In this article, Moira McKeown takes us through HMRC’s position on the taxation of cryptocurrency and discusses some alternate views.

When the price of Bitcoin soared to nearly $20,000 in 2017 it sparked increased hype in cryptocurrency. Since then, Bitcoin has generated enormous amounts of publicity and its continued exorbitant price rise has attracted worldwide interest and investors. Many have made large gains and interest in cryptoassets continues to grow and develop. This resulted in HMRC publishing their views on the tax treatment of cryptoassets. This article provides a general overview of the UK tax position although there are many facets of crypoassets not covered herein.

What are Crypoassets?

Crypoassets are assets or items of value that exist digitally, which are created by software. They can be transferred, stored and traded electronically. The main types of crypoassets recognised by HMRC are exchange tokens (better known as cryptocurrencies or coins); utility tokens, security tokens and stablecoins. This article focuses on exchange tokens.

The two most common cryptocurrencies are Bitcoin and Ether. All transactions relating to these coins and tokens including their creation and change of ownership are recorded on blockchains – effectively these are databases that act as the books and records on the digital network.

Taxation

In general, HMRC take the view that most individuals hold cryptocurrency as a personal investment to profit from the purchase on disposal. In those circumstances when the cryptoasset is sold any profit made will be subject to capital gains tax. The actual tax treatment will depend on the fact pattern. In some situations, the profit will be subject to income tax or PAYE if received as remuneration for employment. The main scenarios are outlined below.

Investment

The starting point will be that the purchase and sale of cryptocurrency is by way of investment unless the taxpayer can demonstrate otherwise. HMRC do not consider cryptoassets to be money or currency. Cryptoassets fall within section 21 (1) TCGA 1992. Therefore, HMRC view them as chargeable assets for CGT.

Exchange tokens can be owned and have a market value that can be realised on an exchange or marketplace. Gains arising on the disposal of cryptocurrency will therefore be subject to CGT at normal rates. A disposal will arise when tokens are sold, exchanged for a different type of token, used to pay for goods/services or gifted (with the exception of transfers between spouses/civil partners). The allowable costs to arrive at the chargeable gain are listed at section 38 TCGA 1992. However, HMRC only allow certain exchanges fees (see HMRC’s Cryptoasset Manual at CRYPT022150).

Cryptocurrencies satisfy the definition of securities at section 104 TCGA 1992, meaning the special pooling rules that apply to calculate the capital gains on the disposal of shares also apply to cryptocurrencies. This means disposals of cryptocurrency will be matched with purchases in a particular order as follows:

1. Same day purchase and sale rules; then
2. Sale and purchase of cryptocurrency occurring within 30 days; and finally
3. General pooling rule.

Losses arising on disposal will be available to offset against capital gains in the same year or carried forward and offset against future gains as normal capital losses would.

Trading

Whether the profit is a trading gain or investment will be determined based on the activities carried out. Each case will be determined based on its own fact and circumstances. There is no clear dividing line. Trade is unhelpfully defined in section 989 ITA 2007 as including “any venture in the nature of trade”. Deciding whether the activity amounts to a trade therefore means resorting to the ‘Badges of Trade’ in case law. These are summarised as follows:

• Nature of the subject matter;
• Frequency of the transactions;.
• Is the transaction related to the trade which the taxpayer otherwise carries on?
• Intention of the taxpayer at the time of purchase; and
• Length of ownership of the asset.

The intention of the taxpayer has been observed to be relevant in case law when considering if trading exists or not. The intention should be matched with the taxpayer’s actions. The list above is not comprehensive, meaning it will be necessary to look at the whole picture having regard to what the taxpayer did.

HMRC view trading in exchange tokens to be like trading in shares. Therefore, it is useful to consider the decisions in case law on trading in shares. In most cases the decision concluded trading did not exist. We can therefore draw on the principles identified in such cases. Common themes included:

1. The greater the number and size of the purchases and sales of marketable securities and the greater the frequency the more likely it will point towards trading;
2. Intention of deliberate profit-making scheme; and
3. There is a degree of organisation.

