Sean Hill, manager, and Sam Goodsell, partner, at accountancy firm, Menzies LLP
The wild west days of cryptoassets may well be coming to an end and with HMRC’s latest updates to their cryptoasset manual in February 2022. This update offers advice on the tax treatment of cryptoassets, that will allow traders, to organise their digital assets in the most efficient way possible. But does the new guidance go far enough?
A common misconception when filing tax returns is what is defined as ‘trading.’ In everyday parlance it means to buy and sell goods or services. However, when it comes to cryptoassets, HMRC state in the manual that only in exceptional circumstances would they expect individuals to buy and sell exchange tokens with such frequency, level of organisation and sophistication that the activity amounts to a financial trade.
Typically, when a cryptoasset, such as a non-fungible token (NFT), is bought and then sold, the seller would be liable for capital gains tax on any gains generated on the sale. These would need to be considered alongside gains related to the ownership of other assets, such as property or shares, for example. If an individual has acquired or invested in a cryptoasset for the purpose of profiting in the future, then HMRC would most likely categorise this as an investment, which would be liable for capital gains tax. However, if an individual or business is involved in the creation, minting and initial sale of an NFT(s), this will be treated as a ‘Trade’ and subject to income tax.
To help clarify matters, HMRC’s Cryptoassets Manual provides detailed and comprehensive guidance, and links to additional resources. However, for someone unfamiliar with self-assessment tax forms, it may be too dense and confusing. The manual uses examples to help illustrate specific points, but these are unlikely to match an individual trader’s situation exactly. Each trader should start with a list of their transactions and work out how the guidance relates to them, rather simply selecting the most beneficial tax regime.
To complement the Cryptoassets Manual, HMRC also has a manual which outlines the ‘9 badges of trade’ to assist in defining trading activity. These badges include a profit-seeking motive, the number of transactions that occur and the way the sale is carried out. By using the nine badges as a checklist, asset owners can identify whether their transactions constitute trading or not. In cases of ambiguity the decision lies with HMRC, however, there is a process in place to appeal if the asset owner disagrees. In these cases, businesses should consider consulting a professional, as they will be able to identify the necessary records and evidence to argue their case.
Individuals trading cryptoassets should ensure that they keep detailed records of transactions as they go, which can be presented to professionals at the end of the tax year. Every time funds are exchanged between different types of cryptocurrency, for example, Bitcoin to Ethereum, it counts as a chargeable event. This is because this transaction is treated for tax purposes as a disposal of an asset and the acquisition of a new asset. The number of chargeable events could affect how much tax is owed.
Traders who are making a high volume of transactions should also seek specialist advice. Most tax professionals will consult or work closely with a software provider that automatically keeps track of transactions with the client’s permission, streamlining tax declarations at the end of the year. This means that the transactions will not have to be manually calculated, which could be a time-consuming and expensive process. Tax advisors will need access to all digital wallets and other accounts where cryptocurrencies are stored.
As the guidance from HMRC is relatively new, there are still ‘grey’ areas that are open to interpretation. For example, cryptoassets can be converted from one format to another, which is known as a ‘bridging transaction’. There is still some debate whether bridging transactions, for example between Ethereum and Wrapped Ethereum, represent a chargeable event. Although at present this transaction is treated as a disposal for capital gains tax purposes and can give rise to a tax liability.
While the manual is helpful, it is likely to be confusing to a non-professional. Traders who want to calculate their own tax liability, based on the information provided, would be advised to get this reviewed and approved by a tax specialist. This is particularly important where a large volume of transactions has taken place or individual transactions have a high value, as it will give a greater certainty over the final tax liability. Traders can be certain that regulation in this area will increase in the future, as the HMRC learns more about the world of cryptoassets and the tax revenues it can generate.
