Crypto assets in the UK: When is a tax return due?

Crypto assets, such as Bitcoin, Ethereum and other cryptocurrencies, have become increasingly popular in recent years as a form of investment, payment and alternative asset class. However, many crypto investors may be unaware of their tax obligations in the UK, or may find the tax rules confusing and complex.

In this blog post, we will try to provide a classification of the different types of crypto assets, how they are taxed in the UK and explain when a tax return is actually due as they are instances where you can avoid having to go through that if your profits and/or proceeds in the tax year are below certain allowances. 

What are crypto assets? 

Crypto assets are digital tokens that use cryptography to secure transactions and control the creation of new units. They are typically recorded on a distributed ledger, such as a blockchain, that is accessible to anyone on the network. Crypto assets can have different characteristics and functions, such as: 

• Exchange tokens: These are intended to be used as a method of exchange or payment, such as Bitcoin or Litecoin. They do not provide any rights or obligations to the holder, other than the ability to transfer or exchange them. 
• Utility tokens: These provide access to a current or future service or good, such as Ethereum or Filecoin. They may also have some exchange value, but their main purpose is to enable the use of a platform or network. 
• Security tokens: These provide rights and obligations similar to traditional securities, such as shares or bonds. They may entitle the holder to dividends, interest, voting rights or ownership of an underlying asset or business. 
• Stablecoins: These are designed to maintain a stable value relative to another asset, such as a fiat currency or a commodity. They may use various mechanisms to achieve this, such as backing by reserves, algorithmic adjustments or collateralisation. 

How are crypto assets taxed in the UK? 

HMRC does not consider crypto assets to be equivalent to currency or money, and therefore treats them as a traditional asset for tax purposes. In addition, HMRC considers that investing in crypto assets is not analogous to gambling (such that any profits made on investments in crypto assets would not be taxable). 

Depending on the nature and purpose of the crypto transactions, they may be subject to either Capital Gains Tax (CGT) or Income Tax (IT). The general principles are as follows: 

• Capital Gains Tax (CGT):
  This applies when an individual disposes of crypto assets that they own as a personal investment. A disposal occurs when the individual sells, exchanges, transfers or gifts their crypto assets to another person. The taxable gain is calculated by deducting the allowable costs (such as the acquisition price and transaction fees) from the disposal proceeds (such as the sale price or market value). The gain is then taxed at either 10% or 20%, depending on the individual's total income and gains for the tax year. The individual can also utilise their annual CGT allowance (£6,000 for 2024/25), which means that any gains below this threshold are tax-free. 
  
  
• Income Tax (IT):
  This applies when an individual receives crypto assets as a form of income or reward. This may include situations where the individual: 
• Mines crypto assets using their own equipment and resources. Mining is the process of validating transactions and creating new units of crypto assets on a network. The taxable income is calculated by deducting any allowable expenses (such as electricity and depreciation) from the market value of the mined crypto assets at the time of receipt. 
• Stakes crypto assets on a network. Staking is the process of locking up some crypto assets on a network to participate in its governance and security, and receiving rewards for doing so. The taxable income is calculated by deducting any allowable costs (such as transaction fees) from the market value of the staked crypto assets and rewards at the time of receipt. - Receives crypto assets from their employer as a form of remuneration or benefit. The taxable income is calculated by using the market value of the crypto assets at the time of receipt. 
• Receives crypto assets from an airdrop. An airdrop is when new units of crypto assets are distributed for free to existing or potential holders. The taxable income is calculated by using the market value of the airdropped crypto assets at the time of receipt. 

The income from crypto assets is then taxed at the individual's marginal rate of IT, which can range from 0% to 45%, depending on their total income for the tax year.

How to put Bitcoin in your ISA or in your SIPP

With the recent run-up in Bitcoin price, a number a people in the UK have been wondering how to get some Bitcoin exposure inside their pension or their ISA. 

While in many jurisdictions such as the US or Canada, it's possible to get exposure to Bitcoin in tax wrappers such as pension funds, the UK financial conduct authority, in its great wisdom, decided that it was way too risky for the average Joe. 

The way most people get Bitcoin exposure in tax wrappers is by buying exchange listed trackers such as the Grayscale Bitcoin Trust (GBTC) in the US, the Bitcoin Fund (QBTC.U) in Canada or XBT Provider and BTCetc in Europe. While it was possible to buy such trackers into SIPPs in the past, the FCA made it illegal in early 2020. And the situation will actually get even worse next year since sale of such trackers will be altogether forbidden to all private investors in the UK. 

