HMRC has issued its first detailed guidance on the tax treatment of cryptoasset transactions specifically clarifying the rules for transactions at businesses and companies
The guidance explains what taxes businesses may need to pay, and what records need to be kept, but HMRC cautions that this is a fast-moving sector which is developing all the time, while the terminology, types of coins, tokens and transactions can vary.
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).
However, the guidance makes clear that if a company or business is carrying out activities which involve exchange tokens, they are liable to pay tax on them.
Such activities include buying and selling exchange tokens; exchanging tokens for other assets (including other types of cryptoassets); ‘mining’ assets; and providing goods or services in return for exchange tokens.
If the transaction does not have a pound sterling value (for example, if bitcoin is exchanged for ether), an appropriate exchange rate must be established in order to convert the transaction to pounds sterling for the purposes of filling in a tax return.
Individuals and companies must also keep records of the valuation methodology.
HMRC says the question of whether a trade is being carried on is a key factor in determining the correct tax treatment, and this will depend on the degree and frequency of activity, the level of organisation, and intention (including risk and commerciality).
If a person or business’s activities amount to a trade, the receipts and expenses will form part of the calculation of the trading profit. If the exchange tokens are held as part of an existing trade, profits of a revenue nature will need to be included in the trading profits. For example, if a company carrying on a trade accepts exchange tokens as payment from customers, or uses them to make payments to suppliers, the tokens given or received will need to be accounted for within the taxable trading profits.
Cryptoassets can be awarded to ‘miners’ in return for verifying additions to the distributed ledger. Whether such activity amounts to a taxable trade (with the cryptoassets as trade receipts) will depend on the particular facts.
For example, using a home computer while it has spare capacity to mine tokens would not normally amount to a trade. However, purchasing a bank of dedicated computers to mine tokens for an expected net profit (taking account the cost of equipment and electricity) would probably constitute trading activity.
As regards corporation tax, HMRC highlights the fact it does not consider any of the current types of cryptoassets to be money or currency, and thus any corporation tax legislation which relates solely to money or currency does not apply.
If the activity concerning the exchange token is not a trading activity, and is not charged to corporation tax in another way (such as the non-trading loan relations or intangible fixed asset rules) then the activity will be the disposal of a capital asset and any gain that arises from the disposal would typically be charged to corporation tax as a chargeable gain.
As HMRC does not consider exchange tokens to be money, exchange tokens do not create a loan relationship as there is typically no counterparty standing behind the token and, as such, it does not seem that the token constitutes a debt.
However, if exchange tokens have been provided as collateral security for an ordinary loan (of money), a loan relationship exists and the loan relationship rules will apply (whether the company is the debtor or creditor). On the other hand, if exchange tokens are loaned - as opposed to traditional currency - it is unlikely that this would constitute a loan relationship.
All exchange tokens are digital and therefore intangible. However, they count as a ‘chargeable asset’ for capital gains tax and corporation tax if they are both capable of being owned and have a value that can be realised.
If a company or sole trader holds exchange tokens as an investment, they are liable to pay corporation tax on any gains they realise when they dispose of them, as a partners or members of partnerships.
A ‘disposal’ is a broad concept and includes selling exchange tokens for money; exchanging exchange tokens for a different type of cryptoasset; using exchange tokens to pay for goods or services; or giving away exchange tokens to another person
Certain costs can be allowed as a deduction when calculating if there is a gain or loss. These include the consideration (in pounds sterling):
- originally paid for the asset;
- transaction fees paid before the transaction is added to a blockchain;
- advertising for a purchaser or a vendor;
- professional costs to draw up a contract for the acquisition or disposal of the exchange tokens; and
- the costs of making a valuation or apportionment to be able to calculate gains or losses.
The costs of mining activities (for example equipment and electricity) do not constitute allowable costs when calculating the gain or loss for corporation tax and capital gains tax purposes, because they are not wholly and exclusively to acquire the exchange tokens.
HMRC’s guidance covers in detail the pooling rules for companies which use a mix of types of exchange tokens and which need to account for their disposal and for any gains or losses.
It notes, that as with other types of assets, businesses and companies can crystallise losses for exchange tokens that they still own if they become worthless or of ‘negligible value’.
