What are the tax implications for both of my clients, and will Client B get any relief for the lost hard drive?
Cryptocurrencies are intended to function as a form of electronic cash and store of value, however HMRC do not consider them to be currency or money. This means they often meet the definition of an asset and disposals can lead to chargeable events for capital gains purposes. A person may have a trade or miscellaneous income from mining cryptocurrency or be paid by their employer in cryptocurrency, in which case income tax may be applied.
There are no tax rules specific to cryptocurrencies and so general principles apply. However, HMRC have a Cryptoassets Manual which outlines their views on this subject. Of course, a different interpretation is possible, but this should be backed up by facts and source material and is best explained to HMRC in order to avoid the possibility of penalties.
HMRC’s views as to whether CGT or income tax rules apply is at CRYPTO20050.
Your client has acquired and held bitcoin over the last 6 years and is looking to dispose of it to realise its value. This meets the definition of a chargeable asset for CGT as it is one which is capable of being owned and has a value which can be realised. See CRYPTO22000.
As we have a variety of acquisitions over the ownership, when it comes to disposing of some or all of the asset you will need to pool the acquisitions to work out their cost. Pooling applies to most cryptocurrencies in the same way that it applies to most shares and securities in companies – s104 TCGA 1992. It tells us how to identify which tokens are being disposed of when we have multiple acquisitions of the token over a period of time. Purchases are split into three categories:
- Firstly, we are deemed to of disposed of any tokens that have been acquired on the same day.
- Next, we are deemed to have disposed of any tokens that are acquired in the next 30 days.
- Finally, your client will be deemed to of disposed of any tokens in what is referred to as the ’section 104’ pool. As your client has only acquired bitcoin over the last 6 years, all of these acquisitions will be placed in the s.104 pool and the total amount and price will be used to work out an average cost per unit when we make a disposal from this pool.
If the client was to hold more than one type of cryptocurrency, they would all need to be pooled separately as only assets of a nature that can’t be distinguished from each other can be pooled – see CRYPTO22200.
Tokens can be awarded to people who verify transactions of cryptocurrencies, this is often called ‘mining’ and can be profitable. See CRYPTO21000.
As your client is involved in mining cryptocurrencies it is likely he will be charged to income tax on the value of the assets he receives either as trading or as miscellaneous income. Depending on the size of your clients mining operation it may amount to a trading activity where the tokens received are taxed as trading receipts, but if it does not amount to this the income will be treated as miscellaneous income.
If Client B has kept his mined cryptocurrency and is now looking to dispose of it, he will have to pay capital gains tax on any uplift in value. Where we have the same cryptocurrency acquired multiple times, we will again need to look at the pooling rules as we did for Client A. See CRYPTO21150
Unfortunately, HMRC do not consider your client misplacing his hard drive to be a disposal for the purposes of capital gains tax. This is because the tokens will still exist and your client will still be recognised as the owner on the cryptos distributed ledger, even though they cannot access the tokens – see CRYPTO22400. If your client can prove to HMRC that they have no chance of recovering the hard drive, they may be able to make a negligible value claim under s.24 TCGA 1992 – see CRYPTO22500.
The effect of a successful negligible value claim from your client will result in a deemed disposal of the token, and immediate reacquisition for its negligible, often nil, value. This will create a capital loss for your client which he can use against the disposal of cryptocurrencies in the same year, or any other disposals they may have in that year. If they can show the asset was of negligible value in either of the previous 2 years, the loss may be carried back.
In summary, as is the same for any asset, we need to look at the reason the cryptocurrency was acquired in order to decide whether we apply capital gains or income tax as the correct treatment. Cryptocurrencies of the same type are pooled in the same way as shares and securities of the same type for capital gains.
Remember, members of our VIP Tax Team service can call our priority advice line for instant help with tax, VAT and employment queries such as this.
To unlock your access to the advice line, plus tax & VAT consultancy support, monthly eCPD modules, in-depth webinars and more, call 0800 231 5199 or book your free My VIP Tax Team consultation now.
Please share this article with your clients