Cryptoassets - what are they and what are the tax implications?

Many ordinary people and businesses, and by that we mean people who don’t usually engage in financial trading, have tried their hand at investing in crypto currencies. Some have fared well, but many over the past year have suffered significant losses, due to recent crashes in this space. As with any traded asset one may make a financial gain or a loss, but the question arises as to how one reports such gains or losses to HMRC. This is especially poignant if as an individual you’re not usually reporting via an SA100, as maybe the case with employees on PAYE, or perhaps exploring their use in your business.

This article explores the world of cryptocurrencies (and NFTs) and explains how HMRC treats them, how to report them to HMRC and what taxes you’ll be expected to pay.

Cryptocurrencies in the news

Over the past few years cryptocurrencies have made the headlines, sometimes because of meteoric price rises and at other times catastrophic crashes. Some have been caught out in what appeared as the new ‘gold rush’ – investing heavily and initially seeing significant gains, but then very quickly watching the currency crash, wiping out almost everything. In short, if you invest in cryptocurrencies you need a strong stomach as you’re in for a wild ride.

That doesn’t deter everyone though, to the point where significant numbers of people not accustomed to financial trading have put their toe in the crypto ocean – and it’s a very large ocean indeed. By March 2022 there were over 18,000 different cryptocurrencies in existence.

What is a cryptocurrency?

The definition given by Wikipedia is this: “A cryptocurrency, crypto-currency, crypto, or coin is a digital currency designed to work as a medium of exchange through a computer network that is not reliant on any central authority, such as a government or bank, to uphold or maintain it.”

But why is there such an interest in cryptocurrencies? Here is a summary of the main reasons:

1. It is not a ‘fiat’ currency. This means that it is not a currency controlled by a government – i.e. legal tender, like the Dollar, Pound or Euro. This of course means that because it isn’t backed by a government institution like the Bank of England, its value can vary wildly, as indeed it has recently, just like stock prices. This is why it is considered a more risky form of investment, and some would say a form of gambling. So, in short – it’s owned by everyone and no one: it is decentralised. HMRC refers to cryptocurrency as “DeFi” – Decentralised Finance.
2. It is almost impossible to manipulate or forge. Unlike centralised ‘fiat’ currencies, which can be forged and manipulated because of a ‘centralised ledger’, crypo’s decentralised basis means there is no central ledger, as it is ‘distributed’, in fact, it’s part of each transaction.
3. The power of the Blockchain. It’s worth spending a little time understanding the blockchain if you’re considering investing in crypto currencies. A good summary can be found here.

 In short though, the blockchain is a powerful piece of mathematics that encrypts and keeps track of each transaction. Every transaction has a unique code called a ‘hash’ and forms a ‘block’ of information. The block is added to the chain, which is the public database where all blocks are stored. Blocks are added to the chain chronologically and distributed worldwide among millions of computers.

This is why it is almost impossible to forge or manipulate, because someone would have to control a majority of those computers in order to change the blockchain. This would also take an enormous amount of computer resources. The bigger the block chain becomes over time, the harder it is to crack.
4. Privacy. While cryptocurrencies use mathematics to track transactions between parties, powerful encryption keeps personal information private, in this case the identities of the parties crypto ‘wallets’. This is one reason why cryptocurrencies have drawn bad press because it is the favoured currency of criminal gangs, money launderers and extortionists.
5. Reduced reliance on the banking network. We’ve all experienced at one time or another, the problems traditional financial institutions have. This ranges from account access issues to network outages, hacked accounts and of course, bank failures, although thankfully less common. Basically, banks are a single point of failure in a system millions of people rely on daily. Cryptocurrencies were intended as a way to move away from this centralisation, making the transaction between two parties, just between the two parties – no middle men. This is another reason why governments and banks are concerned about the rise of crypto.
6. Money transfer. Sending money to somebody internationally can be a real pain. Even though it is an electronic exchange processed in milliseconds, the institutions still want to charge an ‘arm and a leg’ for the service. Once you understand the process, crypto transfers are very smooth, and you don’t have anyone looking over your shoulder at the amounts or where they came from – no freeze on funds while the bank checks authenticity or reports high value fund moments to the government.

