For those of you that still think crypto is outside HMRC’s reach, think again!
Whether you’re a casual trader, a long-term holder of crypto, or someone dabbling in NFTs, HMRC will increasingly be able to track you down.
Most people now realise that cryptoassets are taxable, but it’s not just when you sell tokens for cash. Swapping one cryptocurrency for another, say, trading Bitcoin for Ethereum, counts as a disposal, and if there’s a profit, it’s likely to be taxable.
Using crypto to buy a pizza, a new laptop, or even giving it away in some circumstances? That, too, could be a taxable event.
Tax returns are getting a crypto update
In fact soon there’ll be a specific section just for crypto activity on your self-assessment tax return.
You’ll need to disclose the type of tokens you hold, when you bought or received them, how many you’ve got, and their value in pounds at the time of the transaction.
That means no more guesswork. You’ll need proper records.
HMRC advises keeping digital wallet addresses, dates of transactions, and bank statements. And if HMRC decides to investigate? Well in certain circumstances, they can look back as far as 20 years.
Right now, crypto exchanges don’t automatically report your activity to HMRC. But that’s also changing.
From 2026, new global transparency rules are expected to come into play. These rules could force platforms to start handing over customer data to the tax authorities, including HMRC, similar to the way online marketplaces like eBay and Etsy now report their seller’s income.
So, if you’ve been quietly trading or earning in crypto, the window for staying under the radar is closing fast.
Mining, earning, and spending crypto? It All Counts
What about crypto mining? Well, that counts as income too and should be reported as such on your tax return.
And if you’re getting paid in cryptocurrency, you still need to account for income tax and National Insurance. In most cases, this should be taken care of through PAYE, but if it isn’t, the responsibility lies with you.
What’s more, even where income tax is accounted for, if you later sell that crypto at a profit, you could also be hit with a Capital Gains Tax bill.
HMRC is already taking action
Last year, HMRC sent letters to individuals they suspected of failing to report crypto-related income and gains with a 60-day deadline to reply.
If you’ve missed declaring income in previous tax years, there is a way to sort this out through HMRC’s disclosure facility. But be prepared, this could result in penalties and interest on unpaid tax, so if you do get a letter, it’s always best to get professional advice before you reply
The crypto world moves fast, but HMRC is catching up. Whether you’re a miner, trader, investor, or someone paid in crypto, you need to be compliant.
Next Steps
At ETC Tax, we make crypto tax compliance clear, simple, and stress-free. We understand how the rules apply, how to get your records in order, and how to protect yourself from unnecessary penalties.
If you think you might have something to declare or just want peace of mind, get in touch with us today.
The talk of crypto town at the moment is very much the Ethereum Merge or simply The Merge which happened today.
I’m not talking about some kind of BBC drama by numbers whose formula consists of picking a verb at random and prefixing it with the definitive article.
No, we are talking about the shift by the Ethereum blockchain from the Proof of Work engine to Proof of Stake.
Sadly, I will only attempt to answer the first three… and (more sadly) throw in some obligatory tax content (otherwise Mrs Wood won’t let me write any more articles).
Crypto is full of jargon, which is saying something from someone who works in tax. I have tried to explain this away as much as possible. However, we have a very useful ‘cryptionary’ that might assist where I fall short.
Consensus Mechanisms
General
The challenge of any system of digital money lacking third-party oversight is how to prevent more nefarious characters from abusing it.
How can the network, made up of many nodes, reach agreement (or consensus) regarding the data it receives? What information is correct and what is incorrect?
Proof of work
The Bitcoin protocol introduced a mathematical solution to this problem. This is the “proof of work” (“POW”) consensus mechanism. The idea is that it makes the economic cost of attacking the system disproportionate to the potential benefit of such a move.
Let us say that I want to purchase some cryptocurrency and I execute this through my wallet using a decentralised exchange. Here, each node will attempt to validate this transaction by competing with other nodes to solve a complex mathematical puzzle.
Where a node is successful in being the first to find the ‘hash value’ of the transaction, you can add to the ledger. It will transmit this data to all of the other nodes in the network who will also verify its validity.
The process of mining rewards a successful node with a “block reward” which is usually in the form of newly mined tokens.
Determining the correct hash requires computer processing time which in turn requires energy (and sometimes a lot of it!). This is a double-edged sword for POW consensus mechanisms. For instance, as a positive, a bad actor might invest a huge amount of resources in making sure that he or she is first to find the hash. However, it would be highly unlikely that the rest of the network would accept the nefarious player’s block of transactions. As such, our bad actor has expended a lot of energy and cost for no result. On the other hand, the energy costs of POW blockchains such as Bitcoin led to criticism for having an adverse environmental impact.
