Understanding your tax obligations in the crypto world

With Bitcoin’s value slipping and reports suggesting that Q1 of 2018 was the worst quarter in its history, it seems the recent wild run on the crypto-scene has come to an end. Yet, digital currencies continue to attract the interest of the governments, investors, commentators and fintech innovators alike.

The reason for this is two-fold. On one hand, the technology that underpins cryptocurrencies – blockchain – holds disruptive potential likened to that of the internet itself. With its transparent, permanent and immutable record keeping, the potential of the technology to secure transactions between multiple parties is hard to argue with.

On the other hand, regulators are increasingly ramping up efforts to establish the legal status of e-money as the technology matures. It is clear that traditional financial institutions and lawmakers plan to get more involved in addressing this and the current lack of regulatory oversight in the UK today.

Mark Carney, Governor of the Bank of England, and others have consistently called for the crypto asset ecosystem to be held to the same standards as the rest of the financial system – and there have been some signs of progress here. Earlier this month, for example, one of the world’s top cryptocurrency exchanges, Coinbase, was granted a licence to operate by the UK’s Financial Conduct Authority (FCA), confirming it had been assessed and met certain anti-money laundering and processing standards, deeming it suitable to acquire a regulated status in the UK.

That said, the way in which cryptocurrency is taxed is fast becoming a burning issue. This is especially the case for current and prospective investors.

Understanding your obligations

Worryingly, many investors may not even be aware that they owe tax on their cryptocurrencies today. As in nearly every other aspect of tax, different countries and jurisdictions will have varying guidelines for declaring tax and equally different approaches to tackling evasion. As such, depending on where you are domiciled for tax, you may be breaking the law – or about to.

In the US, tax authorities view the likes of Bitcoin, Ripple and other cryptocurrencies as a form of property, rather than a true currency, and so it may be subject to capital gains tax. Taxpayers are therefore required to declare all cryptocurrency transactions in their annual tax returns, with the applicable tax applied to each deal. Meanwhile, in Germany, Bitcoin is classified like stocks and shares – capital gains tax is applied to profits made within the first year of ownership. After this point, their transaction will fall within the scope of a non-taxable ‘private sale’, exempting them from further taxation.

When it comes to enforcement, however, the US Inland Revenue Service (IRS) takes a much more active role monitoring virtual currencies and managing the infrastructure that enables trading than its European counterparts to date. In February of this year, for example, it assembled a dedicated team of investigators to counter tax evasion in the cryptocurrency industry. It argues that Bitcoin, and others like it, can be used in the same fashion as foreign bank accounts to facilitate tax dodging. It recently compelled Coinbase to send data on 13,000 of its users as part of an investigation of this kind – a move we may see from HMRC here in the UK in the future.

Tax in the UK

In Britain, the guidance provided by HMRC about cryptocurrencies is limited to a policy paper from March 2014. That said, while an official framework for cryptocurrency related tax remains forthcoming in the UK, the Treasury’s current regime may still mean that some individual investors are falling foul of compliance with the law as it stands.

Overall, the Revenue looks at the personal circumstances of an individual to inform a decision on whether tax is paid on crypto gains or not. The individual must prove whether they are a hobbyist or a professional investor and they will be taxed accordingly.

First of all, HMRC treats hobbyist traders in the same way that it treats those involved in other speculative activities, like gambling: they are currently exempt from paying tax on gains. This approach is fortunate in that it recognises the inherent volatility of the bitcoin market and means that a personal investor would not be hit with a tax bill for gains subsequently lost because of coin values plummeting.

Alternatively, if HMRC considers that an individual or corporation involved has a professional interest in the industry, then taxes would be payable. This is assessed on a case by case basis so the resulting decision, in this respect, will often be difficult to predict. If liable, profit and loss activity must be reflected in accounts under normal Corporation Tax rules. This is applicable to those involved at all levels of the process – whether trading, mining or operating an exchange and providing supporting services.

Where to next?

As with all income and gains generating assets, a tax system for cryptocurrencies will surely emerge – such a system and associated measures would also go some way towards addressing concerns that virtual currencies are still being used to enable fraud, money laundering and finance illicit activities like cybercrime.
The advice is to fully research your situation by contacting HMRC, an accountant or a tax adviser and keeping a full record of any advice given. If it appears that the HMRC are likely to find that your gains are taxable, it would be wise to put aside any gains in a contingency account to cover any tax that might fall due. Despite the decentralised nature of cryptocurrencies and the associated hype about this, they are taxable as financial assets by law in many countries. Ultimately, even in the crypto world, the old adage of  death and taxes still applies.