Tag: Accounting

Author: Jo Crookshank, Partner; Simmons & Simmons, LLP.

The discussion in this document reflects legal principles as of February 13, 2020.

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An overview of the UK tax treatment of Bitcoin and similar cryptocurrencies, following the publication of HMRC guidance.

There has been increasing general interest in cryptocurrencies, such as Bitcoin, ICO tokens and the technology behind such currencies and tokens in recent years. Naturally, much of this focus has been on the valuation of such currencies and tokens – and the profits or losses that individuals holding such currencies and tokens might make. However, what is the tax treatment of Bitcoin, other cryptocurrencies and tokens? Are gains subject to tax in the UK? 

HM Revenue & Customs (HMRC) has released updated guidance on the tax treatment of individuals on such cryptocurrencies and certain exchange tokens (referred to by HMRC as “cryptoassets”) in its policy paper, “Cryptoassets for individuals”. The paper expands on guidance previously issued in  Revenue & Customs Brief 9/2014, which dealt only with Bitcoin and similar cryptocurrencies, but essentially confirms that, depending on an individual’s personal circumstances, transactions in relevant cryptoassets will either be subject to income tax as trading income or subject to capital gains tax (CGT) on the disposal of a chargeable asset. 

Background 

Cryptocurrencies are a type of digital money. The first cryptocurrency was Bitcoin but since its release in 2009, there is now a proliferation of different types. Cryptocurrencies can be bought or sold with other currencies, used to purchase goods from sellers who are willing to accept cryptocurrencies as payment, used to 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. However, the better view appears to be that the English courts would recognise the ownership rights which a person has in Bitcoin, despite any formal difficulties in the application of traditional features of English law. 

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 that is secure and usually anonymous. 

In HMRC’s latest guidance, HMRC also addresses 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 its use as a means of exchange or investment, rather than being underpinned by any person, group or asset. HMRC distinguishes this form of token 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. 

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 CGT purposes. As such, foreign currency is an asset for CGT 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, ie gold, silver or other metal coins or bank notes which are not normally used as legal tender or coins of numismatic interest.

The taxation of profits on cryptocurrencies 

In the UK, HMRC have recently provided updated 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) in its policy paper, “Cryptoassets for individuals”. The guidance recognises  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. 

Income tax 

Where an individual regularly buys and sells cryptocurrencies, the individual may be trading in cryptocurrencies and, as such, subject to income 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. In particular, the courts have previously given guidance that the courts should be wary of awarding “trading” status to an individual speculating in financial instruments and that the prima facie presumption should be that he or she is not. The guidance suggests that a trade in cryptoassets would be similar to a trade in financial instruments and therefore the same approach to determining whether or not a trade exists should, in general, apply. Whilst there is a possibility that transactions may be regarded as so highly speculative that the activity is akin to gambling or betting, such that any profits are not taxable as trading profits and any losses cannot be offset against other taxable profits, the guidance points out that HMRC do not consider the buying and selling of cryptoassets to be the same as gambling. 

Employment income 

Where cryptoassets are received as earnings for employment 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 crypto assets 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 payment in kind and pay Class 1A NICs to  HMRC.

Where a person is investing in cryptocurrencies, despite any formal legal uncertainty as to its nature,  HMRC take the view that cryptocurrencies should be treated as intangible property and chargeable assets for CGT purposes. Accordingly, where a person buys and sells, for example, Bitcoin as an investment or buys Bitcoin and uses it as payment for other transactions, there will be CGT  consequences. Since Bitcoin will be treated as an asset for CGT purposes, the buying and selling of  Bitcoin will give rise to capital gains or capital losses as appropriate. Equally, where Bitcoin is used to  buy other goods or services, the use of the Bitcoin as a currency will give rise to a disposal of the  Bitcoin with taxable gains or losses arising. Similar considerations will arise where one cryptoasset is  exchanged for another or cryptoassets are gifted to another person – in each case a disposal may  arise for CGT purposes with any gain being subject to tax. 

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 crytoasset should  be pooled and any transaction will result in a part disposal of the pool of assets. There are also special rules where a person acquires pooled assets within 30 days of disposing of the same assets. 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  CGT 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. 

