United Kingdom Allows: London Clarifies Taxation of Crypto Assets

After the explosive activity of 2017, crypto markets are experiencing severe depression and stagnation. Currently, crypto assets are more of a burden than valuable assets for many holders. The reason lies in the chaotic and inconsistent strengthening of state regulation of tokens and cryptocurrencies worldwide.

And just last week, Her Majesty's Revenue and Customs (HMRC) issued a report outlining its interpretation of crypto assets from a taxation perspective. This report should be seen as another step towards the legitimization of cryptocurrencies and tokens. Previously, recall, the Bank of England and the Financial Conduct Authority of the United Kingdom jointly published their report.

We propose to delve into the British interpretation of crypto assets, as this could impact the fate of the entire digital and cryptographic asset industry.

Crypto Assets in the UK

Cryptocurrencies in the UK and the EU are partially legalized, but they have a unique status that distinguishes local regulation from that of the USA, Japan, and Singapore—the largest crypto markets, where dealing with crypto assets is permitted.

According to reports from HMRC, the Bank of England, and the relevant authorities, a 'crypto-asset' is defined as "a cryptographically secured digital representation of value or contractual rights that can be stored, transferred, or traded electronically." It is not classified as currency or money.

Furthermore, crypto assets should be divided into three categories, rather than two as in some other jurisdictions:

- Security tokens, which possess characteristics similar to traditional securities;

- Utility or product tokens, which grant access to specific goods or services;

- Exchange tokens, which function primarily as means of payment.

In its latest report, HMRC uses the term 'exchange token' instead of 'cryptocurrency,' and most tax recommendations focus on this type of asset.

Exchange tokens include classic cryptocurrencies like Bitcoin or Litecoin, which can be used purely as payment methods. They do not confer property rights or access to goods/services.

The concept of crypto assets typically involves the use of blockchain technology and Distributed Ledger Technology (DLT), enabling decentralized transactions without a central processing center.

Security tokens, on the other hand, resemble traditional securities (such as stocks or derivatives) and can grant ownership rights or entitlements to profits.

Utility or product tokens provide access to a particular platform, where the holder gains rights to receive goods or services. An example is Ethereum.

Businesses often issue utility tokens to solve practical problems. For instance, they might use tokens to create digital discount coupons for online stores. However, these tokens cannot serve as substitutes for money or as securities.

Taxation of Crypto Exchanges

HMRC explains that the process of buying and selling crypto assets can be interpreted as "financial trading" only in "exceptional circumstances". These circumstances are determined based on factors such as the complexity and frequency of operations, the level of organization involved, etc.

Income tax takes precedence over capital gains tax here. In practice, this means that income tax will apply, with rates in the UK ranging widely from 0% to 45%, depending on the circumstances.

The department believes that most owners of crypto assets are individuals holding them as personal investments. In such cases, capital gains tax applies, with rates varying from 10% to 28% depending on the volume of capital.

An important administrative point: the owner of crypto assets must collect and store all transaction data themselves, as crypto exchanges retain this information for only a short period. Details to record include not only the amount but also the type of asset, the nature and date of the transaction, wallet addresses, and bank statements. All this information must be reported in the tax return.

Another crucial detail: even transactions conducted without using fiat currencies must be converted into pounds sterling for tax purposes. For example, when exchanging bitcoins for litecoins on a crypto exchange, UK tax residents must declare profit or loss in terms of the British national currency. HMRC refers to this approach as "self-assessment".

Taxation of Wages Paid in Cryptocurrency

HMRC requires the application of income tax for wages paid in cryptocurrency. The regulator notes that this tax extends to exchange transactions if the employer conducts them for the purpose of paying salaries in cryptocurrency. This is also applicable if remuneration is calculated from profits obtained from working with crypto assets. Insurance contributions apply to this sum, but pension contributions do not.

As indicated by the regulator's clarifications, the employer acts as the tax agent in such cases, reporting these transactions to HM Revenue and Customs. Employees, however, should keep in mind the capital gains tax if the cryptocurrency is later used as an investment tool.

Crypto assets are treated as property only in the context of inheritance.

Taxation of Mining

Mining is a common method of earning today by creating new blocks in the blockchain chain and facilitating transactions using computing power within a distributed network. In return for providing equipment for the network's needs, miners receive rewards in the form of mined cryptocurrency.

HMRC will subject such rewards to income tax. The rate depends on the miner’s activity, risks, commercialization of the activity, etc. The declaration specifies the value of the crypto assets at the time of receipt in monetary equivalent (pounds sterling). Additionally, capital gains tax applies if the person intends to hold the crypto assets for investment purposes for more than 30 days.

Regulation of Airdrops

An airdrop is the free distribution of tokens or cryptocurrencies for promotional or other purposes. Crypto startups use this tool to attract attention to new tokens and to expand the network of holders. Such startups often have their own infrastructure (smart contracts, miners, etc.) for issuing and maintaining a distributed network.

According to HMRC, tokens received for free, without exchanging for goods or services, are not subject to income tax—i.e., they are not taxed. This ruling applies to crypto assets that are not connected with trade or economic activity, or mining, which, as we already know, is accounted for separately.

