Cryptocurrency - tax and governance of the new financial frontier

02 December 2019

At its height in December 2017, bitcoin reached a value of over $19,000, only to trade for under $4,000  for much of early 2019. It is not an exaggeration to say that cryptocurrency fortunes were made and lost over this period, and cryptocurrencies are now a fact of investment life.

Aside from obvious concerns about volatility and which option to back, ‘crypto’ creates administrative challenges for trustees and company directors. For example, consider two areas: tax treatment and money-laundering. 

Tax treatment

Since most cryptocurrencies are not traded in sterling, gains and losses must be converted into sterling for tax purposes. Any transaction involving a cryptocurrency will be a disposal for tax purposes, including using your bitcoin to buy a coffee.

Regardless of how it is used, HMRC considers crypto to be a non-monetary asset, which it thinks most people hold as an investment. As a result, HMRC now says that such ‘cryptoassets ’ should be taxed in one of two ways:

 i) Income tax

Anyone who genuinely trades crypto will be subject to income tax on profits generated. The frequency of transactions, level of organisation and sophistication would be looked at to reach a conclusion on this. 

Profits generated from cryptoasset ‘mining’, whereby ‘miners’ generate new cryptoassets in return for undertaking tasks related to the underlying ‘blockchain’ technology, and fees related to mining activity are generally chargeable to income tax, but such activity may not amount to a trade if the level of organisation and sophistication is limited. 

Losses resulting from activity that amounts to trading  can be used to shelter other income, but it is likely to be difficult to convince HMRC that anyone regularly making losses is ‘trading with a view to profit’. 

ii) Capital gains tax (CGT)

In all other cases, crypto gains are subject to CGT, and crypto capital losses can generally be set against other capital gains. 

Keys

Crypto requires a key to access it. If this is lost this is not considered a disposal as the cryptoasset still exists. A negligible value claim could possibly be made if it can be proved that there is no prospect of recovering the key  and the cryptoasset can never be accessed.

Theft and fraud

Theft is not considered a disposal by HMRC as the owner still has a right to recover the cryptoasset concerned and therefore no loss can generally be claimed if your crypto is stolen. Similarly, if payment is made but no cryptoasset is received, a capital loss generally cannot be claimed. On the other hand, if you buy and receive cryptoassets that turn out to be worthless, it may be possible to claim loss relief.

iii) Inheritance tax (IHT)

Crypto is subject to IHT as it is considered property. However, working out the location of the asset is challenging, since by its nature crypto is spread between computers all over the world. Does the ability to access crypto through your phone mean that this is where the asset is situated for IHT purposes? We don’t know at the moment, but sooner or later this is going to be a big issue.

Money laundering

Identifying the source of crypto is uniquely challenging. Unlike traditional currencies, bitcoin is essentially created out of nothing. If someone wants to settle this into trust, how do you identify that they purchased or mined it rather than received it as the proceeds of crime?

Crypto is attractive to criminals because of its anonymity and impossibility to trace, but these qualities may be overstated. Each blockchain contains within it the unique history of that ‘coin’, listing every transaction since its creation. Cybersecurity experts are already using this history as part of criminal prosecutions, and it is not much of a stretch to see this becoming part of the anti money-laundering kitbag for advisers, administrators and governments. The amount of resource required to identify the history of even a single blockchain is daunting though, and as crypto becomes more fully integrated into financial systems, we will need to balance the need to combat crime with the realities of a world where transactions happen within fractions of a second.

The future?

In a short space of time, the number of cryptocurrencies and their use has expanded massively. Advisers, administrators and governments are all scrambling to catch up with the reality of what is already happening, and we will all need to change the way we think about what ‘money’ is and how it works. Crypto may be the future, but getting it wrong might just land you in jail.

 

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