While it's still possible to get Bitcoin exposure directly by buying the cryptocurrency on exchanges such as Coinbase, Kraken or Gemini (and soon Paypal), some people would rather do that into a tax friendly container such as an ISA or a SIPP. And in such containers you cannot buy cryptocurrencies nor any of the available listed trackers. 

But a recent development that we talked about in our previous post is providing an alternative way to achieve that goal in a stealth way. Indeed, as more and more listed companies put Bitcoin on their balance sheet, and as the price of Bitcoin increases, those companies in effect are becoming virtual Bitcoin ETFs, allowing shareholders to get indirect exposure to Bitcoin if they buy the stock. 

How to put Bitcoin on your Balance Sheet

The COVID-19 pandemic and the resulting economic crisis has pushed all governments around the world to print money like never before resulting in a global devaluation of cash assets. People and companies sitting on large piles of cash have struggled to invest that cash into harder assets such as gold, real estate or equities (in particular big techs that have been perceived as less immune to the COVID-19 dislocation event). 

But more and more people have been turning to Bitcoin as well. Indeed the cryptocurrency has all the characteristics of a hard currency (the supply is limited by a hard cap of 21 million coins) without the downside of existing options (lack of convenience, low liquidity, elastic inflation -- as prices increase, inflation rate increases as well along with economic incentives). As fears that government might outlaw the cryptocurrency fade away, more and more corporates are taking the plunge. This is a virtuous circle: as more and more companies hold the cryptocurrency on their balance sheet, and as governments acknowledge and regulate that behaviour, the legal risk evaporates. 

Microstrategy was the first public company to announce that they converted the majority of their Treasury into Bitcoin, a total of $425 million. Since then a number of businesses have disclosed that they had done or intended to do that as well. Coldcard creator, Rodolfo Novak, has even put up a web page listing those businesses. 

Converting part of your Treasury into Bitcoin is more complex than converting it into another currency, especially if you don't have the resources of a large public company. But if you're ready to protect your funds with a swarm of cyber hornets, here are some of the issues and how to deal with them:

Security

As most people know, holding Bitcoin is hard. Everyone has heard of hacks or mistakes that have cost Bitcoin owners their savings. As a company putting a significant amount of your Treasury in Bitcoin, you have a fiduciary responsibility to ensure that those funds are secured properly. You have basically 3 options. 

UK Tax treatment of Crypto-Assets for Businesses

HMRC published a guidance note last year (see our article) on the taxation of cryptocurrencies for individuals. They have now produced a similar document for businesses (see gov.uk website). The HMRC's approach in this policy paper is, as expected, conservative, and it stands in line with other countries’ tax treatment for cryptocurrencies. It's noteworthy however that the HMRC explicitly states that it does not consider crypto as a currency, and the policy paper is careful to use the term "crypto-asset" instead of "cryptocurrency" throughout.

Corporation Tax

Where a token/crypto-asset is being used in a trading activity, companies are to be taxed on their trading profits. Profits need to be calculated in GBP therefore all transactions need to be converted into GBP at the time of the transaction.

Where a token/crypto-asset is used in a non-trading activity, it is be treated as an investment and so any gain on disposable is to be subject to CT on chargeable gains. Some but not all costs can be allowed as a deduction when calculating the gain. Cost of mining for example is not allowed unless the mining activity is done as a trade. The calculation method is following section 104 of the TCGA 1992 i.e. using a pool per asset class but with slightly different anti-bed-and-breakfast rules (a sale is matched against the pool unless a purchase happen in the next 10 days -- and not 30 as usual). And in case of a hard fork, cost base needs to be split on a "just and reasonable" basis.

Pensions: the Lifetime Allowance time bomb

With rates at historical lows, with $9.5 trillion worth of government debt carrying negative yields and with governments around the world addicted more than ever to Quantitative Easing, fiat money around the world is losing its value faster than ever. It means that the value of a pension fund invested in hard assets (and yes Bitcoins are also an option...) is more susceptible than ever to go over the The Lifetime Allowance (LTA) at some point. Indeed, you just need an 8% annual return over 20 years to multiply the value of your pension by a factor of 5!

The Lifetime Allowance (LTA) is the overall limit a pension plan can reach before its owner is being penalised by a 55% tax upon withdrawal. The Lifetime Allowance after having reached £1,800,000 in 2011/2012 was reduced all the way down to £1,000,000 in 2016/2017 and stayed there for a couple of years before starting to increase again with the CPI (consumer price index) in 2018/2019. It is now at £1,055,000 (2019-2020).

