If you have invested on Cryptocurrency and NFT’s and you have not researched on tax on Cryptocurrency and NFT’s then this is the article to read.
Even if you are new to this but you have probably heard commotion about cryptocurrencies and NFT’s in some shape or form. Perhaps you’re interested in investing or selling in these markets and need clarification on how they’re taxed. Maybe you’re just wondering what on earth they are! This article will attempt to explain that (and more) in very simplified terms.
What is Cryptocurrency?
Everything in this article will be easier to understand if we grasp the basics of cryptocurrency. The easiest way to describe cryptocurrency is by referring to it as a digital asset. It uses modern technology to distribute exchanges and transactions across a large network of computers. This technology is called a blockchain, and while we’d really need an entire article to fully explain blockchains themselves, we can summarise it by looking at it as a collection of computers that keep track of every single transaction on its network. This is known as distributed ledger technology, and it ensures trading and ownership is secure and not influenced by any external factors like governments or market crashes.
Ok – so why would you want that?
There are several advantages to using a cryptocurrency. Transfers of money are cheaper and more efficient, and its decentralised networking system won’t collapse due to one point of failure. It generally means that governments and external sources can’t touch it, either. The key word is decentralised – people and parties all over the world can exchange money and currency independently, without the need for institutions like banks.
However, they also come with many disadvantages. At the time of writing, they aren’t used as legal tender anywhere in the world apart from El Salvador, meaning it’s a bit tricky to pop to the shop for a litre of milk and paying for it via bitcoin. Their prices are also volatile, and the sheer amount of electricity needed to run the computers that track cryptocurrency is considered to be damaging to the environment.
Where do you get Cryptocurrencies?
You can either purchase cryptocurrencies from crypto exchanges such as Cash App, Coinbase or crypto brokers, or by mining. Mining is another topic that would take a long time to fully explain, but it simply refers to the process of solving mathematical problems in exchange for bitcoin. Yes, like a real life coal miner would have to travel down deep into the earth and labour to get coal, crypto and bitcoin miners have to solve maths equations in exchange for bitcoin, a very popular type of cryptocurrency. Ironically, they’re both deemed detrimental for the environment; while fossil fuels have their obvious negative side effects, the sheer amount of electricity used to host the software required for bitcoin mining is extremely expensive and harmful for the Earth!
So… are they legal?
Yes. You aren’t breaking the law by using a cryptocurrency, and just because they aren’t yet widely accepted in every transaction doesn’t mean they aren’t okay to use. However, a lot of cryptocurrency activity has been used for illegal and nefarious means, including money laundering and purchases on the dark web. The decentralisation of transactions can be a liberating process with many genuine benefits, but it also lends itself to aiding criminal activity.
How are Crypto and Bitcoin taxed?
Whether they’re the future of financial investment or just a short lived fad, it’s important to understand cryptocurrencies and how they are taxed if you plan on using them. The main point to remember in all of this is that wherever you are in the world, cryptocurrency is taxable.
Despite not being a physical currency, cryptocurrency is seen by many as an investment. This is why HMRC sees it as an asset rather than currency or money. Luckily for us, assets are still taxed. How wonderful! However, as the market is relatively new, the legislation around cryptocurrency tax is constantly changing.
If you are trading cryptocurrency, you’ll have to pay capital gains tax on any profit that you make. HMRC refers to cryptocurrency as tokens, and you’ll have to pay tax on any activity that counts as disposal of these tokens. What counts as token disposal in HMRC’s eyes? Well…
- Using tokens to pay for services and goods
- Selling tokens for currency
- Exchanging tokens for other tokens (eg other types of cryptocurrency)
- Giving away tokens to another person, unless it’s as a gift to a recognised type of partner such as a spouse or civil partner.
Any or all of these activities will have you paying capital gains tax on cryptocurrencies.
Do I Need to Pay Tax?
Everyone has a tax-free allowance for capital gains tax. Anything above this allowance is taxable. The current tax-free allowance is £12,300 for for capital gains tax. There are also some allowable expenses that are specific to cryptocurrency that you can further deduct from your overall tax payment, which include:
- Marketing or advertising for a buyer or seller
- Making a contract for a specific transaction
- Transaction fees that are paid before the transaction is logged in the blockchain
However, you can’t deduct costs through expenses if you’ve already done this with profits for income tax, which unfortunately is separate to capital gains tax. You also can’t do it for the cost of mining activities that you need for bitcoin mining, including electricity and computer equipment.
How Do I Pay My Tax on Cryptocurrency?
All income and profits made on cryptocurrency are reported on the annual Self Assessment tax return form. Like with anything else, it’s very important to remember to keep records of your taxes so you know all your reports on cryptocurrency activity are accurate. According to HMRC, this includes:
- The number of tokens you have disposed and the date of disposal
- The type of tokens (eg Bitcoin, Ethereum)
- The amount of tokens you have left
- The value of said tokens in GBP sterling
- All bank statements and addresses of wallets
There are other variables that make this quite a messy topic. Also, the process is different for businesses that trade in cryptocurrency alongside other activities.
