Cryptocurrencies and digital assets have gone from an obscure part of finance to centre-stage over the last year, attracting both institutional and personal investors – understandable given their meteoric value increase during 2020 & 2021.

But its ‘cryptic’ nature, while appealing in many ways, may have tax liabilities that investors – new investors in particular – should be aware of, as Jonathan Allwood, Personal Tax Manager, Bracey’s Accountants, explains.

Broad attraction

In October 2020, Miami-based art collector Pablo Rodriguez-Fraile spent almost $67,000 on a digital token stating that he owns a 10-second video artwork that he could have watched online for free; he went on to sell that same digital token for $6.6 million. 

While most of us won’t have a neat £50,000 disposable income to invest, the above is a prime example of the vast gains that can be made from crypto-investments. Likewise, if we consider the growth curve of Bitcoin over 2020, its appeal to an audience beyond the typical portfolio holder becomes clear. 

The Meteoric Rise of Bitcoin

Cryptic crypto

While its appeal may be evident to both existing and new investors, by its very nature crypto-investment has its complications – and implications when it comes to an investor’s tax obligations.

The first challenge lies in the location of the asset. Crypto-assets are decentralised and digital in nature and, as such, do not have a physical location or exist anywhere. However, determining the location of assets is important for tax purposes and particularly for UK residents, non-UK domiciles as it can change the tax consequences dramatically.

HMRC guidance (note: this is not legislation) states that exchange tokens, which would include the likes of bitcoin, are located wherever the beneficial owner is resident. For UK residents, this means the crypto-asset would be treated as a UK asset.

For non-domiciled UK residents, however, the situation is potentially far more complex with greater permutations of tax consequences.

The second challenge lies with how gains on crypto-assets are calculated. Many crypto-assets are traded on exchanges that do not use pound sterling and it is also common to directly exchange one crypto-asset for another. Add into this the daily volatility in the crypto market, and actually valuing your crypto-assets on disposal can be tricky. 

The key point here is that HMRC views different types of crypto-assets as separate assets for capital gains purposes. The swapping of your bitcoin for, say Ethereum, will trigger a disposal for capital gains tax purposes even if no traditional currency has been received. In this case, the individual investor would realise either a taxable gain or loss as a result and may need to make further disposals of crypto-assets into actual currency to meet their tax obligations.

Tax inevitability

While the market is nascent, many new investors may still be able to declare gains on crypto trading before the deadline or before HMRC make an enquiry into their tax affairs. As this is a growth market, it is not surprising that HMRC have already made steps to obtain information from trading apps and platforms regarding investors who have bought and sold crypto.

It is only a matter of time until HMRC are able to pursue investors that may have historical capital gains tax liabilities to declare. And with a January 2022 deadline to declare capital gains from investments sold before 5 April 2021, this may well happen sooner rather than later.

For amateur traders and investors, it is therefore now the time to ensure that they understand and seek trusted and expert advice on their tax obligations with regard to cryptocurrency trading, lest they incur unexpected penalties that eat into their much-prized gains.