The Ultimate UK Crypto Tax Guide 2020
The tax collecting body of the UK, HMRC (Her Majesty's Revenue and Customs), has started to more aggressively enforce its crypto tax policies. As cryptocurrencies like bitcoin have grown in popularity over the years, so has the amount of people who are making money by investing or trading them. Under the UK crypto tax rules, this income is considered capital gains and is accordingly subject to capital gains taxes.
Taxes can be a complicated subject. In this guide, we break down everything you need to know when it comes to cryptocurrency taxes for UK citizens.
What is Cryptocurrency?
If you’re reading this guide, it’s likely that you’ve already dabbled with cryptocurrencies like bitcoin. We won’t do a deep dive on the fundamentals of crypto within this piece, but we will explain how the UK government views them.
In their policy paper, HMRC explains that cryptoassets (or ‘cryptocurrency’ as they are also known) are cryptographically secured digital representations of value or contractual rights that can be:
- traded electronically
There are various types of cryptoassets including exchange tokens, utility tokens, and security tokens. HMRC does not consider cryptocurrency to be currency or money.
UK Crypto Tax Basics
From a tax perspective, investing in cryptocurrency is very similar to investing in other assets like stocks, bonds, and real-estate. This means that capital gains and losses rules apply when you dispose of your cryptocurrency. “Disposal” is a broad term that essentially means whenever you get rid of a cryptocurrency.
HMRC explains that disposals include:
- selling cryptocurrency for money
- exchanging cryptocurrency for a different type of cryptocurrency
- using cryptocurrency to pay for goods or services
- giving away cryptocurrency to another person
So you officially ‘dispose’ of your crypto whenever you carry out any of these four scenarios, and you are subject to capital gains taxes on any gains you realize—similar to if you were disposing of stocks or other forms of investments.
Christopher purchases 1 BTC for £5,000 in July. Two months later, he sells that 1 BTC for £7,000. Christopher recognizes a £2,000 capital gain on the sale/disposal of his 1 BTC.
Meg purchases 20 XRP for £50. A month later, she trades the 20 XRP for 0.05 ETH. At the time of the trade, the fair market value of 0.05 ETH is £70. Meg recognizes a £20 capital gain on this trade of her XRP.
John purchases 1 ETH for £100. A week later, he uses his 1 ETH to buy a new flatscreen TV. At the time of the purchase his 1 ETH has a fair market value of £120. John recognizes a £20 capital gain from disposing of his 1 ETH to buy his TV.
Calculating Crypto Capital Gains
In the examples above, the capital gains calculation is extremely straightforward as there are only two transactions to account for. The formula we use to calculate these capital gains and losses is as follows:
Fair Market Value - Cost Basis = Gain/Loss
Fair Market Value is the market price of the cryptocurrency at the time you sold, traded, or disposed of it. Cost Basis refers to the amount it cost you to acquire the coin.
In our 1st example above, £5,000 is Christopher’s cost basis and £7,000 is the fair market value at the time of the sale. This results in a £2,000 capital gain.
Calculating capital gains and losses from your crypto transactions becomes a bit more complex when you have multiple transactions to account for. The UK requires a specific type of method for calculating the cost basis of your coins known as Shared Pool Accounting.
Shared Pool Accounting
With the shared pooled accounting method, you are essentially averaging out all of the costs you have incurred to acquire your crypto. You take these averages to come up with your cost basis per coin.
Emma buys 1 ETH for £100 in July and another 1.5 ETH in September for £400. In December, she sells 1 ETH for £300. What is her capital gain using shared pooled accounting?
- July - Buy 1 ETH, £100
- September - Buy 1.5 ETH, £400
- December - Sell 1 ETH, £300
In this example, Emma has a total pool of 2.5 ETH. To calculate her costs basis on a per ETH basis, we need to average out her total costs.
Her allowable costs for her total pool of 2.5 ETH are £500. We then simply divide her total allowable costs by her total pool of ETH.
