How cryptocurrency trading is taxed
The price of bitcoin is currently on a bull run much like it was when we first wrote about cryptocurrency in 2017. However despite HMRC confirming their stance in their guidance there still appears to be misconception as to how cryptocurrency trading is taxed.
Is a crypto trader speculating?
The tax rules state that gambling transactions are specifically exempt from capital gains tax. Therefore it follows that someone who is a professional gambler is considered outside the scope of UK tax
In their original guidance HMRC rather foolishly suggested that speculating in cryptocurrency might be considered akin to gambling 'depending on the facts'. It's difficult to comprehend why HMRC may have originally come to this conclusion - although the guidance was published before the ascent of cryptocurrency.
We suspect that HMRC had not envisaged Bitcoin's rapid and significant rise in value. Having been caught by surprise originally, they have now subsequently backtracked from this position.
Because, investing in cryptocurrency involves the purchase of an intangible asset (with a potentially volatile value) and not a transaction purely based on a winning or losing outcome it does not fall within the definition of a 'bet' as determined in case law.
It has been speculated (if you'll pardon the pun) that cryptocurrency transactions could fall within the 'spread betting' category and thus be exempt from capital gains tax. However there is no specified 'end date' to determine the 'winners' or 'losers' involved in the transaction. Because the 'winning' or losing' outcome is only determined at the point the cryptocurrency is sold, it is difficult to draw a parallel between crypto trading transactions and spread betting activities.
Although, there is a possibility that an argument for spread betting tax treatment could be applied if an individual invests indirectly in cryptocurrency and by reference to a spread betting index.
Certainly in HMRC's updated guidance they are firmly of the opinion that the preferential gambling tax treatment referred to above, should not be applied to the buying and selling of cryptocurrencies by an individual. However in this fast evolving sector there may be some transactions involving cryptocurrencies, which depending on the facts, might be regarded as gambling.
Will cryptocurrency trading be taxed as trading profits?
Where someone is trading in cryptocurrencies and making profits then it would be disadvantageous for these to be taxed as income. This is because generally speaking they will be taxed at higher rates, than if the Capital Gains tax treatment applies.
How cryptocurrency trading is taxed will therefore be dependent on whether HMRC consider an individual who is involved in cryptocurrency trading is actually realising profits (or losses) from a trade. The outcome will ultimately be determined as a question of fact by reference to pre-existing tax case law.
When determining if an individual is carrying out a trade, HMRC's is guided by the so called 'Badges of Trade'. Put very simply these 'badges' are a number of indicators that have evolved from tax case law over the years. These point towards whether someone is carrying out a venture in the nature of a trade and thus generating business profits subject to income tax.
Essentially the more 'badges' HMRC are able to metaphorically 'pin' on a transaction the more likely they will contend a trade is being carried out. However one could argue these badges are merely indicative and ultimately the tax treatment will be determined on the facts in the round.
Unfortunately there is no specific case law relating to whether cryptocurrency activities amount to a trade. However as we originally suggested many years ago, a parallel can be drawn between an individual trading in cryptocurrencies and someone who undertakes share trading transactions on the stock market etc.
Putting matters into context, where an individual has suffered losses as a result of share dealing (and perhaps other financial instruments) they may contend they are carrying out a trade, in order to obtain the benefits of sideways loss relief against their other income.
HMRC are likely to resist such moves in all but the most clear cut situations and this has been an approach evident from a number of tax cases where individuals were unsuccessful in arguing their share dealing activities amounted to a trade. HMRC considered that they were transactions of an investment nature and thus subject to capital gains tax rules.
Occasionally there are some exceptions where HMRC have been unsuccessful in arguing for this tax treatment. The most notable example of this recently, was the case of Mr Ali who successfully argued that his share dealing activities amounted to a trade. This was largely borne out by the fact that his share dealing activities were operated by reference to a business plan which gave them a 'deliberate and organised' quality, thus pointing towards a trading activity.
Conclusion
HMRC are well aware of the volatility of cryptocurrencies and the possible benefits an individual might achieve by obtaining the potential flexibility for relieving losses that the income tax treatment allows.
For this reason they consider a similar tax treatment to that of share trading should be applied when determining how cryptocurrency trading is taxed. Their default position being that they consider any profits realised by an individual trading in cryptocurrencies should be taxed as capital gains.
Therefore the presumption by HMRC is that cryptocurrency trading activities undertaken by an individual do not amount to trade and will not be subject to income tax rules. However it may be possible for this argument to be rebutted where you can demonstrate a deliberate and organised way of operating your trades and where you have substantial cryptocurrency transactions .
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