If you’re now at the stage where you’ve gone beyond scratching your head and are starting to despair, fret not. Professional accountants such as ourselves at Cubed Consultancy can help with your tax on digital goods, whether it’s bitcoin or NFT’s!
Oh dear, we were almost finished. I suppose, on the subject of cryptocurrency and blockchains, it’s important to tackle another element of digital investment that is taking the world by storm right now.
Three little letters are the talk of the investment world and are possibly even cropping up in your everyday conversation, most likely when you scream “What on earth is an NFT?” If you struggle to wrap your head around it, you’re definitely not alone.
NFT simply stands for Non-Fungible Token.
I know, that explanation probably didn’t make much difference. Let’s try and simplify it as much as possible.
The “non-fungible” part simply means it’s a unique item and can’t be replaced. So, they are unique and irreplaceable. Okay. Like cryptocurrencies (which we now definitely understand), NFT’s are also stored on a blockchain, most often the Ethereum blockchain. NFT’s are just another type of crypto token, except the focus is on ownership of a digital good or piece of art. Well, philosophically speaking, “art” is a term that is loosely applied when talking about NFT’s, because sometimes the things that are sold in the name of non-fungible tokens are not very artistic at all.
Take what Jack Dorsey did, for example. Last year the Twitter CEO sold his very first (and now infamous) tweet as an NFT on a site called Valuables to the tune of almost $3 million. I’ll let you read that again. Yes, the tweet was deemed worthy of such value, but what’s more, the buyer does not even necessarily own the tweet itself – instead, they bought a digital certificate of the tweet that was signed and verified by its creator, Jack Dorsey.
In a sense, the highest bidder bought themselves an autograph of a tweet that was freely available for everyone to read 15 years prior. They don’t own the tweet itself, not anymore than somebody who screenshots the tweet owns it. They just own a token that says they have bought ownership of the digital item.
Why Are We Doing This?
It’s all about perceived value. An NFT is just the name that is given to a digital good that a buyer can purchase sole ownership of, possibly even selling it to other buyers at a later date. What makes these digital items so valuable? There’s no one specific reason; it’s the same way people can determine the value of physical assets, like how a tea set may sell for a five-figure sum on a rather more high-stakes episode of The Antiques Roadshow. A lot of the time, value is based on how much people want a certain item, and we’re now seeing that it doesn’t matter if it’s physical or digital – if it’s deemed to have worth, people will pay for it (especially if it’s owned by a celebrity).
Ok, understood. So how are NFT’s Taxed?
NFT’s are even newer than cryptocurrency, so many tax offices haven’t issued concrete guidance on how to tax them. Many just treat them the same way they treat other cryptocurrencies, which is by taxing through capital gains tax. Different rules apply to creators and buyers, though.
Some summarised points to keep this as simple as possible:
- If you buy an NFT with fiat (regular) money, it is not taxable.
- However, if you buy an NFT with cryptocurrency, it is a taxable transaction in the same way any cryptocurrency transaction is taxable.
- If you sell an NFT, it’s also taxable, whether you’re the original artist or just the seller.
- Capital Gains Tax is paid on any profit you make from this. If you’re the artist, you may have to pay Income Tax on this instead if it is viewed as your income.
- If you swap an NFT for another NFT, it’s seen as exchange or disposal of an asset, so it is still subject to Capital Gains Tax.
- If you make an entirely new NFT in a process known as minting but don’t actually sell it, this isn’t taxable. Taxing of NFT’s only comes where you are viewed to be disposing of tokens or profiting off of a transaction.
- Like with cryptocurrencies, if you gift an NFT to your spouse or legally recognised partner, you won’t be taxed either.
As guidelines are really just forming around NFT taxation, we would expect the likes of HMRC to issue more concrete guidance in the future. However, as taxation of NFT’s comes via cryptocurrency, it’s a good idea to report any tax on NFT transactions you take part in on your Self Assessment Form along with other cryptocurrency activity.
The Bottom Line to all of this
The world of cryptocurrency and NFT’s is full of opportunity, but it’s also a little bit chaotic. It’s an excellent idea to enlist the help of professional accountants and financial advisors to help you navigate the ever changing rules and pitfalls of cryptocurrency tax. Hopefully you learned some valuable information about cryptocurrency and how they’re taxed from this article, but should you require any more help or have any questions, please get in touch with us here at Cubed Consultancy. We are a Hertfordshire based consultancy company headed by two chartered accountants, Mark and Richard.
With years of financial experience between us, we are clued into this new world of digital tokens and assets and how they affect your annual tax returns. We work closely with all types of clients, whether they are individuals or businesses, in order to tailor to everyone’s unique financial needs and requirements. If you’re worried about how you’re tracking your activity with cryptocurrencies or if you just need a bit of advice, please get in touch with us or book a free consultation