoassets will be taxable to income tax (trading income). However, if the stock was instead retained as investment property there is an additional tax liability that arises at the point where the cryptoasset(s) move(s) from trading stock to investment property. In effect, there will be a self-sale at market value at the point of transferring the cryptoasset from trading stock to an investment property. The profit (or hypothetical profit) will be chargeable to income tax (trading income). One difficulty here is pinpointing the exact point when this occurs and in practice, this is not always clear. Once the cryptoasset is held as investment property, any further taxable event will be chargeable to CGT, as investment property, detailed above.
(2) Mining Activity (Miscellaneous Income). If a taxpayer had previously mined cryptoasset(s) and is taxable to miscellaneous income, if the cryptoassets are later sold, HMRC guidance states that the taxpayer will be chargeable to CGT on the profit.
An airdrop is the allocation of cryptoassets, which may or may not be in return for something.
An airdrop is taxable to IT if it is received in return for doing something, which includes the expectation or provision of a service. This will be subject to income tax, as either:
• Trading income (again, also chargeable to NI); or,
• Miscellaneous income.
An airdrop may not be a taxable event if the transfer is received in a personal capacity, or not received in exchange for something, such as the provision of a service (i.e. work).
Cryptoassets Received as Earnings
Cryptoassets received as employment income are chargeable to IT and NI.
There are two separate categories that apply to the taxation of cryptoassets received by taxpayers. Both result in the taxpayer being taxable to IT and NI, however there are differences in relation to how the tax is administratively collected. The two categories are:
• Readily Convertible Cryptoassets (RCC); and
• Non-Readily Convertible Cryptoassets (NRCC).
RCC’s are taxable through PAYE like any other income payment. Therefore, IT and employee NI will be deductible at source by the employer and paid to HMRC on the employee’s behalf based upon the value of the cryptoasset. Similarly, employer NI is also payable.
NRCC’s are not taxable through PAYE and therefore taxpayers will have to register for self-assessment and declare NRCC’s on a self-assessment tax return. However, guidance states that employers should treat these as ‘payments in kind’ and therefore pay any Class 1A NI on the payments.
The above also applies if a third party makes a payment of cryptoassets for earnings on behalf of another individual/company. Tax treatment will depend upon whether the cryptoasset is an RCC or NRCC.
Conclusion – crypto asset tax
Overall, HMRC’s policy paper offers some clarity in relation to the relevant tax treatment of cryptoassets. However, there are some areas that do need further consideration and clarification. Similarly, there are other areas that are arguably contentious in their application. Notably, this paper only states HMRC’s opinion on the appropriate taxation of cryptoassets and therefore, it is likely that aspects may be challenged and clarified, before a tribunal.
If you or your clients need any advice in relation to crypto asset tax, or indeed if there are any other tax issues that you feel we may be able to help you with, please contact us at email@example.com or on Cheshire – 01925 363006, Manchester – 0161 711 1310 or London – 0203 7058320.