In its policy paper on crypto taxes, the HMRC (Her Majesty's Revenue and Customs) has laid out guidelines for how cryptocurrencies or rather 'exchange tokens' (crypto that is intended to be used as a method of payment) are taxed. In this guide we will break down the legal jargon in simple terms with practical examples and use-cases.
Individuals that hold crypto as a personal investment will be liable to pay capital gains tax when they dispose of their cryptocurrency. 'Disposal' has been defined by the HMRC as:
- selling crypto assets for money
- exchanging crypto assets for a different type of crypto asset
- using crypto assets to pay for goods or services
- giving away crypto assets to another person
Naturally, the amount of capital gains will be the difference between the sales proceeds from the disposal and the acquisition cost of the crypto asset i.e. sale price minus buying price. If you're a higher or additional rate taxpayer, your capital gains tax rate will be 20%. If, on the other hand, you're a basic rate tax payer, your tax rate will depend on your taxable income and the size of the gain.
There are also special rules for high frequency traders or businesses as we will see in the next section. If you are not a business you can skip ahead to the Calculating cost-basis section for an overview on how the actual capital gains are calculated.
Cryptocurrency trading as a business
If you are carrying on a business that involves cryptocurrency transactions, then the rules are more complex. You may be liable to pay a number of different taxes like CGT, Income Tax, Corporation Tax, Stamp Duties and even VAT depending on the type of transaction.
Note that the HMRC may decide to treat you as a business even if you are an individual if your level of activity is comparable to a business. So how does the HMRC decide whether you're holding crypto as an investment or whether you qualify as a crypto trader? Here's what the HMRC has to say about it:
Only in exceptional circumstances would HMRC expect individuals to buy and sell crypto assets with such frequency, level of organisation and sophistication that the activity amounts to a financial trade in itself. If it is considered to be trading then Income Tax will take priority over Capital Gains Tax and will apply to profits (or losses) as it would be considered as a business
In this case, a trade in crypto assets would be similar to trading in shares, securities, etc. This means that crypto traders can refer to the Business Income manual (BIM56800) for more information on the relevant approach.
Calculating your capital gains / cost-basis
Since the HMRC considers crypto assets to be intangible, a special pooling method is used to calculate the cost of an asset when it's disposed. With the pooling method, you basically end up averaging out the acquisition cost of all the crypto you've purchased to calculate the cost basis.
Natalie bought 1 BTC for £1,000. 6 months later she bought 0.5 BTC for £2,000. So her total pool of bitcoin is 1.5 and total allowable costs are £3,000.
Let's say Natalie sells 0.5 BTC some years later for £3000. This is what her capital gains calculation would look like:
|Less allowable costs||£3,000 x (0.5 / 1.5)||£1000|
Post this sale, Natalie will have a remaining pool of 1 BTC with an allowable cost of £2000.
Be mindful of the bed-and-breakfasting clause
The rules of Same-Day and 30-Day that apply to shares also apply to cryptocurrency. This is done to prevent wash sales i.e. selling crypto and buying it back in an attempt to realize losses and reduce your tax burden.
Let's understand the same day rule first. If you sell a cryptocurrency and buy another crypto of the same type on the same day, the cost basis for your sale will be the acquisition cost of the crypto you bought on the same day. This will be the case even if the acquisition of the crypto takes place before the sale - as long as they are both on the same day.
The 30-day rule is also quite similar. Any of the crypto you acquire within 30 days of a sale will be used as its cost basis.
These rules are in place to make sure that you don't sell your holdings at the end of the tax year to create losses that you can write off, and then buy them back immediately after.
Simon owns 2.5 ETH. He has spent £2000 acquiring this crypto, which is his pooled allowable cost. Let's say Simon sells 1 ETH on 29th August 2018 for £3000, and buys 0.25 ETH on 12th September 2018 for £700. Since this 0.25 ETH has been bought within 30 days of the disposal, it doesn't go into the pool. Here's how Simon's capital gains will be calculated:
Step 1: Calculating gains on the 0.25 ETH
|Consideration||£3000 x (0.25 / 1)||£750|
|Less allowable costs||£700|
Step 2: Calculating gains on the other 0.75 ETH
|Consideration||£3000 x (0.75 / 1)||£2250|
|Less allowable costs||£2000 x (0.75 / 2.5)||£600|
After this transaction, Simon still has a pool of 1.75ETH which has allowable costs of £1400 remaining.
Tax on Buying / Selling / Trading cryptocurrency
Buying cryptocurrency (eg. GBP → BTC)
There are no taxes on buying crypto in the UK, or even hodling it for as long as you want. You should still keep records of these transactions so that you can deduct the costs when you eventually sell them.