£500 / 2.5 = £200/ETH
Her cost basis per ETH is £200.
We can use the equation from above to calculate Emma’s capital gain from the sale of her 1 ETH.
Fair Market Value - Cost Basis = Gain/Loss
£300 - £200 = £100 Gain
Emma recognizes a £100 capital gain from selling her 1 ETH in December.
Same Day and Bed & Breakfast Rule
Things get a bit more complicated when you factor in two additional rules that apply with capital gains in the UK: the Same Day Rule and the Bed & Breakfast Rule.
Each of these rules are designed to prevent wash sales, which is a scenario in which an investor intentionally sells or disposes of an asset that has decreased in value and then buys it back soon after. This behavior maximizes tax benefits and helps the investor minimize his or her capital gains.
The Same Day Rule and the Bed & Breakfasting Rule exist to eliminate the tax benefits that would exist from this behavior.
The Same Day Rule
If you sell a cryptocurrency and buy another crypto of the same type on the same day, the cost basis for your sale will be the acquisition cost of the crypto you bought on the same day. This will be the case even if the acquisition of the crypto takes place before the sale—as long as they are both on the same day.
The Bed & Breakfast Rule
Also known as the 30-day Rule, this rule states that any of the crypto you acquire within 30 days of a sale will be used as its cost basis.
Each of these rules affect which cryptos you “sell” and the order you sell them in—from an accounting perspective.
When calculating your gains and losses and applying these three rules, your cryptocurrency will be treated as being disposed of in the following order:
- Same Day Rule: coins acquired on the same day as the disposal are consumed first
- Bed and Breakfasting Rule: coins acquired in the 30 days following the day of disposal
- Crypto-pool accounting: all previous coins purchased, price averaged
Let’s consider the following trade history and calculate the associated capital gains/losses in accordance with each of these rules.
- March 1 - Buy 1 BTC, £1,000
- May 1 - Buy 1.5 BTC, £3,000
- July 1 - Buy 1 BTC, £2,000
- July 1 - Sell 1.5 BTC, £3,000
- July 10 - Buy 0.25 BTC, £500
By applying each of the rules above, your bitcoin is priced and disposed of in the following order:
- Same Day: 1 BTC w/ cost basis of £2,000 (from July 1 purchase)
- Bed & Breakfast (30-Day rule): 0.25 BTC w/ cost basis of £500 (From July 10 purchase)
- Crypto-pool: 0.25 BTC w/ cost basis of £400. [(£1,000 + £3,000) / (2.5 BTC)]*0.25
So to calculate the capital gain from the July 1 sale of 1.5 BTC, we add each of these up to arrive at the total cost basis for that 1.5 BTC: £2,000 + £500 + £400. We can then plug this into our capital gain and loss formula.
Fair Market Value - Cost Basis = Gain/Loss
£3,000 - £2,900 = £100
In this example, the investor recognizes a £100 capital gain.
The Challenge For Traders
As you can see, these capital gains and losses calculations can quickly become tedious when there are a significant number of transactions to account for.
In addition, many cryptocurrency traders have been trading for months, sometimes years without keeping records of their trades. To properly calculate your capital gains and losses, you need to have records for the price in GBP for every crypto asset you traded or sold at the time of the sale. Remember, trading one cryptocurrency for another is considered a disposition, and you need to calculate the gain or loss in GBP on the trade.
This is a huge problem for cryptocurrency traders as this fair market value data in GBP is not always readily available. Cryptocurrency exchanges quote most trades in other cryptocurrencies—not fiat currencies—so trying to track down historical GBP values for all of your trades becomes a near impossible task.
This challenge is the reason why many cryptocurrency traders are turning to cryptocurrency tax software to automate the entire capital gains and losses reporting process.
Why Can’t My Crypto Exchanges Give Me Capital Gains and Losses Forms?
