Cryptoassets: widespread misunderstanding on tax treatment must be addressed – Dion Seymour
Crypto & Digital Assets Technical Director, Dion Seymour, discusses the evolution of UK crypto regulation in recent years, along with the need for broader understanding among cryptoasset owners of the tax implications of these assets, in Thomson Reuters Regulatory Intelligence.
Dion’s article was published in Thomson Reuters Regulatory Intelligence, 10 August 2023.
Cryptoassets have been in existence for more than a decade, and the developments have been both evolutionary and revolutionary, giving rise to many questions about how they should be regulated. Regulators have also moved at a fast pace, as has been seen with the recent launch of the EU Markets in Crypto-Assets Regulation (MiCA), which attracted considerable media attention.
Developments in relation to the taxation treatment of such assets are equally important, but tend to be less headline-grabbing, although there has recently been one notable exception.
The UK House of Commons Treasury Committee report on cryptoassets was published in May and attracted considerable media attention. One of its main recommendations is that buying cryptoassets should be treated as gambling. Few of the witnesses who provided evidence were tax experts, which is understandable as this is a complex specialist subject.
Unfortunately, this meant that the recommendation was made with seemingly little consideration as to what the position is on tax or how it could work.
The committee is not alone, however, in failing fully to understand the tax treatment of cryptoassets. This article looks at the basics of taxation in relation to cryptoassets and highlights some of the main pitfalls.
HM Revenue & Customs (HMRC) first released tax guidance in 2014, but it was not updated until 2018 and 2019 with a much more detailed position. In 2021, HMRC released a manual entitled “CRYPTO”, indicating that it was expecting guidance to be updated more regularly. HMRC’s crypto guidance is one of the most detailed published by any tax administration and gives a good overview of some of the tax issues. It is one of the very few tax administrations that has covered the taxation of decentralised finance (DeFi). Some areas of the manual, however, need to be updated, for example, on topics such as non-fungible tokens (NFTs).
Last year, HMRC published a report on a survey which explored individuals’ level of understanding of the taxation of cryptoassets. Worryingly, the results showed that only 28% of individuals who either currently own or had owned cryptoassets had read the HMRC guidance.
The report also showed that most of the respondents were unable to correctly identify when a tax liability could arise: for example, only half of the survey respondents who owned cryptoassets knew that when they sold their cryptoassets for fiat currency (such as pounds Sterling or the U.S. dollar) this could give rise to a tax liability. The report will undoubtedly have been quite a troubling reading for HMRC.
There is therefore a clear need for a better understanding of how cryptoassets are taxed, and it may be best to start with the basics.
How are cryptoassets taxed?
First, there is no such thing as a “crypto tax” with specific legislation that relates to cryptoassets. Unlike the situation with regulations, however, the absence of explicit tax laws for cryptoassets does not mean that they are not taxable. It should also be noted that there is generally little interaction between regulation and taxation, as tax follows laws that are collectively known as the “taxes act” which include income tax, capital gains tax, and corporation tax. It is therefore necessary to go back to “first principles” and treat cryptoassets as any other form of property.
As with other assets, how they are used is more important than what they are. For example:
- if they are used for an investment purpose, as is most common, then any gains are taxed by capital gains tax or corporation tax of a company;
- where they are provided as remuneration, for example, from employment, any cryptoassets received by the individual are generally charged an income tax and National Insurance contributions;
- if they are used as part of a trade, any profit arising can be charged an income tax (for businesses) or a corporation tax (for corporates).
This may sound simple, but UK legislation is complex and the uniqueness of cryptoassets can still create uncertainty. Certainly, as revealed by the HMRC survey, most cryptoasset owners are themselves unsure whether their activities are taxable.
When does a cryptoasset transaction become taxable?
It should now be clear that cryptoassets can be as taxable as anything else, but many cryptoasset owners also appear quite uncertain when those assets become taxable. For example:
- The sale of cryptoassets for fiat currency is taxable. As noted above, only half of those interviewed for the HMRC survey who own, or had owned, cryptoassets knew this.
- Cryptoasset-to-cryptoasset transactions are taxable. For some, it may seem that cryptoassets are not real or like tangible assets such as a house, so it is hard to understand how the sale of one cryptoasset, say Bitcoin, for another one, say Ether, can be taxable. Cryptoasset-to-cryptoasset transactions are very common with cryptoasset owners, but even though cryptoassets are not tangible, they are still considered to be an asset for tax purposes. This means that a Bitcoin to Ether sale is taxable. Only 28% of respondents (for those that owned cryptoassets) in the HMRC survey knew this.
These misconceptions perhaps come from the belief that cryptoassets are money, and money is not taxable. This is incorrect, however, as cryptoassets are not considered to be the same as the pound in one’s pocket (or in the bank), meaning that when they are used — for example, to pay for something — that can create a tax liability.
A special comment needs to be made about gambling. When HMRC released its first guidance in 2014, certain comments within it led some to believe that buying and selling cryptoassets was gambling. This was incorrect, and the guidance in 2018 made the point that buying cryptoassets is not the same as gambling for tax purposes. The Treasury Committee’s recent comments that it considers the purchase of cryptoassets to be like gambling, however, may have led some to believe that any gains are now tax-free. This revisiting of old topics may well prove unhelpful for HMRC.
What to look out for
Where there is non-compliance, this tends not to relate to just one aspect of a transaction — for example, tax — but can often be an indicator of the person’s overall approach and attitude to fulfilling their obligations. Failure to fulfil tax obligations can occur for several reasons, however, ranging from a failure to take care all the way to deliberate fraud.
Owning cryptoassets per se is not a problem, but the lack of a clear understanding of the taxation of cryptoassets means that not everyone will understand the tax consequences. Even though HMRC did not conduct a survey for businesses, it would be reasonable to expect that this risk exists for both individuals and businesses alike.
The question then becomes how to separate involuntary non-compliance from tax evasion. That can only be established by understanding the intent of the actor. Most cryptoasset owners appear not to have read HMRC guidance, but the survey found that the overwhelming majority of those who had done so confirmed that it had helped them understand their obligations.
In terms of de-risking, it seems that asking those with cryptoassets if they had read HMRC guidance may be a green flag if they confirm that they have.
HMRC’s survey results indicate that more education is needed, and as has been highlighted in this article, the taxation of cryptoassets is often overlooked. Future articles will look at more complex topics such as NFTs and Web3, also known as the Metaverse.