Selling cryptocurrency (eg. BTC → GBP)
Any sale of cryptocurrency is subject to Capital Gains Tax. Every different cryptocurrency is seen as separate CGT (Capital Gains Tax) asset.
John sells 1BTC in November 2017 for £12000. His cost for 1 BTC was £9000. In this case, his total capital gain would be £3000. This would be taxed at the appropriate rate depending on his tax bracket.
Trading one cryptocurrency for another (eg. BTC → ETH)
The HMRC makes it quite clear that exchanging one crypto for another also constitutes a taxable event. This means that you're basically disposing of a CGT asset and acquiring another one. The market value of the crypto that you receive is considered as the sales price for that transaction. If this crypto cannot be valued for some reason (eg. ICO tokens), then you can use the market value of the crypto you sold.
Let's say your costs for 0.1 Bitcoins was £500. In November 2017, you exchanged 0.1 Bitcoin for 2 Ether. At this time, the market value of 2 ether was around £800. This basically means that £800 is your sales proceeds and £500 is your cost basis, so the total capital gains would be £300.
Cryptocurrency to Stablecoins (ex. BTC → TUSD or TUSD → BTC)
A stablecoin is simply a class of cryptocurrencies that offers price stability by being backed by a reserve asset, usually a stable fiat currency like USD. As far as the HMRC is concerned, stablecoins like TrueUSD are exactly the same as any other cryptocurrency, and so the tax treatment is the same as for regular crypto to crypto trades.
Paying for goods or services with cryptocurrency
From a tax perspective this is the same as selling crypto and is subject to CGT. It's important to remember that the market value of the crypto that you use to pay for something will be counted as the sales proceeds.
Moving crypto between your own wallets/accounts
While there's no tax on moving crypto between different wallets, it's important to note that you need to keep a track of these movements. If you don't take these movements into account the HMRC might assume they are disposals and tax them.
Let's say Mitch buys 4 LTC for £400 on Coinbase. He then moves the funds into his LTC wallet and from there he moves the funds to his Binance wallet and sells them for £500.
If Mitch uses a crypto tax software like Koinly to generate his crypto tax report, he will have to connect all 3 wallets. If he only syncs his Coinbase and Binance wallet but not his LTC wallet, then the software won't be able to identify that the funds transferred to the Binance wallet are the same ones purchased on Coinbase. If all 3 wallets are synced, then the software will be able to generate an accurate tax report.
If for some reason, a particular wallet is no longer available, Mitch can make these changes manually using the Koinly web interface. He will mark the transfer from Coinbase as "ignored" so that Koinly doesn't realize gains on it. Then he would have to change the value of the incoming transaction on Binance to match the cost-basis of the outgoing transaction from Coinbase.
Tax on Income from Mining / Staking
Mining or staking of cryptocurrency can either be considered as a hobby or as a full-fledged business. This will depend on several factors such as:
- degree of activity
Mining as a hobby
If your mining activity is classified as a hobby, then any income from mining has to be declared separately under the heading of "Miscellaneous Income" on your tax return.
The income in this case will be the fair market value of the crypto at the time you receive it. Appropriate expenses can be deducted from this income before adding it to the taxable income. Also keep in mind that when you dispose of this crypto, that will be subject to capital gains tax. Rewards received in exchange for staking activity will also be considered miscellaneous income and be subject to taxes. You will also have to pay National Insurance Contribution for this transaction.
Mining as a business
If mining is classified as a business based on the criteria mentioned above, then the mining income will be added to trading profits and be subject to income tax. Similarly, fees or rewards received in exchange of any mining/staking activity will also be added to taxable income. Appropriate expenses would be deductible, of course.
While disposing of such cryptocurrency, any gain in value from the time of acquisition will be added to the trading profits. You will also have to pay National Insurance Contribution for this transaction.
Tax on Hard Forks
A hard fork refers to a situation when a particular cryptocurrency splits into two, and crypto holders receive crypto from the new fork due to their holdings in the original crypto. In this case, the value of the new crypto is derived from the original crypto that's already held by the individual.
Crypto received from a hard fork, is therefore, not subject to income tax.
However, after the fork, the crypto assets have to go into their own pool. The deductible costs related to the original crypto assets will be split between the two different pools — one for the original asset and one for the newly forked crypto. The HMRC doesn't have any particular guideline for this apportionment. This splitting of costs should be just and reasonable under section 52(4) Taxation of Capital Gains Act 1992. Standard practice is that the cost of the original crypto is apportioned between the old and new crypto assets in line with the market values of both assets on the day after the hard fork.