Remittance basis 

Where a person is resident but not domiciled in the UK and claims the remittance basis of taxation,  income and gains which have a source outside the UK are only taxed if they are remitted to the UK. In  December 2019, HMRC updated their guidance to state their view that cryptoassets will be located in  the UK where the individual holder is resident in the UK. This means a person who holds such assets is liable to pay UK tax if they are a UK resident and carry out a transaction with their crypto assets which is subject to UK tax. HMRC argue that taking this approach provides a “clear, logical,  predictable and objective rule which can be easily applied”. This approach will also be relevant for inheritance tax purposes. 

An individual trading in Bitcoin in the UK would be treated as in receipt of profits arising in the UK and subject to UK tax regardless of whether they are a remittance basis user. 

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. 

Airdrops 

An “airdrop” is where a person receives an allocation of cryptoassets, for example as part of a  marketing or advertising campaign. Whether or not cryptoassets received as part of an airdrop are subject to income tax will depend on whether or not the recipient is expected to do anything in return or whether they are received as part of a trade or business involving such assets. If not, then  cryptoassets received in a personal capacity as part of an airdrop may not be subject to income tax but instead are likely to be treated as an investment with any subsequent disposal within the scope of  CGT. 

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”. 

HMRC’s guidance in Revenue & Customs Brief 9/2014 (which has not been updated in its latest note)  goes further, however, and confirms the VAT treatment of a number of other features of Bitcoin and  other cryptocurrencies: 

• income received from Bitcoin mining activities will generally be outside the scope of VAT  on the basis that the activity does not constitute an economic activity for VAT purposes  because there is an insufficient link between any services provided and any consideration  received 
• income received by miners for other activities, such as for the provision of services in  connection with the verification of specific transactions for which specific charges are made, will be exempt from VAT under Article 135(1)(d) of the VAT Directive as falling  within the definition of “transactions, including negotiation, concerning deposit and  current accounts, payments, transfers, debts, cheques and other negotiable instruments”,  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 under Article  135(1)(d). 

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Comment 

It should be noted that HMRC’s guidance recognises 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, as noted above, the guidance recognises 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. 

Author: Andrea S. Kramer, McDermott Will & Emery*

The statements in this document reflect guidance issued as of March 19, 2020.

Some virtual currency units and positions are treated as commodities for U.S. commodity regulatory  purposes by both the CFTC and the courts. This raises the question of whether the IRS might follow the  CFTC’s lead and treat certain virtual currency units or positions as commodities for tax purposes and, if  so, on what basis? The answer to this question is important because treating a virtual currency as a  commodity for tax purposes could significantly affect its tax treatment. At the date of this  Memorandum, IRS Notice 2014-21¹ and the 2019 Frequently Questions (FAQs)² tell us that the IRS views convertible virtual currency as property, not foreign currency, for federal tax purposes.³ We have  no Treasury or IRS guidance as to whether virtual currency might be taxed as a commodity. This  Memorandum addresses whether virtual currency and positions might be taxed as commodities.⁴ 

Definitions of Commodities 

When considering whether property is a commodity for tax purposes, the IRS has deferred to the CFTC  in considering what constitutes a “commodity.”⁵ The CFTC gets its regulatory authority from the  Commodities Exchange Act (CEA), and the CEA defines a commodity quite broadly to include certain enumerated agricultural commodities, “all other goods and articles,” and “all other services, rights, and interests. . . in which contracts for future delivery are presently or in the future dealt in.”6 Based on this broad definition, the CFTC has already asserted jurisdiction over certain—but not all—virtual currency transactions.⁷

We can also look at the Internal Revenue Code provisions that refer to or define commodities. For example, there is a trading safe harbor provided for certain foreign investors in the U.S. commodity markets.8 For the trading safe harbor, commodities are defined as being “of a kind customarily dealt in  on an organized commodity exchange” where transactions of its kind are “customarily consummated at  such place.”9 In Rev. Rul. 73-158, the IRS applied the trading safe harbor to off-exchange sales of raw sugar,10 ruling that the term commodities is used in its ordinary financial sense. The IRS said that commodities include all products that are traded and listed on U.S. commodity exchanges, including actual commodities and commodity futures contracts. 

