Investing may be an excellent way to generate wealth, but depending on what you invest in, and how you do so, it can mean you may need to pay more tax. Investing in cryptocurrency is no different. You may need to pay Capital Gains Tax (CGT) due to holding this asset class.
Calculating tax owed for a self-assessment tax return can be complicated, even if you are just dealing with self-employment income and expenses. That becomes even more complex when you start to add capital gains. Understanding the tax rules and what tax you need to pay is crucial before making any investment decisions, including investing in crypto. Crypto transactions can have material implications on the tax rate you eventually pay.
What does the HMRC deem as cryptocurrency?
Her Majesty’s Revenue and Customs (HMRC) does not view digital currencies like standard currency. It has taken the view, instead, to group them into different types or categories:
Exchange tokens are arguably the most common type of crypto asset. Bitcoin is a prime example of an exchange token. Exchange tokens can be used as a means of payment but are also seen by many as an investable asset in their own right.
Utility tokens and exchange tokens have many similarities. They can be traded on exchanges or in person to person transactions, so they are also an investable asset. However, they can also be seen as a means of accessing specific goods or services through a distributed ledger or platform. Businesses issue utility tokens and then accept those tokens as a form of payment for particular goods or services.
Security token holders have certain rights or interests in a business. Those rights or interests include ownership, a share of future profits, or the requirement to be repaid a certain sum of money in the future.
Stable coins are pegged to a tangible asset or a fiat currency. They were invented to dampen the volatility that characterises many cryptocurrencies.
What are the tax implications of making profits on cryptocurrency?
In the main, if you are a UK resident, you may need to pay CGT if you:
- Sell any tokens
- Exchange tokens for another type of digital asset (i.e. Bitcoin to Ethereum tokens)
- Use your digital currency tokens to buy goods or services
- If you give any type of crypto asset away to another person, other than your spouse or civil partner
- Donate any digital assets to charity
Each one of these situations is a taxable event in the eyes of HMRC, and you may have to pay UK tax in the tax year you declare it.
How much cryptocurrency tax do I have to pay?
To calculate your tax due, you need to look at each of your cryptocurrency transactions and see what gains, if any, you have made. However, even working out your profits is not always straightforward. For the most part, you would calculate your gain as the difference between what you paid and what you sold it for. If you happen to acquire the asset for nothing, you need to use the market value when you received it to work out your gain. If you sell cryptocurrency within 30 days of buying it, the calculation can be slightly different, which the UK Government website explains comprehensively.
You are allowed to deduct certain costs from your gain. That can include the pooled cost of your tokens, as long as that cost considers the rules mentioned above. Other allowable costs are:
- Transaction fees incurred before a transaction is added to a blockchain/distributed ledger
- Any advertising for a buyer or seller
- Costs incurred when writing a contract for a transaction
- Making the valuation that enables you to calculate the gain made in a transaction
Costs you have already submitted and those incurred during mining activities are non-deductible.
If you find that the total taxable gain you have made is above the annual tax-free allowance (or the Annual Exemption Amount), you will need to pay CGT. If you are a basic-rate taxpayer, you currently pay a 10% tax rate of CGT, rising to 20% if you are a higher-rate payer. The Annual Exempt Amount is £12,300 for the tax year 2021/22 and is to remain the same until the tax year 2025/26.
What does holding crypto assets mean for your income tax?
No one likes paying tax to HMRC. Yet you must get it right so you are not lumbered with a more enormous bill in the future due to penalties you may incur from not declaring income. While declaring gains made on your crypto transactions may increase your tax bill overall, bear in mind this usually means you are earning more money, too.
Reducing your tax bill means making the most of the initiatives at your disposal. That means using your ISAs and ability to pay a certain amount into a pension pot each year, amongst others. Again, to ensure that you are not only staying on the right side of the law when it comes to tax, seeking the help of a tax accountant can also allow you to remain tax efficient. Everyone’s situation is different, so there is no one size fits all answer to how much tax you owe on crypto assets or any other type of income you may have.