The Ethereum network, up until the merger, also used POW (albeit being a variation on the one used by Bitcoin). However, the Merge represents a shift to something called Proof of Stake (“POS”).
Proof of Stake (“POS”)
This is a mechanism some other blockchains use (e.g. Tezos and Cardano). Here, only members of the network with a financial stake may add blocks to the distributed ledger. Rather than battling with other members of the network to solve a problem, so-called validators in a POS network do not compete with each other. Instead, they must prove that they own an amount of the network’s tokens in order to be able to generate a block on the ledger.
The rationale is that the greater a person’s financial investment in a network, the lower the likelihood that the person will be a bad actor. As such, influence is proportional to the number and value of tokens a person holds in the relevant network.
Capice?
What is the Ethereum Merge?
Essentially, the Merge is the shift from POW to POS without closing down the Ethereum network.
You know I like an analogy. The more tortured the better. So here goes…
It is therefore the equivalent of changing a car from an combustion engine to an electric whilst driving down the M6 toll.
But why is it called The Merge?
Well, this is because, from a technical perspective, it is doing exactly what it says on the tin. In other words, the event is the merging of two separate blockchains.
Two separate blockchains?
You do ask a lot of questions.
Of course, one of these is the current blockchain which is officially called the Ethereum Mainnet. Alongside this, for some time, there has been a ‘shadow’ POS version of the blockchain called Beacon Chain.
Now the Merger has taken place, the POS blockchain has taken over.
So, a bit more than not leaving your TV on standby!
However, the resulting coin, referred to as Ethereum 2.0, is not a new token.
What are the tax implications of the Ethereum Merge?
Where there is simply a merger of the two blockchains and one essentially owns ETH tokens under a POS system rather than a POW consensus mechanism. As such, I cannot see how there is any disposal for tax purposes. In other words, we are not exchanging one distinct cryptocurrency for another which, as you may be aware, would usually be a disposal for tax purposes.
I think this view is supported by HMRC’s manuals.
The shift from mining coins to staking / forging is unlikely to change the taxpayer’s income taxes position either. Generally speaking, for average investors, this will be treated as Miscellaneous Income. Those who mine or stake on a more deliberate and organised basis will likely be within the trading income rules.
But is there a potential, ahem, canary down the crypto mine?
For fork’s sake
Although we do not know for certain, the Merge might result in a fork of the Ethereum blockchain.
A fork might occur where there is some disagreement in the coin’s community as to how a particular coin might develop. As such, the blockchain splits and the two different communities go their own way.
Blockchain forks have happened before with, most famously, with Bitcoin Cash being a fork of Bitcoin. Ethereum itself has previously undergone a hard fork in the past which resulted in the creation of Ethereum Classic or ETC (no relation!)
The rumour is many Ethereum miners are somewhat anxious about these developments (I can’t think why – other than they have warehouses full of much less profitable mining rigs.) As a result it is expected that there will be a ‘hard fork’ in the blockchain with the disgruntled miners keeping on their digital mining helmets and continuing to mine the token on their own version of the blockchain. This will be done by ETHW Core under the highly creative moniker ETHPOW with its token called ETHW.
Where new tokens are issued as a result of the fork then it is likely that TCGA 1992, s. 43 (“Assets derived from assets”) will apply in relation to the new tokens. As such, the costs for capital gains purposes will need to be split between the old and new tokens on a just and reasonable basis.
Conclusion
Undoubtedly, the move for Ethereum from POW to POS will be significant. As stated above, it massively reduces the energy input required to keep the blockchain living and breathing.
Of course, bitcoin is the biggest and most well-known of the cryptocurrencies. However, without angering the bitcoin maximalists, the Ethereum is much more useful. Indeed, as per the figures produced by Outlier Ventures for Q4 2021, it is the blockchain with the most active developers. In reality, Ethereum and Cardano are in a league of their own, with the others merely also rans.
Further, Ethereum is the father and / or mother of NFTS and, anecdotally, they say many potential investors were reluctant to explore this world of Bored Apes and Cool Cats because of the environmental concerns. The Merge may assuage this objection.
If you have any queries about the Ethereum Merge, tax on cryptoassets, or tax in general then please do get in touch.
As I wrote recently on our blog (1st November 2021 – “Crypto Tax Planning”), crypto activities are becoming ever more sophisticated. A year ago, our crypto clients were individual traders, buying and selling tokens for a profit. Now, we are advising metaverse developers, developers of GameFi projects and successful NFT artists.
An area we are now focusing on with many clients is research and development. Blockchain is cutting-edge technology and so the space is ripe for this generous relief.
For a small or medium company, a successful claim for R&D will result in 230% of qualifying expenditure being deducted from the bottom line for taxable profit or an immediate cash payment from HMRC of 33.35% of the expenditure for a loss-making company.
