Cryptocurrency is riding high these days. But even as more investors are taking a chance on digital currency, many are still confused about how to treat it for federal income tax purposes. Philip Needham BA FCA, whose firm consults clients interested in blockchain and bitcoin, took his time to explain tax planning opportunities for those who buy bitcoin to hold as an investment or set up a business in the UK to take payment in bitcoin.
In this article, Philip Needham talks about the following topics:
- Bitcoin is more like cash than a bank account.
- Records of bitcoin transactions should be maintained.
- Gains on disposals of bitcoin are subject to capital gains tax.
- Businesses should beware of holding excessive amounts of bitcoin.
In the short term, bitcoin is likely to remain in demand as an investment asset but, in the medium term, it is likely to become more in use as a means of exchange, a universal currency, and probably many other uses that we have yet to imagine.
The tax implications are still being thought through, although Revenue & Customs Brief 9/2014 outlines HMRC’s approach to the taxation of cryptocurrencies. The first thing to understand is that bitcoin is far more like cash than a bank account. Once bitcoin is spent there is no record. There is no bank statement to which the owner or HMRC (Her Majesty’s Revenue and Customs) can refer. There has been much written about how attractive this is to criminals and the black economy, which may or may not be correct. Cash also has a history of being attractive to criminals and the black economy. The battle between criminals and the state will undoubtedly be eternal, but in the meantime cryptocurrencies are almost certainly going to move into the mainstream.
We have had cash for thousands of years and taxes for just as long. We have had double entry bookkeeping and record-keeping for several hundred years. These can work perfectly well for bitcoin and other cryptocurrencies.
If a person uses bitcoin only to buy games or to send money overseas, these are consumer transactions and there is no obligation to keep records. But if someone:
- buys bitcoin to hold as an investment; or
- sets up a business to take payment in bitcoin;
that person must keep proper records and report any gain or income to HMRC. The department has the power to impose penalties of up to £3,000 ($4,142) a year for not keeping proper records and charging 100% fines for failure to report and pay liability to tax, which may also be a criminal offense liable to imprisonment.
Eventually, apps may be developed that keep records of cryptocurrency transactions, but for now it is important to record transactions on conventional media. Keeping these records is essential for serious investors.
For investment holdings, the records required should be in the same format as those for conventional investments such as stocks and shares. Each investment (cryptocurrency) has its own ledger (spreadsheet), at the top of which is shown the nature of the asset. Then, by columns:
- the date of the transaction;
- the nature of the transaction — buy or sell;
- the number of units of the cryptocurrency;
- the value of the transaction in sterling; and
- perhaps a running total of the investment units — the cryptocurrency value.
Apps are available that transfer between cryptocurrencies — this is the sale of one asset and purchase of another and therefore a tax point.
The annual exemption for gains under £11,600 ($16,016) is available for bitcoin transactions. However, in light of the recent growth in value of bitcoin, this may not be enough to cover all gains. A client, 18 months ago, bought £10,000 ($13,807) of bitcoin; this is now valued at about £120,000 ($165,684). The client is considering moving half of his holding to ethereum — another digital currency — but it is important to realise that this would trigger a capital gain with about £9,000 ($12,426) of tax potentially due for a higher-rate taxpayer.
For businesses, the situation is different. Each may have several bank accounts and a petty cash account. It is not unusual to have one or more accounts in a foreign currency. Each cryptocurrency is a foreign currency for accounting purposes. Some accounting software has multicurrency capability but, even the most basic accounting software can be adapted to keep multicurrency transactions.
For example, if the existing accounts are in sterling, set up a new ‘company’ for the cryptocurrency account. Keep the accounts in the cryptocurrency, then monthly or quarterly translate into sterling and post into the sterling accounts. The difference in value is put through as a profit or loss on exchange each time you post into sterling.
Alternatively, cryptocurrency transactions can be kept on the existing accounts, a new bank account set up and each transaction recorded at its sterling value. The account is brought to its correct sterling value once a month by putting an entry in profit and loss on exchange.
As with cash transactions, it is vital to keep the record in real time, bearing in mind that the transaction itself leaves no trace.
Currency gains and losses made in the course of normal trading will be taxed as part of the trading profit, but the important consideration here is to record correctly the trading income and expenditure.
Investors should consider using their annual exemption each year, either by switching to a different cryptocurrency or a different asset class, creating a gain of £11,600 ($16,016 – the annual exemption), and establishing a new higher base cost for the new asset. This practice is common among professional managers of share portfolios, but much harder for owners of property portfolios. For investors in cryptocurrencies the ease of making the deal and the lack of associated costs make this kind of bed-and-breakfast transaction an obvious option.
For businesses, there are fewer tax planning opportunities; instead they must give more consideration to risk. It is fantastic to receive payment in bitcoin with none of the charges and commissions associated with PayPal or conventional banks. But currency risk will be a new problem for many businesses. It is helpful if suppliers can be paid in bitcoin, but most will have set prices in sterling. Recent months have seen a huge volatility in bitcoin values, with a substantial fall over a few weeks. Some investors may now be sitting on losses. Those losses will be allowable for capital gains tax purposes in the normal way and investors might want to consider crystallising these before the year end in case the value does not recover.
As always, investors — whether individuals or businesses — should obtain professional advice, and make sure they understand the risks and consequences if they venture into cryptocurrencies.