The hidden tax pitfalls of cryptocurrency

Lynn Gracie, Private Client International Tax Director, author of blog about tax domicile

If cryptocurrencies are not the most popular form of investment, they are almost certainly the most talked about. And no wonder – it’s thrilling stuff. Cryptocurrency is relatively new and mysterious to many people. A tantalising balance of high risk and high reward. Crypto investors are the pioneers of the investment world.

However, while it is easy to start investing based on the exciting potential of cryptocurrency, few people devote much of their time to the tax situation surrounding it.

But what is the point in chasing above average returns (and accepting above-average risk) if those returns are diminished by poor tax planning? So, we aim to provide a few pointers that you should take into account if you are considering crypto investment.

The tax reporting challenge

UK tax legislation has taken many years to evolve to its present format – and there have been no specific amendments to accommodate the unique nature of crypto. This means it may not always be obvious when a disposal is triggered. While investors know that selling shares is a taxable event, they may be unaware that swapping one crypto token for another, for example, may trigger a disposal. Equally, there are many online sales platforms that accept cryptocurrency as payment – and paying for goods in such places will also trigger a disposal.

The problem lies in the virtual nature of cryptocurrencies. Swapping tokens or using them for payment does not feel the same as converting them into cash. So, investors are often unaware that it may be reportable. From a tax point of view, you are seen to have sold it for a monetary value and then bought something else for the same amount.

The issue is further complicated by the fact that HMRC will consider the average purchase cost of your crypto investment over time to measure your capital gain. So, if you have been acquiring a few tokens each year and then dispose of some of them, the capital gain may not be what you immediately expect.

A global investment with local taxes

Unlike national currencies, cryptocurrencies recognise no borders – and herein lies a further pitfall for unwary investors. Different countries are taking different approaches to taxing them. This can be misleading for UK taxpayers, who may be operating on exchanges in different geographies.

Your tax liabilities generally depend on where you reside. So, regardless of where you trade, UK taxpayers have to play by HMRC’s rules. We have seen examples where UK investors were unaware that they had triggered a disposal because they followed guidance published on US websites, aimed at US investors, which suggested that they wouldn’t do so.

Dealing with losses

The recent failure of FTX has highlighted the risks of operating in cryptocurrency. When the exchange failed, it affected millions of investors, both individual and institutional, and is a cautionary tale for those thinking of dipping their toes in cryptocurrency waters.

But the exchange’s failure has also shone the spotlight on the difficulty of accounting for losses. In the same way that capital gains can be difficult to assess, it may not always be clear when losses can be claimed. In the case of FTX, the investment has not (yet) disappeared but is frozen – which means that a disposal has not yet taken place but is on hold while the Securities Commissions sets about the long process of investigating the exchange’s downfall. It may be frozen – but that doesn’t necessarily mean a loss has crystallised.

FTX investors should also be aware that HMRC does not view the theft of crypto to be a disposal – so it may not be possible to claim losses in this case.

A new type of investment – and a new breed of investor

Understanding such issues, and knowing what to expect in terms of tax liability, is easier for seasoned investors. However, the advent of crypto has also given rise to a new and less experienced type of investor which means they may be less accustomed to regular tax reporting.

HMRC has powers which require leading crypto exchanges to share information with them, so all investors should take care to accurately record transactions. This may be particularly challenging for those who are not used to its complexity and may not appreciate what is reportable and what is not. Far better to speak to someone who can help you manage your assets from a tax perspective than to wait for a letter from HMRC.

A safe route through dangerous territory?

Nobody needs to be told that cryptocurrency is a high-risk option. But investors who fail to anticipate and report the taxable effect of crypto investment are taking additional and unnecessary risks.

Cryptocurrencies are not like other investments. So, anticipating tax liabilities may also be more complex than you thought. Find out why.

How AAB can help you with

Tax Investigations

HMRC’s powers allow them to investigate the tax affairs of any individual or business. We understand this can be difficult and distressing, but we’ll support you throughout an enquiry, working hard to minimise any penalties. Our team members have many years’ experience of dealing with tax investigations, from both working for HMRC and spending a significant amount of time advising our clients.

View our tax investigation service

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