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Cryptoassets: Taxation of Businesses

Author: Jo Crookshank, Partner at Simmons & Simmons, LLP

The discussion in this document reflects legal principles as of  February 06, 2020.

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With the increasing interest in cryptocurrencies, such as Bitcoin, HMRC released updated  guidance in December 2018 on the tax treatment of individuals on such assets and certain other  exchange tokens (referred to by HMRC as “cryptoassets”) in its policy paper, “Cryptoassets for  individuals”.  

HMRC has now released its second such policy paper, “Cryptoassets: tax for business”. The  paper expands on earlier guidance by applying it to the provisions for the taxation of companies  and other business organisations.  

Background  

Cryptocurrencies, such as Bitcoin, are a type of digital money. They can be bought or sold with  other currencies, used to purchase goods from sellers who are willing to accept cryptocurrencies  as payment, make investments in various assets and are being retained as investments  themselves. Given the unique proprietary features of Bitcoin, there appears to be a degree of  uncertainty and ambiguity as to whether Bitcoin and other similar cryptocurrencies would, legally,  qualify as property for English law purposes.*  

The technology which allows cryptocurrencies to work is known as “blockchain technology”. The  blockchain is a database containing evidence of transactions between different users. Multiple  networked computers hold all or part of a sequence of information, which is arranged into  “blocks”. The information is sequenced in chronological order and added to the blockchain by the  network without reference to users’ identities or personal details. The updated blockchain is then  saved so rapidly across the network that it is almost impossible for a hacker to change the  information contained on every single computer on the network in order to manipulate a  transaction (assuming there are no vulnerabilities in the software). This effectively means that  once a transaction has been recorded, it cannot be edited or deleted. It therefore acts as a  distributed digital ledger which is secure and usually anonymous.

In HMRC’s December 2018 guidance for individuals, HMRC addressed formally the position of  “exchange tokens” which encompass cryptocurrencies such as Bitcoin. HMRC defines such  exchange tokens as being intended for use as a method of payment, making use of distributed  ledger technology and where the value of the tokens is based on their use as a means of  exchange or investment, rather than being underpinned by any person, group or asset. HMRC  distinguishes these forms of tokens from utility or security tokens, as they do not confer any rights  or access to goods or services, nor do they provide a debt or profits interest in a business.  

That guidance on the tax treatment of Bitcoin, other cryptocurrencies and relevant exchange  tokens (referred to as “cryptocurrencies” or “cryptoassets” in the rest of this note) recognised two  possible treatments for profits or gains made on cryptocurrencies: trading profits which will be  subject to income tax, and capital gains which will be subject to CGT. For further details on the  December 2018 guidance, see “Taxation of Bitcoin and other similar cryptocurrencies”.  

Taxation of currencies generally 

Where a person trades in foreign currencies on a regular basis, then the profits of that trade may  be subject to tax as trading profits (and within the scope of income tax or corporation tax as  appropriate). 

In the absence of trading, all forms of property, other than sterling, are assets for capital gains  purposes. As such, foreign currency is an asset for capital gains purposes and the disposal of  foreign currency may, therefore, give rise to chargeable gains or allowable losses. In addition to  the sale of foreign currency for sterling, there is also a disposal if foreign currency is used to  purchase an asset, for example. 

From a VAT perspective, transactions, including negotiation, concerning currency, bank notes  and coins used as legal tender are exempt from VAT, with the exception of collectors’ items, e.g.  gold, silver or other metal coins or bank notes which are not normally used as legal tender or  coins of numismatic interest. 

The guidance expressly states that HMRC do not regard any of the current types of cryptoassets  as “money” or “currency” such that none of the specific rules applying to such assets is applicable  to cryptoassets.  

