HMRC's Approach to Cryptocurrency Taxation

Her Majesty's Revenue and Customs (HMRC) published its first detailed guidance on the taxation of cryptocurrencies (which it refers to as "cryptoassets") in December 2018, with subsequent updates as the crypto landscape has evolved. The fundamental principle is that cryptocurrency is not treated as currency or money but as a form of property for tax purposes.

The tax treatment depends on the nature of the activities undertaken and the parties involved. For most individual investors, the primary tax considerations will involve either Capital Gains Tax (CGT) or Income Tax, depending on the specific circumstances.

HMRC's Classification of Cryptoassets

HMRC currently recognises four main types of cryptoassets:

• Exchange Tokens: Cryptocurrencies like Bitcoin and Ethereum designed to be used as a means of payment
• Utility Tokens: Tokens that provide access to goods or services on a specific platform
• Security Tokens: Tokens that provide rights similar to traditional investments like shares
• Stablecoins: Tokens designed to maintain a stable value, often pegged to fiat currencies

While there are some nuances in how these different types might be treated, for most individual investors, the tax treatment will be similar across categories.

Capital Gains Tax on Cryptocurrency

For most individual investors, Capital Gains Tax (CGT) will be the primary tax consideration when dealing with cryptocurrency.

When Does CGT Apply?

CGT applies when you dispose of cryptocurrency. HMRC considers the following to be disposals:

• Selling cryptocurrency for fiat currency (e.g., GBP, USD)
• Exchanging one cryptocurrency for another
• Using cryptocurrency to purchase goods or services
• Giving away cryptocurrency to another person (except to a spouse/civil partner)

Calculating Capital Gains

The capital gain (or loss) is calculated as follows:

Capital Gain = Disposal Proceeds - Allowable Costs

Allowable costs typically include:

• The original purchase cost of the cryptocurrency
• Transaction fees associated with buying and selling
• Professional costs for valuation or determining tax treatment
• Costs of making improvements to the cryptoasset (rarely applicable)

CGT Rates and Allowances

For the 2023/24 tax year:

• The annual tax-free CGT allowance is £6,000 (reduced from £12,300 in the previous tax year)
• Basic rate taxpayers pay 10% CGT on gains above the allowance
• Higher and additional rate taxpayers pay 20% CGT on gains above the allowance

Note that these rates apply to most assets, including cryptocurrency. Different rates apply to residential property and carried interest.

Pooling and the "Same Day" and "30-Day" Rules

HMRC applies special "pooling" rules to determine the cost basis when calculating gains on cryptocurrency disposals:

Pooling

All acquisitions of the same cryptocurrency (e.g., all your Bitcoin) are placed into a "pool." The pool has a "pooled allowable cost" which is the total of:

• The original costs of all tokens in the pool
• Any allowable costs associated with those tokens

When you dispose of some tokens, you're deemed to be disposing of a portion of the pooled tokens, and the cost is calculated proportionally from the pooled allowable cost.

Same Day Rule

If you buy and sell the same cryptocurrency on the same day, the tokens you buy are matched with the tokens you sell in the following order:

1. Assets acquired on the same day as the disposal
2. Assets acquired in the 30 days following the disposal (on a "first in, first out" basis)
3. Assets from the pool

Income Tax Scenarios for Cryptocurrency

While many cryptocurrency transactions fall under Capital Gains Tax, certain activities may be subject to Income Tax instead.

Mining

If you mine cryptocurrency, the tax treatment depends on whether your activities constitute a trade or are more casual in nature:

• Trade: If mining is conducted as a business activity, profits are subject to Income Tax, and you may need to register as self-employed
• Non-trade: If mining is more casual or hobby-like, the value of tokens received (in GBP) is taxable as miscellaneous income

HMRC considers factors such as degree of activity, organisation, risk, and commerciality when determining whether mining constitutes a trade.

Staking Rewards

Staking involves holding cryptocurrency in a wallet to support network operations in exchange for rewards. HMRC generally treats staking rewards as either:

• Income (if it constitutes a trade)
• Miscellaneous income (if it doesn't rise to the level of a trade)

The value of tokens at the time of receipt forms the acquisition cost for future Capital Gains Tax calculations.

Airdrops

Airdrops are distributions of tokens, often for marketing purposes. The tax treatment depends on why the tokens were received:

• Received in exchange for a service or as part of a trade: Subject to Income Tax
• Received without doing anything in return: May not be taxable as income (though subsequent disposals would be subject to Capital Gains Tax)

DeFi Lending

Decentralised Finance (DeFi) platforms allow cryptocurrency holders to lend their assets and earn interest. The interest received is generally taxable as:

• Income from property (similar to traditional savings interest) if activities are passive
• Trading income if lending activities are substantial and organised as a business

Income Tax Rates

For the 2023/24 tax year, Income Tax rates in the UK are:

• Personal Allowance (up to £12,570): 0%
• Basic rate (£12,571 to £50,270): 20%
• Higher rate (£50,271 to £125,140): 40%
• Additional rate (over £125,140): 45%

Note that these bands may vary for Scottish taxpayers.

