With cryptocurrencies and other crypto assets becoming more prevalent in the digital financial world, holders of crypto assets need to be aware of the tax implications, whether they are trading or mining.

What is a crypto asset?

Bitcoin is probably the most well-known of crypto assets, but the industry has come a long way since the first open-source Bitcoin was released in January 2009.

The term crypto assets now encompass all types of cryptocurrencies and tokens. An example of these digital assets is a non-fungible token (NFT) used to confirm ownership of something that exists only online. 

Why is it important to understand the tax implications?

In March 2021, Pablo Rodriguez-Fraile sold an NFT for a 10-second video for $6.6m (£4.8m). He had purchased it just five months earlier for $67,000.

With such huge sums and gains involved in the buying and selling of crypto assets, and the volatility of the market, how they are taxed is a serious talking point. HMRC has been producing guidance on the topic of crypto tax since 2014, but its most substantial guidance was only published earlier last year.

Cryptoassets manual

HMRC has made it clear that this manual is an iteration of existing views, ‘rather than a revolution, so it is not surprising that there have not been any significant changes to what had been previously published.

However, it does now include more topics, such as differences in tax treatment for NFTs, and is in a more user-friendly format. Its main aim is to help ‘people understand the tax implications that can arise from transactions involving crypto assets. 

It is important to note that the manual is currently only guidance and there is no specific crypto asset tax legislation, which means taxpayers must apply the existing rules around the taxation of more traditional physical assets.

Capital gains tax

The starting point for determining taxation is whether the crypto holder is trading or investing.

Generally speaking, HMRC believes that individuals hold crypto assets as a personal investment and as such, are liable for capital gains tax on any profits made above the annual exemption amount.

With such volatility in the market over the last 12 months or so, and prices hitting a record high in April 2021, those who sold at the top will be facing hefty tax bills. Shortly after that peak, prices dropped significantly and some by as much as 50%. If investors sold for a loss, this can be set off against other gains to reduce an overall capital gain.

Income tax

Should crypto holders be buying and selling tokens at a level that HMRC considers them to be trading, then they will be liable for income tax instead of capital gains tax.

There is no clear-cut point at which an individual is trading, but for tax purposes, those involved in mining and validating transactions, or taking, and yield farming are more likely to be treated as if they are trading.

HMRC will generally use the ‘badges of trade’ tests as a starting point to make a decision.

Location

Another critical factor in crypto taxation is where the assets are deemed to be located. This is not straightforward as their very nature is that they are digital and not physically located anywhere.

However, it is an incredibly important point for UK resident non-UK domiciled individuals, as they generally do not pay income tax or capital gains tax on non-UK income and profits, unless it is later sent to the UK. Therefore, the location (or situs) of assets can have dramatic consequences on the amount of tax to be paid by these individuals.

The manual suggests that crypto assets are located where the beneficial owner is resident, meaning that if the individual lives in the UK, then the asset is located in the UK too, and taxed as such.

HMRC powers

The publication of the manual has led to a renewed focus on HMRC’s information gathering powers.

It notes that under schedule 23 of Finance Act 2011 or schedule 36 of Finance Act 2008, HMRC can request information from crypto exchanges. It is also able to make requests through the Mutual Legal Assistance Treaty, European Investigation Order, and General Data Protection Regulation (GDPR).

We know from reports dating back to August 2019, stating that UK crypto exchanges such as CEX.IO and Coinbase had received requests for customer data and transaction histories, that this is not a new practice. The block also quoted a spokesperson for HMRC in October 2020, who said that ‘HMRC regularly gathers data from a range of information sources using powers provided by parliament’.

To clarify exactly what powers HMRC does have, Gherson Solicitors sent a Freedom of Information request to HMRC. The response confirmed that HMRC has:

• used powers to gather information about customers’ transactions
• exercised rights to request information from other tax administrations
• received data from crypto exchanges about their users

The future of crypto tax

The increased regulatory focus on crypto assets means it is likely that the manual will continue to be developed and could turn into the legislative framework that would clear up the uncertainty around the taxation of digital assets, such as determining investors versus traders, and the situs of assets.

There is precedent for regulatory legislation to be used as a basis for tax legislation and it is possible that is what will happen here.

In the meantime, HMRC is likely to continue making use of the powers it does have to gather information from crypto exchanges about personal investments and holdings. Therefore, if you are in the fortunate position of sitting on gains, it is highly recommended that you seek specialist legal advice.