Cryptoassets: the taxman circles

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Cryptoassets: the taxman circles
There is a lot of uncertainty about the tax treatment of cryptoassets (Image credit: Pixabay)

Research published by the Financial Conduct Authority in 2021 concluded that around 2.3mn people in the UK own cryptoassets, up from 1.9mn in the previous year.

More recently, crytoassets have been recognised as a credible alternative investment and form of payment. There has also been increasing interest in non-fungible tokens (or NFTs), which are a form of cryptoasset utilising blockchain technology. 

The relative ease with which such assets can now be acquired, and the interest generated by the potential for profit from holding such assets, has contributed to the interest of HM Revenue & Customs and tax authorities around the world in taxing gains from the sale of them.

While it may have initially been considered an opaque form of investment, HMRC now has specific powers that it has exercised in recent months to obtain information from UK cryptoasset exchanges about their customers. 

HMRC is tasked with reducing the tax gap due to tax evasion in this area. It will do this by using its sophisticated data mining software to identify when individuals have omitted to declare tax liabilities.

Towards the end of 2021, HMRC launched a campaign encouraging taxpayers to consider their affairs in case they had any cryptoasset gains to declare. These letters are often referred to as nudge letters. 

 

With the existing differential between tax rates and the rules on how both types of activity are taxed, it could be a tax trap for the unwary.John Hood

 

From a UK tax perspective, there was a time when such investments were regarded as gambling, and any gains realised from the sale of such assets would not be taxable. This was, in fact, never the case.

To clarify the position, new guidance was published by HMRC that confirms how HMRC will treat gains made on the sale of cryptoassets. 

The basic position HMRC takes is that most cases involving the sale of cryptoassets are considered investments and any gains realised by UK residents will be subject to capital gains tax.  

This also applies when one type of cryptoasset is exchanged for another. There is anecdotal evidence that people mistakenly believed that as the assets were merely exchanged there was not a disposal for tax purposes. 

In this scenario, the sale of the cryptoasset is treated as a disposal of an asset for ‘normal’ currency such as sterling.

For example, if an individual owns dogecoin (a type of cryptoasset popularised by Elon Musk) and exchanges this for bitcoin (the ubiquitous cryptoasset) this is treated as the sale of the dogecoin for money.

The individual in this situation must work out whether a gain or loss has been realised at the point of exchange based on the difference between the original acquisition cost of the dogecoin deducted from the value of the bitcoin at the time of exchange.

If there is a gain this would be subject to CGT in the UK.  

CGT vs trading activity

While gains realised on cryptoassets are normally liable to CGT, there are situations where the activity of buying and selling cryptoassets may be considered by HMRC to be sophisticated, frequent, and organised enough to be considered a trading activity.

While HMRC acknowledges this possibility in its guidance, there is no exact methodology given.

Normally, when deciding whether an individual buying or selling assets is undertaking a trading activity liable to income tax, there are so-called ‘badges of trade’ that have been considered in the courts to indicate a trade.

HMRC states that trading in cryptoasset is likely to be 'outside the norm' (Image credit: Pixabay)

HMRC states that trading in cryptoassets is likely to be 'outside the norm' (Image credit: Pixabay)

The use of the word ‘trade’ here must not be confused with the simple act of buying and selling itself. Trade denotes a level of activity which is such that it amounts to a business activity rather than a speculative investment.

For example, it is possible for an individual to acquire (or develop) a cryptoasset algorithm that buys and sells cryptoassets many times a day with a level of sophistication that means this is their primary source of income. The expectation is that this will be considered by HMRC to be a trading activity. 

HMRC states that trading in cryptoasset is likely to be "outside the norm". This means that it remains an area where there is significant uncertainty whether these trades are investments liable to CGT or trading liable to income tax.

With the existing differential between tax rates and the rules on how both types of activity are taxed, it could be a tax trap for the unwary, who may think it is nothing more than a hobby with potential lucrative gains.

John Hood is a tax partner at Moore Kingston Smith