Latest Guidance on Taxation of Digital Assets

Blockchain technology has been with us for over a decade now and it is clear that the tax authorities all over the world were not expecting the exponential growth in take-up of these assets.

Governments have lurched from ignoring it, banning it, and embracing it, the current extremes being El-Salvador and China. The official position in the UK, currently is that the government have said they intend to embrace this technology and make the UK a world centre and welcoming place for this technology.

A recent survey found that in the UK there are 3.5m individuals and organisations holding crypto wallets, however, the government has currently no actual legislation on how gains and income from these assets should be taxed. Whilst there are no actual regulations in April 2022 HMRC issued 46 pages of guidance on how they believe these assets should be shoehorned into existing regulations.

So where do we stand now?

Location of the assets.

As digital assets exist only in the cloud (blockchain) this can be a moot point, however, HMRC has said they will treat the assets as being located for tax where the beneficial owner is a tax resident. For most taxpayers, in the UK this pragmatic approach is not a major issue unless you are not UK tax domiciled, in which case the assets can cause problems with Inheritance Tax planning and possibly give rise to remittances to the UK when assets purchased with funds from outside the UK.

Investing

Rather than treating crypto assets as foreign exchange HMRC consider, in most cases, that holding Crypto is an investing activity and has squeezed them into the same regulations as are used for shares and securities.

Therefore, gains are normally subject to capital gains tax, and you will also be able to offset your capital gains tax annual allowance currently £12,300. If you were to make a loss on your investment this can also be offset or carried forward against other capital gains but can’t be offset against your income to reduce your income tax.

Bizarrely, HMRC considers that if a digital asset is swapped for another (i.e. Ethereum purchased with Bitcoin) or staked, this is a deemed sale for Capital gains tax and given that even a small investor can have a surprising number of transactions in a year this can give rise to numerous small gains that can eat into your annual allowance. 

The calculation of these gains can also be time-consuming and fiddley particularly when it comes to the pooling of more than one purchase of the same coin and the application of bed and breakfasting rules (this is where some purchase and sales of assets must be matched and not pooled).

Software is now just beginning to be released that claim to connect directly with crypto exchanges and do the number-crunching, however, their effectiveness and accuracy have yet to demonstrate.

The guidance suggests that staking (lending) crypto, despite being somewhat illogical, does give rise to an opportunity. If when you purchase a new digital asset you were to immediately stake it (giving rise to a deemed disposal at the same value as it was purchased) it will not result in any capital gain. When you are ready to sell the asset if you un-stake it just before selling (giving you a notional purchase at the same value as the sale) there would again be no capital gain on the sale. This would result in no capital gains tax is payable, the downside is there would be no loss to offset against other gains if you sold at a loss.

Unfortunately, this will only work for newly purchased coins.

The guidance would also imply that if there is a run on a coin (such as this week’s collapse of the TLUNA coin) you would be able to make a negligible value claim to crystallise a capital loss that can be offset against gains in the same year or carried forward.

Staking

I have already mentioned the capital gains treatment of assets that have been staked (loaned), the other point to remember is that the return on staking would be treated as interest for income tax.

Trading

If you trade either on the spot market or in futures (often with leverage), with a view to making a profit the taxman will consider you to be a trader and you will have to report this as income on your tax return. You will be able to deduct any expenses, i.e., exchange fees, GAS fees, and may also be able to claim some capital allowances on your equipment etc. Any losses from the trade can also be offset against other income, subject to the normal rules.

Mining

Mining digital assets will always be a trade, however, if you then hold the rewards paid in the crypto you will need to also apply the capital rules for investing.

As this is all based on guidance from HMRC and no legislation is proposed or has been passed this is currently ‘best practice’. When legislation is finally passed by the government things may or may not change.