Tax on Airdrops
An airdrop is a situation when a particular individual is selected to receive crypto, perhaps as part of a marketing or publicity campaign. Income tax will not apply to airdropped crypto provided:
- They're received without doing anything in exchange
- They aren't received as part of a trade or business involving crypto
If airdrops are provided in return for a service, they will be part of either miscellaneous income or trading profits (if you are a business). In either case, they will be subject to income tax.
If this airdrop is received by an individual, it will be subject to capital gains tax at the time of disposal. If it has been received by a crypto business or trader, any increase in valuation will be added to trading profits and be subjected to income tax and you will have to pay National Insurance Contribution on this as well.
Tax on cryptocurrency Margin Trading
There is little clarity from the HMRC when it comes to individuals who trade and invest in Futures, CFDs (Contract for Difference) and margin trading as far as cryptocurrency is concerned.
If an individual is treated as a financial trader, then the gains are added to trading profits and income tax is payable. However, when the individual is not a financial trader, it's not very clear whether gains or losses are to be taxed under capital gains tax or added to miscellaneous income and subjected to income tax. The safe approach is to treat any gains as capital gains.
Tax on ICOs / IEOs
ICOs (Initial Coin Offerings) or IEOs (Initial Exchange Offerings) refer to a situation where investors can purchase tokens/coins in a yet-to-be-released cryptocurrency/company. In this case, investors pay for the new token through existing cryptocurrency like Bitcoin or Ethereum.
In other words, this works like a crypto-to-crypto exchange. You will have to pay capital gains tax on the crypto that you exchange for the ICO token. The "sales proceeds" here will be the market value of the existing crypto (not the new token) on the date that the exchange took place. Plus, this same market value will also serve as the cost basis for the new token that you receive from the ICO, which you can use to calculate pooled costs.
How cryptocurrency gifts are taxed
If you give cryptocurrency as a gift to someone other than your spouse or civil partner, you will have to figure out the market value (in pound sterling) of the crypto on the date that it was given away as a gift. This will be considered as sales proceeds for Capital Gains Tax purposes.
Importantly, if income tax has already been charged on the value of the tokens that are gifted, section 37 Taxation of the Capital Gains Tax Act 1992 will apply. This basically means that the
"sales proceeds" will be reduced by the amount that has already been subject to income tax, and then be subjected to CGT.
Janie is a UK resident who received crypto worth £500 as a gift from her mother. She sold it in May 2018 for £700. The pooled value of her crypto was £500 and her capital gain was £200. Janie's taxable income is £160000 and she falls in the category of additional rate tax payer. As a result her total CGT on the disposal of the crypto would be 20% of £200 or £40.
Tax on Crypto Donations
If an individual donates crypto to charity, they are entitled to Income tax relief on the donated amount. They can also get an exemption from Capital Gains Tax although there are two exceptions:
- In case the individual sells the crypto assets to the charity at a cost which is more than the acquisition cost, they will have to pay CGT on the difference between the selling price (instead of market price) and the acquisition cost.
- In case they make a tainted donation — this refers to a situation where an individual makes arrangements with a charity to get some form of kickback/financial advantage.
Tax on Income Received in the Form of Crypto
Any crypto received as employment income is considered money's worth. If you receive all or part of your salary/freelance income in cryptocurrency instead of fiat currency, you will have to pay income tax and National Insurance contributions based on the value of the crypto on the date of receipt.
The precise rules are different depending on whether the crypto assets you receive are Readily Convertible Assets (RCAs) or not. Any disposal of such crypto assets (that are received as employment income) is subject to Capital Gains Tax.
Greg is a freelance web developer who received a payment from a client in the form of 0.1 BTC in July 2017. The value of the 0.1 BTC was £500 on the date that it was credited to his bank account. This means he needs to add £500 to his taxable income while calculating his tax liability for the year.
Pension contributions with Bitcoin
The HMRC doesn't look at crypto assets as money so they cannot be used to make a tax deductible contributions to any registered pension scheme.
How to Minimize Your Tax Burden
Offsetting Crypto Losses
If an individual sells cryptocurrency for less than the cost basis, then they will have a capital loss. This loss can be offset against the overall gains.
However, the loss needs to be reported to the HMRC first. Losses can be reported either by letter or on the Tax Return itself. Capital losses can be claimed within 4 years from the end of the tax year in which they occured.
Also, if the disposal of the crypto is made to a "connected person", then the actual sales price is not considered as the sales proceeds, the market value of the crypto on the date of the transaction is.
Claiming losses for defunct coins / shitcoins
With crypto assets that can fluctuate wildly, it's not rare for someone to own cryptocurrency that has become worthless or of 'negligible value'. In this case, the owner of the asset can file a negligible value claim.
