On 7 September 2021, El Salvador became the first country in the world to adopt Bitcoin as legal tender. As the country adapts to this ground-breaking challenge, it has also given UK resident Bitcoin investors some potential cause for celebration as it may trigger future tax savings.
Just under a decade ago, a change to UK tax law was introduced which provides an exemption from capital gains tax (CGT) for foreign currency, provided certain conditions are met.
In particular, this exemption applies when an individual generates a capital gain on a “foreign currency debt”. In simple terms, this means that if an individual has a credit balance on a bank account, denominated in a currency other than sterling, no CGT should arise on withdrawals of those funds.
On the face of it, it is easy to assume that Bitcoin might meet these criteria given Salvadorans are now able to formally use the cryptocurrency as legal tender to buy and sell goods. However, before Bitcoin investors rush to move their assets to a digital wallet in El Salvador, there are some important criteria to consider.
The first challenge is whether Bitcoin would be accepted as a currency by HM Revenue & Customs. Until recently, it was relatively uncommon for Bitcoin to be used as a medium of exchange due to its extreme volatility. As Mark Carney, former Governor of the Bank of England, has previously commented, Bitcoin “has pretty much failed thus far on...the traditional aspects of money. It is not a store of value as it is all over the map”.
Some might also argue that Bitcoin is more of a digital commodity. It is commonly referenced as a digital gold rather than a true currency, with supply and demand partly responsible for swings in its value.
Nevertheless, if the El Salvador experiment is a success, it would be harder for HMRC to dispute that it represents a currency for the purposes of these rules. That argument would be stronger still if Bitcoin is adopted as the country’s primary national currency as is rumoured and if other countries follow suit.
The next challenge for UK Bitcoin investors to qualify for tax free gains is that the currency must be held in a bank account.
For UK tax purposes, the definition of “bank” includes a firm with permission from the financial regulators to accept deposits. As it stands, citizens of El Salvador use a digital wallet known as Chivo, supported by Latin America’s leading cryptocurrency exchange, Bitso. For now, Chivo wallets are unlikely to qualify as a bank for the purposes of these rules, but it’s clear the central banks in El Salvador are collaborating with cryptocurrency businesses to increase their offerings. Likewise, there have been various reports in recent years of cryptocurrency platforms seeking banking licences as they look to increase their offerings to crypto investors.
So, the champagne for Bitcoin investors needs to remain on ice for now, but it is quite possible that there could be good news in the future. In particular, if the UK’s financial regulators authorise a cryptocurrency platform to take on deposits and become a “bank”, it could have serious repercussions for cryptocurrency tax revenues.