A company spending £200,000 on qualifying activity would reduce taxable profit by £460,000. A loss-making company would be able to claim a cash payment of £66,700 instead.
Innovation
The building block of crypto is the blockchain and developers are now flexing its power and potential application.
R&D is defined for tax purposes as a project which seeks to achieve an advance in science or technology through the resolution of scientific or technological uncertainty.
The projects on which we are advising are all built on one or other of the current blockchains, such as Ethereum, Fantom or Polygon. Each blockchain has its own underlying code, is developed independently and is pre-existing. Thankfully, for R&D you don’t have to develop an entirely new technology – working with an existing technology to solve a novel problem or modifying or integrating it in a unique manner or developing a new and unique service could qualify just as well.
To qualify for R&D relief, a company must meet a ‘two-limb’ test:
Is the company achieving a technological advance in the field of science and technology?
At the outset of the project, is there technological and scientific uncertainty, which the company would need to resolve to be able to achieve the advance?
To illustrate, we can look to some of the casework we have been working on.
Martian Premier League
Martian Premier League are developing a football manager style game which will be deployed over the Polygon network. The Polygon network is an existing technology. Football manager style games have been a staple of footballer-wannabe-geeks for a decade or more. So, where is the R&D potential?
An area being explored on this project is adapting the Polygon network technology so that it can support elements of the game. The developers are keen that the game will function entirely over the blockchain, rather than simply having elements of it (such as NFT’s representing players) existing on the blockchain as is the case for other blockchain games.
This means that smart contracts will have to be developed to resolve and record events in the game (e.g., working out whether Team A or Team B win a match, calculating the impact of all the different characteristics of the players on each team and their impact on the gameplay).
A similar problem is working out how players of the game will be able to invest earned exchange tokens to “train” their players, to improve different “skills”. Generally, the owner of an NFT is not able to change its characteristics, so this would be a clear innovation.
Taking those discrete projects and holding them up against the definition for R&D, we can see a plausible case for there being a technological development. The developers here are taking the existing technology of the Polygon network code and working out how that code will allow these innovations to work. The project requires working through uncertainty; the team have an objective in mind but how it will be done and what the solution will look like (or indeed, whether it is actually possible) are all unknowns.
In this case, the team have secured significant investment and so cashflow may not be a key concern. Being able to legitimately reduce profits for the purposes of tax means that our assistance in making a claim for R&D will make the project all the more viable and increase retained profit for future investment and development.
An example of improved efficiency which could qualify for R&D can be seen in the case of more than one client who are trying to find ways to reduce gas fees on blockchain transactions.
Every transaction on the blockchain requires a gas fee. For example, an interaction on the Binance Smart Chain (BSC) will require a small fee paid with BNB (the Binance exchange token). This is the fee awarded to miners who record transactions on the distributed nodes which make up the network. So, writing a smart contract and ‘uploading’ it to the blockchain will cost a fee, as will Interacting with that smart contract.
In one case, the developer of a Metaverse environment intends to allow individuals to purchase virtual real estate, represented by NFT’s. Plots of that real estate will consist of many small chunks represented by those NFT’s, so each plot will have multiple landlords. The plots will be ‘rented’ by individuals or businesses who will be able to ‘build’ on them, creating shops, advertising spaces or whatever else their imagination and the technology allow.
This kind of virtual estate management is not new (e.g., SecondLife, developed by Linden Lab in 2003). The introduction of the blockchain adds another level of technological challenge as well as clear advantages and added functionality.
Returning to the metaverse project; each transaction requires a gas fee:
Renting out plots;
Distributing income to NFT holders;
Building on plots and so on.
To achieve a seemingly simple transaction may require a sequence of complex smart contracts in the background.
Gas fees are based on the data involved in the transaction; a complex smart contract will cost more than would a simple one. Accordingly, a project working on solutions to streamline the smart contracts for a transaction could well amount to a qualifying technological advancement.
We have barely scratched the surface of the kinds of technological developments taking place in this space. Any blockchain developer should carefully consider whether the work they are doing would qualify for this extremely generous relief. It could be the difference needed for a successful launch.
Indeed, 12-year-old Benyamin Ahmed has reportedly made £290k after ‘minting’ his own series of ‘Weird Whales’.
He managed to sell his 3,350 emoji style whales to NFT investors – or, as The Byte put it, ’selling NFTs to idiots!’
But what of tax, I don’t hear you cry.
Well, as I often set out, there is no such thing as ‘crypto tax’. It is generally not the type of asset ithat is important, but what one does with it. This applies to most assets – whether crypto, property, shares etc.
The usual distinction is between investment and trade. The former being subject to capital gains and the latter being subject to income taxes. It must be said that it is usually only in exceptional cases that the buying and selling of crypto assets will constitute a trade.