This all makes cryptocurrencies look like fantastic monetary vehicles, and they are, but they’re not without downsides. The main ones are these:

1. It’s still early days and governments still have the ability to impose regulations over their use.
2. If you lose your virtual wallet or accidentally delete your currency, game over. For instance the story in the press about a man whose hard drive with £210 million worth of cryptocurrency ended up in the local landfill.
3. Volatility. The value of a crypto currency can change dramatically quickly.
4. There’s no regulation in the crypto market, e.g. the FCA and therefore no comeback if a currency disappears or is withdrawn. Your investments are like stocks, can go up or down and are not insured like money in the bank.
5. The crypto exchanges – the places where currencies are bought and sold, are not immune from hackers. Wallets stored online (hot wallets) can be lost. This is why many investors prefer ‘cold wallets’ – those stored offline – like the man in the press.
6. Crypto currencies are often the target of scams on social media, with fraudsters trying to trick people into investments using crypto – precisely because they can be traced.

What are NFT’s and are these the same as crypto currency?

We won’t go into detail here as NFT’s are another deep subject to explore, but here’s a quick answer to this question.

NFTs or ‘non-fungible’ tokens are digital assets. This asset represents a real-world object, such as an image, a video, a music file. The digital files that carry the ‘work of art’ are encoded using the very same technology as crypto currencies, but that’s where the similarity ends – they are not currencies. NFTs use crypto currencies to facilitate the sale and purchases of the assets.

NFT’s can be bought and sold just like any other form of investment asset and through exchanges just like crypto currency. Buying and selling NFT’s will however be treated the same way for tax purposes as cryptocurrency.

Should you invest in crypto currencies?

Firstly, Tax Agility is not an investment advisor and so no guidance should be inferred here, what follows is just for interest. 

The relative newness of crypto makes some nervous about significant investments. That said, some of those who dipped their toes in early in this market made absolute fortunes. There are still a lot of opportunities to potentially experience significant gains (and losses), sometimes in the 000’s of percent.

However, like any investment strategy, one should maintain a healthy spread of investments to help offset losses in any one asset. Crypto could be a part of a broader investment strategy, perhaps your more risky investments with potential for high upsides and losses. In short, make sure your eyes are wide open when considering this investment.

The other key point to make here and the original reason for this post, are the tax implications of cryptocurrencies. If there’s a sudden rise or fall in a crypto asset and you decide to exit, you’ll be liable for any gains made. Depending on the value of the crypto asset, this could seriously impact your personal tax circumstances. While this is also true of assets in the form of stocks and shares, the extreme volatility experienced in crypto markets is less frequent in regular investments and so allows for at least some planning or recovery time, and generally allows you to plan a more regimented exit with tax planning considerations. Dumping a large crypto asset in panic, simply because there’s little history in this market, is potentially a different proposition for some.

How are cryptocurrencies and crypto based assets taxed in the UK?

The government’s Cryptoassets Manual provides very clear guidance as to how taxes will apply depending on the circumstances and whether it’s a business or individuals involved.

At the core of this is whether or not a ‘trade’ is being carried on. Profits arising from cryptocurrency asset transactions will be considered as either income or capital gains or for a business, a chargeable gain.

HMRC’s Cryptoassets manual can be found here.

Whether you’re an individual selling crypto assets or a business trading in business assets, Tax Agility can help

The tax regimes around cryptoassets are still in relative infancy. HMRC, as indeed are many tax authorities around the world, is continually reviewing the development of this new area of finance. If and when HMRC begins to treat cryptocurrency like other fiat currencies is anyone’s guess.

For many, how investments like crypto are taxed can be a little confusing, but rest assured that if you have made investments in crypto, either as an individual or a business, and have received profits or losses from trading them, Tax Agility can help you in reporting them in the correct manner. Just give us a call today on 020 8108 0090 to discuss how we may assist.