Cryptocurrency & Tax: A Complicated and Evolving Relationship

By Arianne King, managing partner at London based commercial law firm, Al Bawardi Critchlow.

 

Bitcoin’s value may have slipped since its December 2017 peak, but it is still piquing the interest of the investment community. Many commentators believe that 2018 will be the year when cryptocurrencies finally establish themselves as mainstream investment opportunities. That said, the legal and regulatory status of cryptocurrency is still being established and varies greatly between jurisdictions. This includes the way they are taxed.

 

Tax in the UK

 

It is likely that the UK Government will soon introduce stricter regulations around the use of cryptocurrencies. Its primary aim is to prevent money laundering, tax evasion and other illegal activities. How far these laws will stretch is still unknown; they may or may not impact the way investments are taxed.  However, as a starting point, here is an overview of the Treasury’s current regime.

 

HMRC bases its decision on whether tax is paid on crypto gains on the personal circumstances of the individual involved. If the individual is trading merely as a hobby, any profit falls outside the tax regime so are currently exempt.

 

This also means that any losses are ineligible for tax relief

 

If the use and value of digital currency continues to rise, HMRC could be tempted to take a slice of the pie. However, its current stance is consistent with the way it treats other speculative activities, including FOREX and gambling.  It recognises this is a hugely volatile market, if tax was levied on profits and then the value of coins plummeted, personal investors would be hit with a tax bill on gains they no longer have.

 

UK tax regime for professional investors

 

If HMRC considers that the investor (whether an individual or corporation) has a professional interest then taxes would be payable and the general rules on foreign exchange apply. The profits and losses of a company entering into transactions involving Bitcoin would be reflected in accounts and taxable under normal Corporation Tax rules. This could apply to those trading, mining or processing payments, as well as those providing related services.

 

The difference between a hobbyist and a professional investor isn’t clearly defined; the onus is on the investor to prove their status. If they are deemed to be a professional trader, then income, corporation and capital gains taxes would all apply, just as they would on normal currency transactions.

 

Unless visible in the company’s books following sale of cryptocurrency for fiat currency, with no visibility into cryptocurrency trades, HMRC is wholly dependent on businesses and professional investors disclosing any income generated. This is a similar situation to cash. Just as it is illegal not to disclose cash income, the same is true for digital currencies.

 

Elsewhere in the world: two examples

 

In the US, the IRS treats Bitcoin as property rather than a currency. Related income is subject to short-term income tax rates or long-term capital gains tax rates. Every tax payer is required to declare all cryptocurrency transactions in their annual tax returns, with the applicable tax applied to each deal.

 

In Germany, Bitcoin is classified in a similar way to stocks and shares. Capital gains tax is applied to profits made within the first year of ownership. After this point, they are no longer subjected to taxation and their transaction will fall within the scope of a non-taxable ‘private sale’.

 

These are just two examples; globally there are great variations in the way tax regulators treat these currencies.

 

What next?

 

To add to the complexity, the varying compliance and regulations laws around the world are constantly under review, reflecting the pace of change in the market, the growth in market participation, and each individual country’s appetite to incorporate cryptocurrency into their financial systems.

 

Expect to see considerable changes to tax regulations as the global cryptocurrency markets continue to mature and develop into the mainstream.