The taxation of profits on cryptoassets: trading  

Where a business regularly buys and sells cryptocurrencies, that business may be trading in  cryptocurrencies and, as such, subject to income tax or corporation tax on the profits of the trade  (or may accrue trading losses). Where losses arise, HMRC are likely to carefully consider if the  badges of trade are present before allowing loss relief. The guidance suggests that normal factors  should be considered in determining whether a trade exists, including the degree and frequency  of the activity, the level of organisation and the intention (including risk and commerciality).  

Where cryptoassets are held as part of an existing trade (for example, where received as  payment for services or goods), then profits of a revenue nature will need to be included in the  trade’s profits. 

As well as confirming that cryptoassets are not “money”, the guidance states that cryptoassets  will not give rise to loan relationships for the purposes of the corporation tax rules. This is  because there is no counterparty standing behind the cryptoasset and, as such, it will not constitute a debt. Even if cryptoassets are loaned, HMRC take the view that this would not give  rise to a loan relationship since there would be no “money debt”. (The normal loan relationship  rules would, however, apply to loans backed by cryptoassets provided as collateral.) 

The taxation of profits on cryptoassets: non-trading 

If the activity concerning the cryptoassets does not amount to a trade, then it will normally give  rise to the disposal of a capital asset and a chargeable gain (or loss). The guidance confirms that  cryptoassets will be “chargeable assets” for these purposes if they are capable of being owned  and have a value that can be realised.  

Cryptoassets are by definition intangible and accordingly may be taxed as “intangible fixed  assets” under the corporation tax regime when held by companies. Most cryptoassets will not fall  to be treated as “intangible fixed assets” however as this requires them to have been “created or  acquired by a company for use on a continuing basis”. Cryptoassets which are simply held by a  company will not meet this condition.  

A disposal of a cryptoasset will occur for capital gains purposes whenever a business sells a  cryptoasset, exchanges it, uses it to pay for goods or services or gives it away. The usual rules  apply in determining the disposal value and any allowable costs. However, the guidance suggests  that where cryptoassets are acquired by mining (see below) which doesn’t amount to a trade,  then the costs of that mining activity (such as electricity and equipment) will not be an “allowable  expense” for the purposes of calculating the chargeable gain since those costs are not wholly and  exclusively used to acquire the asset.  

HMRC regard cryptoassets as fungible assets which should fall within the pooling rules. This  means that, instead of tracking the gain or loss on any individual transaction, each type of  cryptoasset should be pooled and any transaction will result in a part disposal of the pool of  assets. However, there are special rules where a company both acquires and disposes of pooled  assets on the same day or within a period of 10 days.  

Where a cryptocurrency is subject to a “hard fork” creating a new cryptoasset, any allowable  costs for pooling of the original cryptoassets will need to be allocated between the original and  new cryptoasset pools. However, such a hard fork should not of itself amount to a disposal given  rise to tax liabilities. 

The paper also provides guidance on the circumstances when a person may be able to make a  “negligible value claim” to crystallise a capital loss on cryptoassets that have become worthless,  including in circumstances where a person loses their private key. As cryptoassets are pooled,  the claim must be made in respect of the entire pool. 

Airdrops 

An “airdrop” is where a person receives an allocation of cryptoassets, for example as part of a  marketing or advertising campaign. Generally, cryptoassets received as part of an airdrop are  likely to be treated as an investment with any subsequent disposal within the scope of taxation on  capital gains. 

Mining cryptocurrencies

Cryptoassets may be awarded to “miners” for verifying additions to the blockchain digital ledger.  Again, whether or not these activities amount to a trade will depend on a range of factors  including the degree of activity and organisation. Where there is a trade, the cryptoassets  received will be the taxable income of the trade. Otherwise, the cryptoassets received will be  taxed as other miscellaneous income. Any fees or other rewards received in return for mining  activities will also be taxed either as trading income or miscellaneous income. 

