If you are residing in the UK, and trading with cryptocurrencies, you could be liable to pay crypto tax.
The HM Revenue and Customs (HMRC) was one of the first tax offices worldwide to seize the lucrative revenue opportunity that United Kingdom (UK) crypto tax may provide. The first distinction is that crypto is taxed as an asset. Many traders succumb to the misconception that crypto should be taxed as a currency. Still, tax authorities view it differently and ultimately hold the deciding power in most jurisdictions.
The importance of disclosure
Some traders might be tempted to avoid disclosure of crypto activity due to doubts over tax authorities’ ability to track crypto transactions across a high number of exchange and wallet services. However, in the UK, this would constitute a false sense of security because HMRC has shown powerful intent to attain customer data from UK-based crypto exchanges.
This leaves crypto traders with no alternative but to be proactive in their tax compliance, or risk an expensive and tedious process of retrospective compliance enforced by the government.
How are crypto assets taxed in the UK?
In the UK, two types of crypto tax are applicable:
- Income tax
- Capital gains tax
These taxes are levied on a range of realisation events as would be applicable on fixed property, shares, forex and collectables.
Income tax is applicable when you earn crypto, for instance, when you receive crypto as:
- Interest or
Tax authorities regard a trade between cryptos as a set of sell and buy transactions, eg. exchanging BTC for ETH. However, disposals are not only realised when converting crypto to fiat currencies. Any event where the stock of one crypto is decreased in exchange for something in return, constitutes a taxable disposal, with one or two exceptions in limited cases.
Spending or gifting crypto is also taxed if the market value of the crypto at disposal is more than its cost.
All these gains are determined using the difference between the cost base and the value at disposal.
What is a cost base?
The cost base is the acquisition cost of an asset sold. For example, if you buy 5 ETH on one day and sell the full 5 ETH the next day for 5 000 GBP more, your cost base and gains are easy to calculate.
If you have a diverse crypto portfolio that encompasses multiple exchanges and wallets, with numerous trading pairs and investment strategies, it becomes much more challenging to keep track of.
Cost base methods are guidelines for keeping track of trading stock costs. A variety of these methods exist, with different countries stipulating their own rules. Commonly used methods include FIFO, LIFO, HIFO, and ACB. The HMRC only allows one cost tracking method, which is the share pooling method.
What is the inventory tracking method?
Share pooling allows three rules to be applied to calculate disposed assets’ cost basis:
- The same-day rule – applies to stock bought and sold on the same day. Once the amount sold exceeds the amount purchased, one employs the next rule.
- The “bed and breakfasting rule” – allows sales and purchases that occur in the same month to be based on the cost of coins purchased in the last 30 days. When selling more than what was bought during this period, one has to apply the section 104 rule.
- The section 104 rule – this method should be used when none of the aforementioned rules applies. It functions like the Average Cost Base (ACB) method in that the cost basis is calculated by aggregating the total amount paid for all assets and dividing it by the total amount of coins or tokens held.
The rationale for using the share pooling method
The HMRC employs the share pooling inventory cost tracking method to disincentivise tax-loss harvesting practices that obscure gains and losses from the tax authorities. Since we have established the only acceptable method to determine the cost bases of crypto assets in the UK, we can move on to how the actual gains are calculated.
Capital Gains Tax
The taxable gains are calculated by subtracting the cost basis from the total value of the disposal. Depending on whether the transaction type falls into the capital gain or income categories, each loss or gain will be added to the appropriate category. The aggregate gains will be taxed at the marginal tax rates, dependent on the taxpayer’s regular income.
Ryan bought 3 BTC in June 2019. It was worth £5,000 per coin when he acquired it, making it worth £15 000 in total. He paid an extra £200 in transaction fees. His cost basis is, therefore, £15 000 + £200 = £15 200.
In July 2021 he sold 3 BTC at £35 000. So he needs to subtract his cost basis from his sale price to figure out his capital gain: £35 000 – £200 = £34 800.
This is his capital gain on which he’ll pay tax. To calculate how much tax he’ll pay, he needs to look at his regular income to determine which Capital Gains Tax band he falls into. Remember to deduct your capital gains allowance of £12 300.
All crypto asset transactions that fall under the income category are taxed at one’s regular income tax band. Transaction types for which HMRC has issued specific guidance include remuneration in crypto, staking rewards, mining tokens and airdrops (in most instances).
Novel developments in the DeFi space are disrupting the traditional taxation frameworks in many jurisdictions, with income opportunities such as yield farming, earning new liquidity pool tokens, crypto lending with interest as compensation and crypto dividends inevitably also set to be classified as income. While guidance on the tax treatment of engage-to-earn and play-to-earn platforms is not clear yet, we believe there is a high likelihood that HMRC will also consider, and tax, inflows from these sources as income.
Non-taxable crypto activity
Exceptions to the taxability of crypto transactions do apply in a handful of instances:
You will not pay tax on crypto in the UK when buying crypto, holding crypto, transferring crypto between your own wallets, gifting crypto to your spouse or donating crypto to charity. A transaction fee exemption applies, but only when the transaction fee is fiat-denominated, which is typically not the case when crypto is being traded.
Addition and removal of liquidity to and from DeFi liquidity would not fall within the conventional scope of disposal events. However, many DeFi protocols are now issuing tokens in exchange for shares in liquidity pools. It will give rise to different views on disposal criteria and probably cause different tax implications. We are keeping a close eye on these developments.
The HMRC is fairly generous when it comes to forks in that coins received from forks are not taxed upon receipt. However, the cost of the crypto received is derived from the previous blockchain, so if you later dispose of coins received in a fork, you will not be able to use the coin’s fair market value on receipt as your cost basis.
The HMRC does not consider involuntary alienations of crypto stock through loss and theft as disposals by HMRC, and therefore cannot be claimed as capital losses. There are exceptions to this rule, with the possibility of making a negligible value claim, yet such claims are subject to strict conditions that can be difficult to validate.
In summary, the HMRC is generally very clear on the tax implications of crypto activity. The best approach to ensure that you attain and maintain crypto tax compliance, is to work with an experienced crypto tax accountant. This will also ensure that your tax submissions are factually informed and optimised to the maximum possible extent within your legal and regulatory framework. If you would like to learn more about how we can help you with this process, please get in touch with us.
(Disclaimer: This does not constitute financial advice)