Activities such as the mining of crypto are more likely to constitute a trade. This will be the case where our miner has invested in a quality mining rig and approaches the activities in an organised, commercial manner.
To borrow a phrase from the master of soundbites Tony Blair, there is third way. Where a person’s activity falls short of being a trade (a relatively high hurdle) but is sufficiently frequent it could be considered as ‘miscellaneous income’.
Of course, it will be fact specific. Here, we are limited by the information available on the BBC website – evidence which I accept might have limited probative value.
At first blush, based on media reports, that Benyamin’s Ethereum revenue might be subject to tax under miscellaneous income. We are told he has tried this before and he didn’t make any money (or Ethereum, anyway). We are told that it is ‘his hobby’ and he “enjoys it alongside swimming, badminton and taekwondo”.
Notwithstanding the fact he has made 290k big ones, it sounds like he approaches this as a hobby.
However, we then hear that he has ‘engaged lawyers to “audit” his work’ (presumably regarding copyright) and has also received advice on how to trademark his own designs.
It therefore starts to feel that Master Ahmed is ticking a number of the badges of trade and, at least, his hobby is becoming a trade.
So, as I say, the weird world of NFTs.
All I need to do now is work out the tax position regarding my Bored Ape which has been fed ‘serum’ and created a quite separate Mutant Ape… Hmmmm?
If you have any queries regarding NFTs, crypto assets, or tax matters in general then please get in touch.
Andy Wood explains how Family Investment Companies can be used as tax-efficient vehicles for a crypto investor.
It is without a doubt that blockchain technology and crypto assets are here to stay. The most recent development in the crypto sphere involved the listing of Coinbase on Nasdaq topping a market capitalisation of $105bn, which settled after a short frenzy at $60bn.
As the space continues to develop and grow, more and more individuals are seizing their opportunities and finding themselves accruing life-changing amounts of wealth. With awareness of tax compliance issues generally being good, investors and developers are shifting their focus towards future planning.
In short, a Family Investment Company (“FIC”) is a corporate vehicle designed to preserve, maintain and grow the family wealth whilst meeting the income requirements of the various parties involved. It is typically considered a structure in which the principles retain control whilst earmarking value for successive generations tax efficiently.
It acts as a useful ‘hub’ from which to pool, manage and grow the family wealth and protect assets from the grips of personal and external creditors.
How can a FIC benefit a crypto investor?
In order to understand how a FIC can benefit a crypto investor, we must understand some of the common and underlying issues faced by them. Based on our recent experience of dealing with crypto enquiries, in summary, the most common issues faced by crypto investors include:
Wealth being accrued in a personal capacity is potentially ‘up for grabs’ in a legal claim or divorce, both now and for future generations;
Significant exposure to inheritance tax leaving a considerable dent in the amount of wealth being passed on to successive generations;
Providing gifts to family members or using the assets to provide an income or earmarking funds for the investor’s family, such as paying for school fees, supporting children during university, helping them to buy their first house or assisting parents with income in their retirement;
Retaining control over the family wealth with the flexibility to bring other family members or external parties into the management of those assets.
Transferring existing crypto assets to a company
When we speak of a ‘transfer’, a company is not usually able to have a wallet or exchange account in its own name. As such, the individual should ensure the necessary arrangements are made to evidence the ownership of the assets.
In many circumstances, the investor will already hold a significant portfolio on his own account. As such, there will be a number of tax implications which may act as a barrier to transferring crypto assets into a company.
The main issue will be that a transfer of crypto assets to a company is deemed to be a sale at market value, crystallising any capital gains which may be outstanding on the portfolio. Often, this will generate a tax charge that the client is not in a position to fund without liquidating some or all of their portfolio.
Of course, the longer-term advantages of using a FIC may outweigh the short-term tax cost, in which case, it may remain a feasible option. It may also be possible to meet this tax charge without using your own funds or liquidating the portfolio, for example, by leveraging part of your portfolio.
If the tax charge is not tenable, then there may be other options available to the investor. For example, where the investment portfolio could be considered to be a serious undertaking with the view to profit, it may be possible to rely on relief specifically designed to allow business (trading and investment) to mitigate a charge when moving into a company.
ETC Tax are at the forefront of the taxation of crypto assets, regularly assisting investors and traders with the compliance and structuring issues. We have a solid grasp on the fundamental and underlying practicalities which allows us to identify and implement planning that is bespoke to each investor’s circumstances and objectives.
To date, ETC has assisted in unique and sensitive cases including large historic and offshore non-compliance affecting crypto investors, crypto-gaming and NFT tokens, unique mining arrangements where there are restrictions and conditions imposed on node operators and working with DeFi platforms.