This claim treats the crypto assets as if they have been disposed of and re-acquired at the amount stated in the claim. This allows you to write off a major loss for an asset that is now illiquid.
The claim only needs to contain the name of the asset which is worthless now, the amount at which the asset should be treated as disposed of (usually £0) as well as the date of the deemed disposal. This claim results in a loss that can be offset against gains once it's reported to the HMRC. The loss and negligible value claim can be made to the HMRC at the same time.
Leveraging Deductible Costs
There are certain allowable costs that can be deducted from the sales proceeds when calculating the gain or loss. Here they are:
- The consideration (in pound sterling) that was originally paid to acquire the crypto asset
- The transaction fees that's paid before the transaction is added to a blockchain
- Any exchange fees related to trades
- Professional costs for drawing up the contract for both acquisition and disposal of the asset
- Costs related to advertising for a purchaser or vendor
- Costs of making an apportionment or valuation in order to calculate the gains or losses
The following costs are not allowable for CGT purposes:
- Any costs that have already been deducted against profits for Income tax
- Costs of mining activities (such as electricity and equipment). That's because in case of individuals mining crypto as a hobby these costs are not wholly attributable to mining crypto. However, some of these costs can be deducted against profits for Income Tax or when the mining equipment is disposed of.
In case mining is being done as part of a business, the crypto assets will form part of trading stock. If they are transferred out of trading stock, the business will be treated as if they bought the crypto at the value that's being used in the trading accounts. This value can then be used as an allowable cost when they decide to dispose of the crypto assets.
Dealing With Loss and Fraud
Losing a private key
If a crypto owner misplaces their private key, the crypto assets are still owned by them and exist in the distributed ledger. That's why the HMRC does not treat this as a disposal from a CGT perspective.
However, in case there is no way of recovering the private key and accessing the crypto assets, the individual can make a negligible value claim so that they can crystallize the loss.
Being a victim of fraud
If your cryptocurrency is stolen/hacked, the HMRC does not consider this a disposal. That's because the individual still owns the assets and has a right to recover them. As a result, no loss can be claimed. However, in case someone pays for crypto assets but doesn't end up receiving any, they can claim a capital loss.
Similarly, an individual who pays for and receives crypto assets that turn out to be worthless, can file a negligible value claim to the HMRC and offset losses.
Filing your crypto tax reports
Here are all the steps you need to undertake to file your crypto taxes correctly:
- Download all the transactions from different exchange accounts and wallets, not just for the assessment year but previous years as well.
- You may have transfers that have been marked as Withdrawal in one account and Deposit in another. Match these transfers so the HMRC doesn't think they are disposals.
- Exchanging one type of crypto for another is also a taxable event. Make sure you assign market rates to all the crypto trades to generate the cost basis accurately.
- Calculate capital gains using the pooling method for the year for which you will be filing the return.
- File your crypto taxes online or complete the paper tax return as the case may be.
This whole process can be quite painstaking. A crypto tax solution like Koinly is one way out. It will allow you to connect your wallets/accounts and carry out steps 1 to 4 automatically, so that you can file your tax returns with ease.
Cryptocurrency filing deadlines
The tax year in the United Kingdom starts from 6th April and goes up to 5th April the next year. If, for instance, you're paying taxes for the year 2018-19, you would have to file your online tax returns by 31st January 2020. You would also be expected to pay your taxes in full by this date. If you're filing paper returns, then the deadline would be 31st October, 2019.
As far as record keeping is concerned, the HMRC correctly states that many exchanges do not keep detailed information about crypto transactions and the onus of maintaining these transactions accurately rests with the taxpayer. These details include:
- the type of crypto asset
- date of the transaction
- whether the crypto assets were bought or sold
- the number of units involved
- value of the transaction in pound sterling
- cumulative total of the investment units held
- bank statements and wallet addresses, as these might be needed for an enquiry or review
You should ensure you download reports regularly from your exchanges as they can lose your data or just delete it permanently after a certain period of data. Again, using tax software like Koinly can help you maintain such a ledger.
Amending tax reports for previous years
The HMRC has recently asked top crypto exchanges for details of UK-based crypto investors. It's time to get your house in order before the HMRC decides to investigate crypto tax avoiders. If you haven't been reporting your crypto income accurately, you should proactively file an amended tax return and make changes to your previous tax reports.
How can Koinly help?
Koinly is a crypto tax software that helps you generate accurate capital gains reports, allowing you to file correct crypto tax returns with ease. With Koinly all you have to do is:
- Connect all your wallets and exchange accounts (via API or CSV files)
- Review your imported data and tag airdrops/forks/mining-income/staking etc so they appear as Income
- Download a complete capital gains report that can be submitted to the HMRC.
It's really that simple. Find out more.