Record-Keeping Requirements

Maintaining detailed records is crucial for accurate cryptocurrency tax reporting. HMRC requires records that enable you to produce a complete and accurate calculation of your cryptocurrency tax liability.

Essential Information to Record

• The date of each transaction
• The type of transaction (purchase, sale, exchange, etc.)
• The quantity and type of cryptocurrency involved
• The value of the transaction in GBP (at the time of the transaction)
• The cumulative total of investment units held
• Bank statements and wallet addresses
• Records of the pooled costs before and after each transaction

Valuation Challenges

For transactions not involving GBP, you'll need to determine the pound sterling value at the time of the transaction. HMRC advises the following approaches:

• Using an exchange rate from the exchange where the transaction occurred
• Taking an appropriate exchange rate from a reputable source (average of multiple exchanges if necessary)
• Keeping records consistent and using the same methodology throughout

Tax Planning Strategies for UK Crypto Investors

While tax avoidance is illegal, tax planning within the bounds of the law is perfectly legitimate. Here are some strategies UK cryptocurrency investors might consider:

Utilise Your Annual CGT Allowance

Consider realising gains up to your annual tax-free CGT allowance (£6,000 for 2023/24) each tax year. This might involve selling and then potentially repurchasing cryptocurrency (though be aware of the "30-day rule" which could affect your cost basis).

Consider Offsetting Losses

Capital losses can be offset against capital gains in the same tax year or carried forward to future years. If you have cryptocurrency that has decreased in value, you might consider selling it to realise the loss and offset it against gains.

Use Tax-Advantaged Accounts Where Possible

While you cannot hold cryptocurrency directly in ISAs or SIPPs, some regulated investment products that provide exposure to cryptocurrency may be eligible for these tax-advantaged wrappers.

Time Your Disposals Strategically

If possible, plan significant disposals across tax years to maximise the use of your annual CGT allowance and potentially benefit from lower tax rates if your income fluctuates.

Keep Detailed Records

Good record-keeping isn't just a legal requirement—it's also essential for identifying tax-planning opportunities and ensuring you don't pay more tax than necessary.

Reporting and Payment

UK taxpayers must report and pay any tax due on cryptocurrency through the Self Assessment system if:

• Total capital gains exceed the annual exemption amount
• The total value of assets disposed of is more than 4 times the annual exemption amount (£24,000 for 2023/24), even if the gains are less than the exemption
• They have taxable income from cryptocurrency activities

Self Assessment Tax Return

You'll need to complete the capital gains summary pages of your Self Assessment tax return, providing details of each disposal that resulted in a taxable gain or loss.

Deadlines

• The deadline for filing a paper tax return is 31 October following the end of the tax year
• The deadline for filing an online tax return is 31 January following the end of the tax year
• Tax payments are also due by 31 January following the end of the tax year

Real-Time Capital Gains Tax Service

HMRC offers a "real-time" Capital Gains Tax service that allows you to report and pay CGT on property and other assets (including cryptocurrency) shortly after a disposal, rather than waiting until the end of the tax year.

Future Developments and Considerations

Evolving Regulations

The regulatory landscape for cryptocurrency in the UK is still developing. HMRC and other regulatory bodies continue to refine their approach as the market matures. Stay informed about changes that could affect the tax treatment of your cryptocurrency investments.

International Considerations

If you're a UK resident but have cryptocurrency on foreign exchanges or have tax residency in multiple countries, your tax situation may be more complex. Consider seeking professional advice to ensure compliance with all relevant tax jurisdictions.

DeFi and NFTs

New crypto innovations like Decentralised Finance (DeFi) and Non-Fungible Tokens (NFTs) present unique tax challenges. HMRC is gradually providing more specific guidance on these areas, but many aspects remain subject to general principles and interpretation.

Conclusion

Understanding and complying with cryptocurrency tax obligations is an essential aspect of responsible investing in the UK. While the tax rules can be complex, particularly with the rapid evolution of cryptocurrency technology and use cases, maintaining good records and seeking professional advice when needed can help ensure you meet your obligations while optimising your tax position.

Remember that tax evasion (deliberately concealing income or gains) is illegal and can result in severe penalties. HMRC has significantly increased its focus on cryptocurrency transactions in recent years, including obtaining data from exchanges to identify non-compliance.

At EnerVscler, our Advanced Trading Techniques and Portfolio Management courses include specific modules on tax-efficient cryptocurrency investment strategies, helping our students navigate this complex area confidently.