Due to the transferable nature of cryptocurrencies, exchanges don’t typically know the cost basis of your assets. This prevents them from being able to give you complete gains and losses reports.
To illustrate this further, let’s look at an example.
Mark buys 1 BTC on Coinbase for £5,000. He then sends it to his cold storage wallet for safe keeping. One year later, Mark sends his one BTC to Binance and trades it for 20 ETH.
In this example, Binance has no way of knowing Mark’s cost basis of his 1 BTC. Binance only can see that 1 BTC entered Mark’s Binance wallet on XYZ date. They have no idea when, for how much, or where that BTC was originally acquired. Because of this, Binance can’t possibly tell Mark what the capital gain or loss was on his BTC trade for ETH. It’s missing an essential piece of the equation: cost basis.
Fair Market Value - Cost Basis = Gain/Loss
This example demonstrates this problem at a small scale. Transfers happen all of the time, and it’s the transferability of crypto that makes it impossible for your cryptocurrency exchanges to report capital gains and losses on your behalf. The reporting burden falls to you as the taxpayer.
To summarize, the second you transfer crypto into or off of your cryptocurrency exchange, the exchange loses the ability to report on your gains and losses. Coinbase explains this themselves to their users within their company tax guide:
Taxes on Crypto Income - Mining/Staking
Cryptocurrency received from mining or staking efforts is considered a form of income. The income you recognize is equal to the Fair Market Value of the crypto at the time you gain possession of the coin.
The amount of income recognized then becomes the cost basis in the coin moving forward.
Roger mines XYZ coin throughout the year. On July 1, Roger receives a block reward of 0.0576 XYZ coin. At the time, this amount of XYZ coin was worth £50. Roger recognizes £50 of income from this mining activity.
The same applies for crypto received from staking rewards.
Your cryptocurrency income from mining and/or staking is classified differently whether you are mining as a hobby or as a business.
Mining as a Hobby
If you are mining as a Hobby, your income has to be declared separately under the heading of "Miscellaneous Income" on your tax return. Appropriate expenses can be deducted from this income before adding it to the taxable income.
Mining as a Business
If you are mining as a business, your mining income will be added to trading profits and be subject to income tax. Appropriate expenses are also deductible.
You can learn if your activity should be classified as a business or as a hobby with HMRC’s guide here.
How to Report Cryptocurrency On Your Taxes
In the UK, you only pay Capital Gains Tax if your overall gains for the tax year (after deducting losses) are above the Annual Exempt Amount (AEA). The Annual Exempt Amounts are pictured below.
When it comes to actually reporting your capital gains, you can use the Capital Gains Tax Service in real time, or report annually in a Self-Assessment tax return. Once you’ve reported via either of these means, HMRC will send you a letter/e-mail with a payment reference number and directions on how you can pay.
Keep in mind, HMRC requires you to keep records of all of your cryptocurrency transactions for at least a year after the Self Assessment deadline. CryptoTrader.Tax generates your capital gains and losses reports for all transactions. These reports will always be available within your account. You can also download them and store them with your records.
What Happens if I Don’t Report My Crypto Gains and Losses?
Under HMRC rules, taxpayers who do not disclose gains could face a 20% capital gains tax plus any interest and penalties of up to 200% of any taxes due. Those found to have evaded the tax could also face criminal charges and jail terms.
In August of 2019, HMRC announced that they are actively seeking cryptocurrency traders who have not reported gains. They are doing so by requesting user information from major cryptocurrency exchanges and using this information to track down suspected tax cheats.
There’s no guarantee what will or will not happen if you fail to file your cryptocurrency taxes with HMRC. However, it’s recommended to stay compliant by properly filing all of your capital gains and crypto related income. If you haven’t been reporting your gains or losses in previous years, you can get everything in order by filing an amended self assessment tax return.
This post is for informational purposes only and should not be construed as tax or investment advice. Please speak to your own tax expert, CPA or tax attorney on how you should treat taxation of digital currencies.