Cryptomining, Blockchain forks, Cryptoassets, Disposal of Cryptoassets, and Pooling: Tax Goes…
Cryptomining, Blockchain forks, Cryptoassets, Disposal of Cryptoassets, and Pooling: Tax Goes Crypto
And so we see cryptomining, the loss of private keys, blockchain forks, cryptoassets, the disposal of cryptoassets, pooling, and so on, appearing within our tax regimes. Our governments are thus finally waking up to the fact that our world is less about physical and more about software, and that cryptoassets will not go away, and are likely to replace many of our existing ways of trading.
I really feel a bit sorry for governments and cryptoassets. Overall they probably wish they would go away, as they do not have the legal infrastructure to properly cope with them. The UK, for example, is currently struggling with any form of legal infrastructure for them, and where much of the understand just goes towards laying out a basic taxonomy (which is often confused). The most developed I have seen is within Liechtenstein, and where their government has properly defined a legal framework or cryptoassets.
Unfortunately, the legal system can take a while to adopt new technology, but when there’s tax revenue involved, governments often speed thing up. And so the tokenization of our world continues, we need to ask serious questions about the ownership of cryptoasset. Most of our law is based on the ownership of physical assets, but in the future, our world may be built around the creation, transfer and ownership of virtual things. And so after avoiding the troublesome growth in cryptoassets, the UK Government has published this [here]:
If you read the document, you see a government department trying to resolve cryptoassets within existing law (“based on the law as it stands at the date of publication”). But the statement of:
HMRC does not consider cryptoassets to be currency or money so they cannot be used to make a tax relievable contribution to a registered pension scheme.
perhaps shows that existing law does not quite respect cryptoassets in the same way as any other asset. The document itself only covers individuals and not for “purposes of a business carried on by an individual”, and you already see the tangled web involved. As someone could be carrying out cryptoasset exchanges on behalf of a company — such as paying miner fees — and for there to be some vagueness in accountability.
And the HMRC identify that — like many others — it is struggling to cope with the scope of cryptoassets:
As such, HMRC will look at the facts of each case and apply the relevant tax provisions according to what has actually taken place (rather than by reference to terminology). Our views may evolve further as the sector develops.
and then makes a global statement which sets up their default position:
Where HMRC considers that there is, or may have been, avoidance of tax, the analysis presented will not necessarily apply.
It is interesting for governments to start to lay-out their understanding of cryptoassets. They define them also as ‘cryptocurrency’, which I think is perhaps a confusing term, as they don’t always involve currency. At the core of this is that cryptoasset are securely signed with a cryptography signature, and can be transferred, stored and traded.
The HMRC get a little confused by saying that not all Distributed Ledger Technology (DLT) methods involve the transfer of cryptoassets — which is a rather confusing observation. What they should have said is that not all cryptoassets involve Distributed Ledger Technology (DLT) methods, as I can send you a token for the ownership of my car, and sign it with my private key. But to make a trustworthy system, we need some trace of the cryptoasset on the DLT. The HMCR then give away that it is not cryptocurrency by saying that there are actually three types of cryptoassets: exchange tokens; utility tokens; and security tokens, and then create a bit of confusion with:
However the tax treatment of all types of tokens is dependent on the nature and use of the token and not the definition of the token.
The HMRC paper then kinda gives up laying down a proper framework, and just says that it will only concentrate on exchange tokens, and then says that it needs a whole lot more work:
This paper considers the taxation of exchange tokens (like bitcoins) and does not specifically consider utility or security tokens. For utility and security tokens this guidance provides our starting principles but a different tax treatment may need to be adopted.
And so we end up with a more pure version of cryptocurrency (exchange tokens). For the HMRC, the windfall of owning crytocurrency comes from Capital Gains Tax when they dispose of their cryptocurrency, and that they must pay Income Tax and National Insurance contributions when they receive them as payment from an employer or from crypto mining. For those who are consistently trading cryptocurrency, the HMRC aims to apply Income Tax to the trading profit from those holding them, and not Capital Gains Tax. This is the case, as a high level of trading would be seen as a business rather than as an individual. This ‘trading’ term is further elaborated on:
A trade in cryptoassets would be similar in nature to a trade in shares, securities and other financial products. Therefore the approach to be taken in determining whether a trade is being conducted or not would also be similar, and guidance can be drawn from the existing case law on trading in shares and securities.
