Tax implications of investing in cryptocurrency

Background

The digital revolution, which is still due to sweep away many of the anachronisms of the industrial age, has permeated our lives: we use the internet daily to send emails or find complex solutions to our simple questions, and robotic process automation is due to modernise the workplace.

In the latter half of the last decade blockchain was heavily invested in with a view to creating a global accountancy system for the ownership of possessions (both tangible and non-tangible). One such type of non-tangible asset that has the potential to provide wealth for its owners is cryptocurrencies – Bitcoin, Ethereum and Ripple to name but a few. These currencies are digital in nature – they were not formally issued by any central banks – and can be traded or used as payment globally.

There are various types of cryptocurrencies such as:

  • exchange tokens that can be used as payment for goods or services (similar to traditional currency);
  • utility tokens that provide the owner with access to certain goods or services; and
  • security tokens that provide the owner with security for a debt or provide the owner with profits from the security.

Cryptocurrencies have created problems from a legal perspective.

  1. Are they truly assets with value and can they be owned?
  2. If they are assets then can they be legally transferred to other individuals (through a will or prenuptial agreement)?
  3. If the owner of cryptocurrencies has a connection to more than one jurisdiction whose laws would govern the transfer of the cryptocurrencies and whose tax regime are they subject to?

In late December 2019, HMRC have released guidance on their view of the law surrounding cryptocurrencies (as it currently stands) focusing on exchange tokens.

The location (or situs) of exchange tokens

In stark contrast to shares and debentures, exchange tokens are considered to be situated for tax purposes in the jurisdiction in which the owner is resident. This will have a greater impact on those who are non-domiciled but resident in the UK and choose to pay their tax on a remittance basis - as the individuals are resident in the UK the cryptocurrencies are treated as being situated in the UK and will be subject to UK tax.

Exchange tokens belonging to individuals who are not resident in the UK are not subject to the UK tax regime.  

Tax treatment of exchange tokens for UK residents

Capital Gains Tax

HMRC considers that the majority of owners purchase or are given exchange tokens on an infrequent basis – that is, they are not frequent traders of exchange tokens. After receiving the exchange tokens they wait for the values to rise and then sell them at a profit. HMRC's view is that profits made on exchange tokens are subject to capital gains tax in the normal way and a liability is incurred every time the exchange token is 'disposed' of (sold, transferred to another, or used as payment) at a gain. From a practical perspective, it is important to keep careful records of the dates on which disposals are made (and the value in Sterling of the exchange token on that date) to ensure that tax returns are accurate – this is especially cumbersome when using exchange tokens as a form of payment.

Income Tax

For substantial traders of exchange tokens, HMRC may tax gains made on exchange tokens as income – income tax rates are generally higher than capital gains tax rates.

Equally, if an individual receives exchange tokens (or any form of cryptocurrency) as a result of employment then the value of the cryptocurrency received is subject to income tax and national insurance contributions – they are taxed in the same way as any other remuneration for employment.  

There are also complex rules for cryptocurrencies received from mining and airdrops that may result in an income tax liability.

Inheritance tax

On death, the value of cryptocurrencies owned by an individual is treated as forming part of the individual's estate and will be subject to inheritance tax – as above the residence of the owner is important.

Considerations

At an early stage it is important to consider and include the ownership of cryptoassets in any wider wealth planning. Owners should also keep appropriate records confirming the following when disposing of cryptoassets:

  • the type of cryptoasset;
  • date of the transaction;
  • if they were bought or sold;
  • number of units;
  • value of the transaction in pound sterling;
  • cumulative total of the investment units held; and
  • bank statements and wallet addresses, if needed for an enquiry or review.