The term commodity is defined even more broadly than it is for the trading safe harbor in the Code provision that allows commodity dealers and traders to elect into mark-to-market. The trader election into mark-to-market defines commodity to include any commodity that is actively traded for purposes of the tax straddle rules,11 including, physical commodities, derivative instruments in any commodity, and evidences of interests in any commodity. Evidences of interests include any option, forward, contract,  futures contract, short position, or any similar instrument in a commodity. 12 The term commodity also includes a position that is not itself a commodity if the position serves as a hedge of a commodity.  

Virtual Currency 

It appears likely that some virtual currency units and positions will be treated as commodities for tax purposes.¹³ The way in which a commodity is defined for CFTC regulatory purposes is likely to serve as the guide for the tax definition for some Code provisions. As a result, those virtual currencies that are treated as commodities by the CFTC are likely to be treated as commodities for tax purposes.  

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Taxpayers should discuss their virtual currency positions with their tax advisors to determine whether any of the Code provisions that apply to commodities might be applied to their transactions.14  Taxpayers should be aware of the possibility that some virtual currency units and positions are likely to be treated as commodities for tax purposes. 

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* This material is for general information purposes only and should not be construed as legal advice or any other advice on any specific facts or circumstances. No one should act or refrain from acting based upon any information herein without seeking professional legal advice. McDermott Will & Emery makes no warranties, representations, or claims of any kind concerning the content herein. McDermott and Andrea S. Kramer expressly disclaim all liability to any person in respect of the consequences of anything done or not done in reliance upon the use of contents included herein. For a complete list of  McDermott entities, visit mwe.com/legalnotices. 

©2020 McDermott Will & Emery. All rights reserved. Any use of these materials including reproduction, modification,  distribution or republication, except as part of the Lukka Library is strictly prohibited without the prior written consent of  McDermott. This material may be considered attorney advertising. Prior results do not guarantee a similar outcome.

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¹ Notice 2014-21, 2014-16 I.R.B. 938. 

² 2019 Frequently Asked Questions. 

³ Notice 2014-21, Q&As 1 and 2. 2019 FAQs. 

⁴ For a discussion of whether virtual currency positions can be treated as securities for tax purposes, see McDermott’s  Memorandum, “Can a Virtual Currency Positon be Treated as a Security for Tax Purposes?” 

⁵ New York State Bar Association Tax Section, “Report on the Taxation of Cryptocurrency,” January 26, 2020.

⁶ CEA § 1a(4) 

⁷ CFTC Press Release, “CFTC Staff Issues Customer Advisory on Digital Tokens,” July 16, 2018,  https://www.cftc.gov/PressRoom/PressReleases/7756-18; CFTC, “Customer Advisory: Use Caution When Buying Digital  Coins or Tokens.”

⁸ 1973-1 C.B. 337. 

⁹ I.R.C. § 864(b)(2)(B)(iii). 

¹⁰ Rev. Rul. 73-158, 1973-1 C.B. 337. 

¹¹ I.R.C. § 475(c)(2)(A). Treas. Reg. § 1.1092(d)-l(c)(1) provides that the actively traded standard requires an established financial market, ranging from an interdealer market to an established financial market. 

¹² I.R.C. § 475(e)(2). 

¹³ Compare Treas. Reg. § 1.6045-1(a)(5) (limiting the definition of commodity to property in which futures have been  “approved” for trading by the CFTC). There is a question as to whether futures that are traded pursuant to the CFTC’s self certification process meet this definition. There is also a question as to whether futures contracts need to trade on a product at all for the product to be treated as a commodity for CFTC purposes.  

¹⁴ For a discussion of some of the Code provisions that apply to commodities, see McDermott’s Memoranda:

1. “When Virtual Currency Positions Are Subject to the Straddle Rules” 
2. “When Can Bitcoin Positions Be Taxes as Mixed Straddles Subject to the Special Mixed Straddle Rules” • Can Virtual Currency Traders Elect into Special Rules that Allow Current Deductions for Trading Losses?