Crypto crash a tax disaster for traders

17 May 2022

Those involved in activities that have generated an income from cryptoassets have significant cause to be concerned by recent events in the market. The most recent crypto crash has been caused by the collapse in value of a ‘stablecoin’, known as UST, which was meant to be pegged to the dollar. One UST coin was supposed to equate to one US dollar but in the last week, the UST price came tumbling down. The resulting collapse in value of the wider crypto market means that some individuals may now have no means of paying what could be a substantial tax liability due to HMRC.

It’s not precisely clear how many individuals are invested into cryptoassets in the UK. The FCA’s last estimates put the figure at 2.3 million adults but that may be a wild underestimation in light of revelations from NatWest chief executive David Lindberg who recently stated that 20 per cent of NatWest’s customers held cryptocurrency. With a reported 19 million customers, Mr Lindberg’s assertion blows the FCA’s figures out of the water. The official FCA figures also fail to take into account how many teenagers may be involved in crypto.

Of those who have been attracted to the space in the last year, a number will be younger people drawn to the space through financial influencers on social media. Some will have been drawn to emerging areas such as Non-Fungible Tokens (NFTs) and Decentralised Finance (DeFi) projects. These areas have seen massive growth in the last year but they are also fraught with risk that young people in particular may have no awareness of.

In both the NFT and DeFi space, it is possible to generate an income from cryptoassets, as opposed to capital gains which many traditional crypto investors will receive. The risk is that they may not be able to offset subsequent crypto losses against that income, leaving themselves high and dry with HMRC.

Taking the NFT space as an example, an individual may create their own NFT and sell it on an online marketplace. It often involves creating a collection of digital artwork and being paid in a cryptocurrency in return. There are numerous reports of teenagers becoming millionaires from selling digital artwork in this way. However, the funds they receive may remain at risk of price volatility, with the most common forms of payment being in the coins Ethereum and Solana.

In terms of the UK tax treatment, an income tax liability will typically arise on the sale of the NFT created by the artist. The income tax due is calculated based on the value of the cryptocurrency received at that time. The danger is what then happens if the coins received fall in value, as both Ethereum and Solana have in the last year. Ethereum and Solana currently stand at 42 per cent and 21 per cent of their market peaks in 2021. As the loss is likely to represent a capital loss rather than an income loss, it is unlikely to be available to offset against the income tax triggered by the NFT sales.

The complex rules for crypto income and gains make it a minefield for the unwary. It’s vital individuals establish the tax position early so that if there needs to be a conversation with HMRC regarding how to make payment, this can be done as early as possible to ensure there is an agreement in place if required.