HMRC also details its rules for some cryptoassets which are not controlled by a central body or person, but operate by consensus amongst that cryptoasset community. When a significant minority of the community want to do something different they may create a ‘fork’ in the blockchain.
A so-called ‘soft fork’ updates the protocol and is intended to be adopted by all. No new types of token or blockchain are expected to be created.
A ‘hard fork’ is different and can result in new types of token coming into existence. Before the fork occurs there is a single blockchain. Usually, at the point of the hard fork, a second branch (and therefore a new type of cryptoasset) is created. After this kind of fork, the new cryptoassets need to go into their own pool.
Similarly, HMRC considers the circumstances of an ‘airdrop’, when someone receives an allocation of tokens or other cryptoassets, for example, when tokens are given as part of a marketing or advertising campaign.
The airdropped cryptoasset, typically, has its own infrastructure (which may include a smart contract, blockchain or other form of distributed ledger technology that operates independently of the infrastructure for an existing cryptoasset. The tokens of the airdropped cryptoasset will need to go into their own pool unless the recipient already holds tokens of that cryptoasset.
VAT is due in the normal way on any goods or services sold in exchange for cryptoasset exchange tokens, calculated as the pound sterling value of the exchange tokens at the point the transaction takes place.
HMRC says exchange tokens received by miners for their exchange token mining activities will generally be outside the scope of VAT on the basis that the activity does not constitute an economic activity for VAT purposes because there is an insufficient link between any services provided and any consideration; and there is no customer for the mining service.
When exchange tokens are exchanged for goods and services, no VAT will be due on the supply of the token itself. Charges (in whatever form) made over and above the value of the exchange tokens for arranging any transactions in exchange tokens that meet the conditions outlined in VAT finance manual VATFIN7200 will be exempt from VAT.
However, HMRC notes that these VAT treatments are provisional pending further developments; in particular, in respect of the regulatory and EU VAT positions.
Venture capital schemes
HMRC says it has received applications for reliefs under venture capital scheme from innovative early-stage businesses which use cryptoassets and distributed ledger technology. The schemes do not include any cryptoasset-specific conditions, and HMRC’s approach is to review such cases in the same way as any other business
A business which is providing goods or services to customers that are operating in the exchange tokens sector (for example manufacturing and selling computer hardware that is optimised for exchange token mining) is likely to qualify, as is one which accepts exchange tokens as payment for goods or services, or is using distributed ledger technology as a means of recording or publishing information.
On the other hand, the treatment of activities such as dealing in exchange tokens, exchanging or broking exchange token transactions, or mining exchange tokens is less certain.
‘Mixed’ activities should also be considered carefully. For example, a company making and selling furniture might accept bitcoin as payment. Although the core activity is the manufacturing and retail of furniture, if the company acquires a large holding of bitcoin that it does not spend, or convert to flat currency, then it may have an additional activity of investing and any subsequent disposal will be a chargeable event.
If an employer ‘pays’ exchange tokens as earnings to an employee, those exchange tokens count as ‘money’s worth’ and are subject to income tax and National Insurance contributions on the value of the asset.
How to account for the income tax and National Insurance contributions depends on whether the exchange tokens are readily convertible assets. Exchange tokens are readily convertible assets if trading arrangements exist, or are likely to come into existence, the effect of which is to enable the tokens to be converted into their monetary value.
If it does constitute employment income, the employer will need to apply a valuation to that readily convertible asset using their best estimate and then subject it to the appropriate PAYE income tax and class 1 National Insurance contribution deductions
If the exchange token is not a readily convertible asset, the employer does not have to apply PAYE Income Tax and Class 1 National Insurance contribution deductions.
However, the employee must declare any amount received in the form of exchange tokens on the employment pages of their self-assessment tax return and then pay HMRC any Income Tax liability arising on that income.
Employers cannot make a contribution to a registered pension scheme with exchange tokens. This is because HMRC do not consider such assets to be currency or money.
For the transfers of exchange tokens to fall within the scope of stamp duty or stamp duty reserve tax, they would need to meet the definition of ‘stock or marketable securities’ or ‘chargeable securities’ respectively.
This will be considered on a case-by-case basis, dependent on the characteristics and nature of the cryptoasset, rather than any labels attached to them. However, currently HMRC’s view is that existing exchange tokens would not be likely to meet the definition of ‘stock or marketable securities’ or ‘chargeable securities’.