If the taxpayer wants to demonstrate they are trading in cryptocurrency they will need to show that they:

• have a deliberate trading strategy;
• conduct transactions based on their strategy;
• maintain some basic book-keeping; and
• have a business plan – preferably a written one.

If a trade exists, any profit made will be subject to income tax. If losses arise these will be available to offset against future trade profits or other income like any other trading losses. The principles outlined above will also apply to corporates who are taxed accordingly under the corporation tax regime.

Gambling

Some taxpayers may be of the view that they are gambling in cryptocurrency in which case any profits should be tax free (loss relief would be denied). Factually, it is likely to be difficult to sustain this argument. This is mainly because the crypoasset market has become more sophisticated and the taxpayer would have to show they are transacting in the market blindly.

To date there has not been any tax case where the taxpayer successfully argued the profits made from the sale of shares (the closet comparison to the sale of cryptocurrency) were gambling and therefore tax free. Besides, HMRC state in their manual they do not consider the buying and selling of cryptoassets to be the same as gambling. However, they do say whether a transaction can be characterised as gambling will be a question of fact, requiring each case to be considered on its own merits.

Non-UK domiciles

The above also applies to individuals who are UK resident but not UK domiciled (“RND”). The main difference will be the application of CGT and inheritance tax (IHT) for non-UK situs assets. RND individuals can claim the remittance basis for gains arising on the disposal of foreign assets and the excluded property rules will apply for IHT, meaning the gains or asset can escape UK tax. However, if the RND individual is deemed UK domiciled for either CGT or IHT purposes, the remittance basis is not available and UK CGT and IHT will arise.

Cryptoassets are digital in nature and therefore don’t have a physical location. Determining the location for tax purposes can be complex. HMRC’s current view is cryptocurrency is located where the beneficial owner is resident under the UK statutory residence test. They claim this gives a clear, logical, predictable and objective rule that can be easily applied. However this view may change in the future. Based on the current thinking, Bitcoins owned by an individual/company resident outside the UK are a non-UK asset. However, Bitcoin held by a non-domiciled UK taxpayer who is UK resident will be a UK asset for IHT and CGT.

The Society of Trust and Estate Practitioners issued guidance in September 2021 outlining an alternative view to the location of cryptocurrency noting HMRC’s view is one view that does not appear to be based on any legal principle. It was suggested a likely approach would build on existing principles of control, ability to deal and, by extension, enforceability based on law governing the proprietary aspects of rights. This is because normally law governing property rights regarding an asset is the law of the jurisdiction in which the asset is located. Therefore, the location would not be linked to the beneficial owner but to the participant in the relevant cryptocurrency system who will be the person who has control over the private key (i.e. the key to authorise cryptocurrency transactions).

In situations where cryptocurrency is not held directly by the beneficial owner but is instead held by a third party such as a cryptocurrency exchange or trading platform on the owner’s behalf it would be the residence of the third party that would determine the location of the asset.

In the absence of any statutory rules it will ultimately be a matter for the courts. In the meantime, it will be for the taxpayer and their agent to decide on what approach to take.

Stamp duty

Finally, in relation to stamp duty, HMRC’s current view is that existing cryptocurrency is unlikely to fall within the definition of stocks and marketable securities to which stamp duty applies. Therefore, stamp duty is unlikely to be charged on cryptocurrency. However, stamp duty reserve tax (“SDRT”) may apply if exchange tokens are given as consideration.

Conclusion

In summary, the tax position of cryptocurrency is considered an investment and the profits, offset by losses, will be subject to capital gains tax unless the individual taxpayer can demonstrate they are carrying on a trade. Non-UK domiciled taxpayers may be able to structure the ownership of their cryptocurrency using an offshore company or trust to ensure the cryptocurrency/assets are non-UK situs assets. HMRC’s current view is the situs of cryptocurrency is based on the residence status of the taxpayer although some professional bodies and legal authorities take a different view. If the taxpayer deviates from HMRC’s view it is likely to be challenged.