The government tests your pension against the LTA when you take a benefit (eg you take a drawdown or an annuity) or when you reach the age of 75. It's called a benefit crystallisation event (BCE). Nowadays, the most popular way to extract money from a pension is through flexible drawdowns. When you take your benefit via a drawdown, 25% of the drawdown is tax free cash and the rest goes into drawdown mode where it can continue to be reinvested tax free (but still potentially subject to the second LTA test -- see below). The money can be taken at any point from the drawdown fund and is taxed as income on the taxpayer when it is taken. The tax free element and what is left in drawdown is compared to the LTA at the time of the crystallization and the corresponding percentage is added to the ones from the previous drawdowns. If you end up over 100% then the additional amount above the current LTA is either taxed at 55% if you take if out of the drawdown pot immediately or 25% if you leave it there (and it will be taxed a second time as income when you take the money out of the fund).

HMRC asking for records of Crypto Exchanges

With Bitcoin looking like it's here to stay, HM Revenue & Customs, is now pressuring crypto-currency exchanges to reveal customers' names and transaction histories, in a bid to claw back unpaid taxes, industry sources said. Letters requesting lists of customers and transaction data have landed on the doorsteps of at least three exchanges doing business in the U.K. – Coinbase, eToro and CEX.IO – in the last week or so, the sources said.

The move is following a pattern set by the U.S. Internal Revenue Service (IRS) and other governments. Last month, the IRS began sending warning letters to over 10,000 Americans who it says participated in virtual currency transactions but did not report them properly.

HMRC is looking to get up to 10 years worth of historical data but that might prove difficult to achieve. Still, even if the administration manages to go back 3 years, it would mean serious tax bills for those who thought trading virtual currencies was a tax free endeavour! HMRC published in 2018 a policy paper explaining the tax treatment of crypto-assets. As described in the paper, for most people, capital gains tax will be due on any gains they might have realised. But doing the calculation of the gain might prove more complex than with other securities. Indeed, transferring bitcoins in or out of an exchange is not a taxable event per se. And conversely, buying something with Bitcoin or receiving income in crypto-currency is a taxable event!

This is why it's crucial to keep records or all transactions and refrain from using crypto-currencies as a payment currency, at least until there is a de minimis exemption like with other currencies. As, even if your gains are below the annual allowance of £12,000 (for 2019/20), you still need to declare the sales if they total more than 4 times the annual allowance, i.e. £48,000. For people who don't already do a tax return, it means registering for Self Assessment. And if you are aware of gains that you have failed to declare in the past, it's a good idea to come forward and call HMRC to avoid steeper penalties.

Tax treatment of cryptoassets: an update from HMRC

HMRC published this week a new policy paper on the tax treatment of crypto-assets. The previous paper was from 2014 (see our previous article on the subject) and this one goes into further details  but only concerns the individual taxpayer. The government has promised a further update for corporations at some point in the future.

In the paper HMRC defines 3 types of assets: Exchange Tokens (such as Bitcoin and most crypto-currencies and that can be used as payment rails), Utility Tokens that provide the holder with access to specific goods or services (such as those issues during an ICO) and Security Tokens which provide the holder with interest in a business (either debt or equity).

Essentially, individuals will be liable to pay either Capital Gains Tax (CGT) if investment is casual or Income Tax (IT) if they are actively involved in the trading of the cryptoassets. The paper goes into quite a lot of details and specifies many possible scenarios and their tax treatment but here are a few points that are worth noting:

Taxing Bitcoins

Because of Bitcoin skyrocket increase this past year from $17 to over $1,200, you cannot escape hearing about those cryptocurrencies and how they will change world commerce for ever. While the Federal Reserve gave tacit approval, stating “virtual currencies like bitcoin have legitimate uses and should not be banned,” and while it's been acknowledged by the Chinese authorities as a valid currency (even though Banks have yet to gain authorisation to use it) there is still a lack of guidance from the tax authorities as to how those new currencies should be treated. There are basically 2 possibilities on how Bitcoins should be treated for tax purposes: either as an intangible asset or as a foreign currency. If a Bitcoin is considered an asset, profits will be taxed as capital gains, i.e at either 18% or 28% depending on your tax band. However if it's considered a foreign currency, then profits will be taxed as income, and therefore as high as 45%.

The problem with saying that it’s a currency is that it is not issued by a government, and traditionally currencies are legal tender issued by governments. In California Bankers Assn v. Shultz, the Supreme Court stated (in a non-tax context): “‘Currency’ is defined in the Secretary’s regulations as the coin and currency of the United States or of any other country, which circulate in and are customarily used and accepted as money in the country in which issued.”