Where the cryptoassets are kept and later disposed of, tax on any capital gains will be due.  Tax reliefs 

The guidance also deals with the interaction of cryptoassets on a range of tax reliefs, such as  venture capital schemes and EIS schemes. In general, the guidance makes the point that each  situation must be looked at on its individual fact and with a view to applying the individual  qualifying conditions. However, the fact that the business may provide goods and services in  return for cryptoassets, provide services or goods to businesses in the cryptoasset sector or use distributed ledger technology will, in itself, prevent a business qualifying for such reliefs. However,  the paper points out that businesses can apply for a non-statutory clearance through the normal  channels in cases of genuine uncertainty and accepts that there are likely to be a number of  cryptoasset cases that fall into this category early on.  

Employment income 

Where cryptoassets are used to pay earnings to an employee they will count as “money’s worth”  and be subject to income tax and NICs on their value. An employer’s obligations in relation to  cryptoassets provided as earnings will depend on whether they amount to “readily convertible  assets”. This in turn depends on whether there are “trading arrangements” in existence. Where  there are trading arrangements (such as with Bitcoin), then employers must deduct and account  to HMRC for PAYE and NICs, based on a best estimate of their value. Where cryptoassets are  not RCAs, no PAYE obligation arises on the employer (instead the individual employee must  report under self-assessment) but the employer must treat the award as a benefit in kind and pay  Class 1A NICs to HMRC. 

VAT 

The European Court of Justice has held that Bitcoin and other cryptocurrencies should be treated  in the same way as other currencies for VAT purposes. Therefore, where a person pays  consideration for the acquisition of Bitcoin, there is a supply that is exempt from VAT under Article  135(1)(e) of the VAT Directive, which exempts “transactions, including negotiation, concerning  currency, bank notes and coins used as legal tender”. 

The guidance confirms the VAT treatment of a number of other features of Bitcoin and other  cryptocurrencies: 

  • cryptoassets received from Bitcoin mining activities will generally be outside the  scope of VAT. This is on the basis that the activity does not constitute an economic  activity for VAT purposes (because there is an insufficient link between services  provided and any consideration received; and there is no customer for the mining  service)
  •  when cryptoassets are exchanged for goods and services, no VAT will be due on  the supply of the cryptoasset and
  • charges (in whatever form) made over and above the value of the Bitcoin for  arranging or carrying out any transactions in Bitcoin will also be exempt from VAT.

Stamp duty, SDRT and SDLT 

HMRC’s view is that existing cryptoassets will not amount to either “stock or marketable  securities” or “chargeable securities” such that no stamp duty or SDRT will apply to transfers of  cryptoassets. Where cryptoassets are used to pay for shares or chargeable securities, then they  will amount to “money’s worth” and within the SDRT charging provisions. The same principle will  apply to SDLT and cryptoassets used as consideration in a land transaction.  

Comment 

It should be noted that HMRC’s guidance recognizes that cryptocurrencies and the technologies  behind them will continue to evolve and that HMRC will need to continue to evaluate their tax  treatment and will issue further guidance as appropriate. Indeed, whilst reliance may generally be  placed on HMRC guidance, an investor or user of any such novel currencies should take care to  consider the nature of the currency on a case by case basis. In addition, the latest guidance notes  that HMRC may not apply the suggested treatment where it considers tax avoidance to be an  issue. 

In addition, the guidance recognizes that there are other types of cryptoassets which are not  “exchange tokens” (ie cryptoassets used as a method of payment, such as Bitcoin), but instead  either “utility” or “security” tokens where different considerations may apply. It is to be hoped that  HMRC will address the position of these other cryptoassets soon, particularly given the  prevalence of utility tokens in the market 

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*There has been debate over whether cryptoassets will qualify as “property” for the purposes of  English law. However, the better view appears to be that the English courts would recognize the  ownership rights which a person has in Bitcoin, despite any formal difficulties in the application of  traditional features of English law. This appears to have been borne out in the recent decision in  Robertson v Persons Unknown, where the claimant sought and obtained an Asset Preservation  Order (APO) over more than £1m worth of stolen Bitcoin. An APO is made in respect of “property”  and in Robertson, the court proceeded on the basis that Bitcoin is a form of personal property. 

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