In the last few years, cryptoassets have changed the way of receiving payments and trading on financial markets, so much so that governments have had to intervene to interpret the different investments from a legal and tax standpoint. Therefore, HMRC has produced guidance related to the current state of affairs in relation to cryptocurrencies.
The Crypto manual has not had comparable tax legislation yet, which means taxpayers must apply the existing rules around the taxation of more traditional physical assets.
Capital gains tax or Income Tax?
The starting point for determining taxation is whether the cryptoholder is trading or investing.
HMRC believes that individuals hold cryptoassets as a personal investment and as such, are liable for capital gains tax on any profits made above the annual exemption amount. In the last years, the blockchain market has experienced high volatility. Therefore, it resulted in assets sold for a loss that be set off against other gains to reduce the overall capital gain.
If investors are 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 traditional "badges of trade" concept as a starting point to decide.
Owners of cryptoassets are in most cases individuals who make a personal investment, usually with the objective of obtaining capital appreciation or to support a specific purchase.
Individuals are subject to Income Tax and National Insurance contributions on cryptoassets received from:
- Employers in the form of "non-cash" payments.
- In the case of Mining, Staking and Airdrops.
Virtual currencies can be used to pay wages to an employee. Cryptoassets received in the form of employment income are valued at "cash value". In this case, the employer is required to report to HMRC the employee's National Insurance tax and contributions due based on the best estimate of the value of that asset. Once the cryptocurrencies are received in the form of wages, the value will be determined when they are received. Cryptoassets are considered to be RCAs (Readily Convertible Assets) as they can be categorized as "commercial arrangements" under section 702 of the Income Tax (Earnings and Pensions) Act 2003.
Cryptocurrencies such as bitcoins are considered to be tokens traded on different platforms to make capital gains by exploiting market volatility. Should the cryptocurrency increase or decrease in value, the subsequent tax event will be subject to tax reporting and will be subject to capital gains. When an individual incurs a loss on trading in cryptoassets, he or she may be able to deduct the loss on future gains, thus reducing the amount of tax owed in subsequent tax years. Tokens can be allocated to "miners" to verify additions to the blockchain's digital ledger.
Mining typically involves the use of computers to be able to solve difficult mathematical problems in order to generate new tokens. Some types of consensuses require "staking" exchange tokens that weigh the right to new tokens. Several factors must be considered in determining whether such activities generate taxable assets:
- The degree of activity.
- The organization.
- The degree of risk.
If the asset is not a "marketable" asset, the sterling value (at the time of receipt) of any token awarded will be taxable as income (under miscellaneous income) with any associated expenses that may reduce the taxable amount. Should the individual retain the assigned assets, they may have to pay capital gains tax when they decide to divest.
An airdrop is where an individual is allocated tokens, for example as part of a marketing campaign through a selection process. Other examples of airdrops can include the automatic provision of tokens because of other tokens in possession or if an individual has registered for an airdrop. Generally, airdrop tokens have their own features (they may include smart contracts, blockchain or another type of smart technology) that operate independently of the infrastructure for an existing cryptoasset.
Income tax is not applied to airdrops tokens in the following cases:
- If nothing is done in return, e.g., if it is not related to any service.
- If it is not part of a tokens exchange or mining business.
Airdrops provided in exchange for or in expectation of service are subject to income tax as:
- Miscellaneous income.
- Receipts of an existing exchange.
As with mining and staking, the sale of a token received by airdrop may result in the payment of Capital Gains Tax, although not chargeable to income tax at the time of receipt. Where changes in value are taken into account as part of the calculation of trading profits, income tax will prevail over Capital Gains tax.