If you are one of the lucky few individuals to have bought Bitcoin or another digital asset six months ago, 12 months ago or (and, if so, congratulations) 5 or more years ago, you are, in all likelihood, sitting on some very large paper profits when the value of your holdings are calculated in fiat currency terms. The next question is, are you tempted to sell – to convert some of those “paper profits” back into fiat? Have you already done so? If so, once again, congratulations. Enjoy those profits, but just don’t forget one very important person – the taxman.
The general principle in many jurisdictions, such as the United States and the UK, is that investment profits (net of purchase and sale costs) are taxed as capital gains. Current tax rates vary, from 20% in the US for top rate income tax payers (although the rates for short term gains, where the asset has been held for less than one year, are higher) and a flat rate of 20% in the UK for higher rate tax payers (with an annual exemption of £11,300, which means that no tax is paid on the first £11,300 of gain).
For UK investors, capital gains generated between 6 April 2016 and 5 April 2017 must be declared, and any tax paid, by 31 January 2018, or penalties become due.
However, Bitcoin and other digital assets do not sit easily within the existing framework of many tax systems when it comes to determining (a) whether there has been a taxable gain at all and (b) if so, how should the gain be assessed to tax?
Is capital gains tax payable on cryptocurrency gains?
HM Revenue and Customs, the UK tax authority, were one of the first to make it clear that they regarded cryptocurrency gains by UK taxpayers as prima facie taxable. In their 2014 policy paper, “Revenue and Customs Brief 9 (2014): Bitcoin and other cryptocurrencies,” HMRC set out their position on the taxation of cryptocurrency profits as follows:
- Whether any profit or gain is chargeable or any loss is allowable will be looked at on a case-by-case basis taking into account the specific facts and applying existing legislation and case law.
- Some gains may fall outside the capital gains tax regime if they can be regarded as “gambling” – gambling winnings are exempt from UK capital gains tax.
- Gains arising from more frequent trading in cryptocurrencies may be regarded as trading income rather than capital gains, and be subject to income tax (and materially higher rates of tax) as a result.
- The basic principle is that cryptocurrency gains are taxed in the same way as foreign exchange transactions. To give an example:
- A pound sterling investor purchases some foreign currency.
- The foreign currency is converted back into pounds sterling at a later date.
- The transaction results in a gain when expressed in pounds sterling (i.e. the investor ends up with more pounds sterling than they started with).
- The foreign currency is treated by HMRC, for UK capital gains tax purposes, as a “chargeable asset”, so that its disposal back into pounds sterling creates a taxable capital gain.
Taxation authorities in other jurisdictions appear to be taking a similar view, with the governments in both the United States and India taking an increasingly aggressive stance in their disclosure demands against both individual cryptocurrency investors and, in the case of the IRS, cryptocurrency exchanges. Coinbase has also recently warned its US customers of the need to declare cryptocurrency gains. In each case, investors should be on notice that governments are looking for their share of any gains from their taxpayers.
Is Bitcoin investing “gambling”?
The possibility of some cryptocurrency gains being regarded as the result of gambling and, as a result, exempt from UK capital gains tax, has attracted some newspaper coverage in recent days, with the prospect of depriving the UK tax authorities of millions in lost revenue. HMRC’s response to this has been non-committal, but other commentators have cast doubt on the applicability of this exemption for cryptocurrency investing.
There is no doubt that investing in Bitcoin and other altcoins is, in HMRC’s own words, “highly speculative”. However, is it any more speculative than an investment in, for example, an early stage venture capital investment or start up, where in each case investment profits would be taxable?
HMRC’s guidance on this point dates back to 2014, a lifetime in the crypto space, and is clearly in need of an update. We believe that it is unlikely, should this issue be looked at again, that HMRC would regard cryptocurrency investing as gambling and, as a result, exempt from tax. At the very least, it would need a very unusual set of facts for an investor to successfully take advantage of this exemption.
Any cryptocurrency investor seeking to use the gambling exemption in the UK should take tax advice before deciding not to declare their gains on this basis.
Gains on “crypto to crypto”?
The focus of taxation authorities to date has been on investors realising their gains back into fiat currency. This approach is fine for investors buying one type of cryptocurrency with fiat and subsequently converting back into fiat – it is the fiat gain that is taxable.
However, with the evolution of other coins, particularly in the ICO space, what happens where investors start to convert one type of crypto into another, and back again? Many coins traded on exchanges do not actually have a crypto/fiat pair – if you want to trade them, you need to do so with a mainstream cryptocurrency like BTC or ETH. Many investors are selling in and out of altcoins and generating gains denominated, not in fiat, but in BTC or ETH. What should be the approach of tax authorities to these “gains”? This does not appear to be an issue to which authorities have given any thought. This may change if, over time, Bitcoin (or some other cryptocurrency) gains widespread acceptance as a means of exchange, giving cryptocurrency investors some real world purchasing power with crypto rather than fiat.
Do not be surprised if, at some point in the future, governments seek to apply current rules on fiat gains to crypto. This would mean an investor in a successful ICO trading out with 10x his original ETH investment having to declare this “gain” and paying a share to the taxman.
We’re not at this point yet, but given the speed of evolution of the crypto industry, it may come sooner than investors think.
BitcoinBro does not give tax advice and, as such, this article should not be construed as tax advice for any jurisdiction. Investors should always seek specialist tax advice when considering their personal tax position.