Importantly, tokens received as part of bounty campaigns (a variation of airdrops) are subject to income tax, as they involve services or expectations of services in exchange for crypto assets. This is viewed as a special type of crypto asset, and the tax base is considered to be their equivalent in pounds sterling at the time of receipt.

The value of cryptocurrency for tax declarations is calculated upon disposal. That is, at the moment when a person buys or sells a token, including for another cryptocurrency or fiat money, but in the equivalent of the British currency. Transfers of such digital assets to others and payments for goods/services are also taken into account.

Tax Deductions and Capital Gains Tax for Individuals

The tax authority permits the use of tax deductions for crypto-business when determining profit or loss in the following cases:

if fiat money was initially paid for the asset;

if transaction fees were paid for adding a transaction to the distributed ledger;

if advertising costs were paid for buyers or sellers, etc.

Costs related to mining (purchase of equipment, electricity bills, etc.) and other expenses that imply activities subject to income tax are not considered for these purposes.

Individuals are instructed to calculate losses and profits if they dispose of crypto assets to determine whether they need to pay taxes and, if so, at what rate. Only those crypto assets donated to charity are fully exempt from taxes (including capital gains tax).

HMRC pays particular attention to the practice of applying Section 104 of the Capital Gains Tax Act. Specifically, to simplify the procedure for taxpayers, it is recommended to combine assets into pools. This allows administering tax not for each separate transaction, which can be burdensome, but for the entire pool at once.

The concept of a pool enables forming a "pooled allowable cost," taking into account the initial reward paid for the tokens in pounds sterling.

In practice, this means that an owner of bitcoins, litecoins, and ethereum can consider not each wallet or transaction individually, but three pools formed by the type of asset. That is, separate pools for "bitcoin," "litecoin," and "ether." The pooled allowable cost of each pool will change depending on the sale or acquisition of crypto assets.

For individuals, however, there's a nuance – they still need to keep track of the amounts spent on each type of cryptocurrency. HMRC itself provides an example of how private individuals should manage their digital assets: Victoria bought 100 Type A tokens for £1,000. A year later, she purchased an additional 50 tokens, but this time for £125,000. Ultimately, Victoria owns 150 tokens purchased at different prices, but for tax purposes, her Pool A is considered to have been bought for £126,000.

Suppose, after a couple of years, she decides to sell 50 crypto assets from Pool A for £300,000. She is allowed to deduct a portion of her expenses when calculating the profit from this transaction. The deduction formula would look something like this: £126,000 x (50/150) = £42,000, where 50/150 represents 50 tokens from Pool A (1/3 of the pool).

£300,000 - £42,000 = £258,000 – this is Victoria's final profit from the deal, and the basis from which the capital gains tax is calculated. Remember, the rate ranges from 10% to 28%.

There is a caveat: this works differently for short-term investments (less than 30 days). That is, for cases where tokens are sold within 30 days of purchase. For example, 4,000 bitcoins were sold by Victoria for £160,000, and a few days later (but less than 30) 500 bitcoins were bought for £17,500, which remain in her wallet. These transactions cannot be combined into a single pool.

Instead of a pool, the profit amount for taxation will be calculated using the following formula: £160,000 x (500/4000) = £20,000. That is, the number of crypto assets at the end of the 30-day period is taken into account, and the taxable amount for this period will be only £2,500, not £160,000.

Crypto assets can be sold for an amount lower than what was paid at purchase. That is, a loss can be recorded, which will reduce the tax base. Furthermore, if the amount of assets is insignificant, you can file a "disposal" claim – that is, exemption from taxation of acquired cryptocurrency.

Such a claim can be filed if the cryptocurrency's value drops to insignificant levels or access to the crypto-wallet is lost. However, cases of theft and fraud are handled by other agencies.

Additionally, tokens received as a result of airdrops or forks are administered separately from pools.

Forks of Crypto Assets

"Forks" (distinguished as "hard" and "soft" – "radical" and "minor") refer to splits in a distributed ledger into two independent block chains. This results in a "clone" of the original cryptocurrency, though it may have a different value and properties implemented by the fork initiators.

For example, Bitcoin Cash branched off from the Bitcoin blockchain as a result of a hard fork (a radical change in the ledger), becoming an independent cryptocurrency. Bitcoin Cash was automatically generated in the wallets of all original bitcoin holders if they had cryptocurrency on balance. There have been approximately 10 forks of Bitcoin alone.

The Tax Service considers that a new independent cryptocurrency emerges as a result of a fork. Consequently, it should also be taxed separately. Here, parallels are drawn with airdrops, which we discussed earlier.

Conclusion

Given the uncertainty that has surrounded the crypto industry for several years due to regulators’ inconsistent positions in other countries, HMRC's balanced stance could significantly impact the global market.

The report contains clear and straightforward requirements for the taxation of crypto assets in the UK. This approach allows both individuals and corporations to legally work with cryptocurrencies.

If successfully applied in practice, this experience will undoubtedly influence other nations. Moreover, following bans in China, restrictions in the US, Singapore, and Japan, crypto businesses (primarily exchanges and large funds) are seeking a new "haven" to operate freely within a legal framework.