Tax and accounting for Cryptocurrency

Tax and accounting for cryptocurrencies is not as simple as it might first appear. Cryptocurrency is an intangible digital token that is recorded using a distributed ledger infrastructure, often referred to as a blockchain.

These tokens are owned by an entity that owns the key that lets it create a new entry in the ledger. Access to the ledger allows the re-assignment of the ownership of the token. These tokens are not stored on an entity’s IT system as the entity only stores the keys to the Blockchain (as opposed to the token itself). They represent specific amounts of digital resources which the entity has the right to control, and whose control can be reassigned to third parties.

HMRC does not treat cryptocurrencies like money. HMRC does not consider crypto assets to be money or currency. Instead, the tax office has grouped crypto assets into four main categories: exchange tokens, utility tokens, security tokens, and stablecoins.

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1. “Exchange tokens” – which include cryptocurrencies such as bitcoin – are those tokens which derive their value from exchange or investment uses. Bottom of Form
2. “Utility tokens” – known as gift tokens pave the way for crypto holders to buy services on a platform through distributed ledger technology.
3. “Security tokens” – which include non-fungible tokens (NFTs) – act as digital contracts for some type of valuable asset.
4. “Stablecoins” are crypto assets that are pegged to the value of fiat money or other assets (one example is Tether).

Anybody who resides in the UK and holds crypto assets will be taxed on any profits made on these assets.

Individuals resident in the UK are taxed on their gains from cryptocurrencies in much the same way as those making gains on stocks and shares. Every time an individual swaps one coin for another, or indeed any other asset when purchasing goods, they are triggering a disposal for UK capital gains tax purposes.

To be clear, your “paper” gains are not taxed. Capital gains tax (CGT) is only due when a disposal has been made – and assuming there are any actual profits to tax.

How capital gains tax affects crypto investors 

Your capital gain is simply the difference between what your cryptocurrency cost you, and how much you sold it for.

There is an annual CGT exemption, which currently stands at £12,300 for the 2021-2022 year. Gains up to this amount are not subject to CGT.

So what do you have to pay?

In broad terms, a UK resident making a capital gain made on the disposal of cryptocurrency is taxed at 10% up to the basic rate of tax (£37,700 to the degree the basic rate is not used) and 20% thereafter.

To calculate any tax due, you need to work out your profit, and then subtract the annual allowance. Then add any remaining profits to your taxable income for the year. If you are still below £37,500, then CGT will be charged at 10%. Above that, and it is charged at 20%.

Calculating CGT can be tricky, partly due to the “30-day rule”. Cryptocurrency holdings are not exempt from inheritance tax either. IHT liabilities can amount to 40% of an estate’s value.

While CGT is the main tax facing crypto investors, activities such as cryptocurrency “mining” and “staking” both can potentially be subject to income tax. Mining is the process by which mathematical calculations are solved and new cryptocurrencies enter into circulation, while staking involves locking in cryptocurrencies to reap the rewards.

“Airdrops”, however, which involve businesses distributing small amounts of a coin to crypto wallets free of charge, often as part of a marketing campaign, won’t necessarily result in an income tax liability unless something is done in return for receiving the coin.

The main thing to be mindful of is that your crypto portfolio is just like your shares portfolio – if you make a profit, it will be liable for tax, and unlike your shares portfolio, you’re not going to be able to hold your crypto in a tax-efficient ISA. But being aware of this from the start means you can plan ahead to minimise any bills.

Accounting for Cryptocurrency   

At first, it might appear that cryptocurrency should be accounted for as cash because it is a form of digital money. However, cryptocurrencies cannot be considered equivalent to cash (currency) because they cannot readily be exchanged for any good or service. Although an increasing number of entities are accepting digital currencies as payment, digital currencies are not yet widely accepted as a medium of exchange and do not represent legal tender. Entities may choose to accept digital currencies as a form of payment, but there is no requirement to do so.

Thus, cryptocurrencies cannot be classified as cash equivalents because they are subject to significant price volatility. However, it does not seem to meet the definition of a financial instrument either because it does not represent cash, an equity interest in an entity, or a contract establishing a right or obligation to deliver or receive cash or another financial instrument.

Cryptocurrency is not a debt security, nor an equity security (although a digital asset could be in the form of an equity security) because it does not represent an ownership interest in an entity. Therefore, it appears cryptocurrency should not be accounted for as a financial asset.

However, digital currencies do appear to meet the definition of an intangible asset in this standard definition of an intangible asset as; “an identifiable non-monetary asset without physical substance.”

It appears that cryptocurrency meets the definition of an intangible asset as it is capable of being separated from the holder and sold or transferred individually and, it does not give the holder a right to receive a fixed or determinable number of units of currency.

How we can help

Whether you are a business or individual, our qualified team of experts will help you understand the rules and regulations in tax and accounting for crypto currency to help you minimise and pay the right amount of tax to HMRC.

Speak to one of our representatives today.