For the first time, the HMRC recognises crypto mining rewards as income, and even gets a little technical by defining the factors involved (risk, organisation commerciality, and degree of activity). Again the HMRC struggles to pin-point whether this is ‘trade’ or not:
If the mining activity does not amount to a trade, the pound sterling value (at the time of receipt) of any cryptoassets awarded for successful mining will be taxable as income (miscellaneous income) with any appropriate expenses reducing the amount chargeable.
And then just sits on the fence for now with:
If the individual keeps the awarded assets, they may have to pay Capital Gains Tax when they later dispose of them.
You start to feel that the HMRC then struggles a bit when it comes to “Airdrops”, and which are rewards for activity:
An airdrop is where someone receives an allocation of tokens or other cryptoassets, for example as part of a marketing or advertising campaign in which people are selected to receive them.
This is where we see the normal cryptocurrency work — such as with Bitcoin — moving towards a tokenized world. For this I could receive one health token from the NHS if I stop smoking, but this could not be seen as a transfer of money. But, I could exchange that health token for a training course in my local GP surgery, and so I have traded something without needing money. This area MUST be a worry to the HMRC, as the need for actual income in fiat currency is vastly reducing, and where we move to a system of moving tokens around. For the HRMC, airdropped tokens will not be taxed if you didn’t actually do the work to gain the token and not part of your ‘trade’:
without doing anything in return (for example, not related to any service or other conditions)
This is about as clear as mud. The HMRC then define that these airdrops will be taxed as Income Tax for receipts of existing trade.
But, when the airdrop becomes worth something, you may sell it, and so this is covered with Capital Gains Tax:
The disposal of a cryptoasset received through an airdrop may result in a chargeable gain for Capital Gains Tax, even if it’s not chargeable to Income Tax when it’s received. Where changes in value get brought into account as part of a computation of trade profits Income Tax will take priority over Capital Gains Tax.
The disposal of cryptoassets gets a whole section to itself and covers:
- selling cryptoassets for money
- exchanging cryptoassets for a different type of cryptoasset
- using cryptoassets to pay for goods or services
- giving away cryptoassets to another person
For this the HMRC just want to see a value associated with the disposal. How this is calculated is not going to be easy, and those involved would perhaps have to have evidence of the price of the given cryptocurrency values at the time of the disposal. A good thing in the paper, is that donations to charities may be exempt from Capital Gains Tax.
And then we come to business costs, and where the HMRC adds costs for blockchain transaction costs on the blockchain, and professional fees for trading. The cost of mining is not covered by this, as they are not involved in actually gaining the cryptoasset, but there is a great deal of vagueness in this.
In pooling, the HMRC likens the pooling of cryptocurrency to the pooling of shares.
any other assets where they are of a nature to be dealt in without identifying the particular assets disposed of or acquired”.
This means that the cryptoassets can be seen not as individual entities, but are just pooled together in the same way that shares and stocks are, and where the costs are associated with the pool rather than the individual cryptoasset. But those cryptoassets which are sold within 30 days of the acquisition will be not be seen as part of a pool, and have separate costs.
One of my favouriate parts of the HRMC document is the mention of blockchain forks, and in the definition of a soft and a hard fork. It basically defines that for a hard fork there are often new tokens issued, and that these are likely to be liable to Capital Gains Tax.
And what about when your cryptocurrency has lost value? Surely that’s a business loss? Well that is covered when the value drops of £0 and involves a negligible value claim for the disposal of the cryptoasset.
And what happens if you lose your private key? That’s like losing the keys to your safe. On the ledger it will still look like you own the cryptoasset, but you’ll not be able to dispose of it, and thus it will not be liable for Capital Gains Tax. If you lose your key on a long-term basis, it is possible to submit a negligible value claim, and where the assets can be disposed of. The same can be submitted if someone has defrauded you of cryptocurrency.
And for your pension, cryptoassets don’t count:
HMRC does not consider cryptoassets to be currency or money so they cannot be used to make a tax relievable contribution to a registered pension scheme.
But they do for inheritance:
Cryptoassets will be property for the purposes of Inheritance Tax.
So if you are passing on your cryptoassets to your kids, make sure you keep a copy of your private key somewhere for them to transfer.
Conclusions
Confused? Yes. It look like that the tax system needs to become a whole lot more technical. What we need, though, is a proper legal foundation for our new tokenised world.