Cryptocurrencies are digital currencies which uses cryptography (the art of writing and solving codes) as a means to keeping it secure. 
These digital currencies are created and used for transactions in open source environments. You can use these cryptocurrencies to make online purchases and, in the US, PayPal recently announced that they will offer a service to their customers to buy, hold and sell these digital currencies through their platform. 
 
There are many types of crypto currencies, including the most well-known Bitcoin, and also Cardano, Dash, Ethereum, IOTA, Litecoin, NEO, Ripple and Stellar, to name a few. Instead of a physical bank note of gold coin, these currencies are confined to being online. 

Are cryptocurrencies legal? 

Having been around for more than a decade, these currencies are clearly more than just a fad. However, they are not regulated and although their use is unrestrained within the EU, some countries have banned their use and its current legal status does vary from one country to the next, so do check carefully before you invest. 
 
Most cryptocurrencies are decentralized, meaning that they are not controlled by a centralised government, and operate without the backing of a bank. 
 
Within the UK, the Financial Conduct Authority (FCA) clearly state that if you invest in crypto assets, you will be unlikely to have access to a Financial Ombudsman or Compensation Scheme if things go wrong. 

How does it work? 

The various different cryptocurrencies are stored in their owner’s digital wallet, and each currency has a ledger to record all the owner’s encrypted identities, how much they own and how much they can spend. 
 
So, if these currencies aren’t a physical thing that can be paid into a bank or stored in a safe, where did it come from? They were created via crypto mining. A “miner” (your computer) solves a complex problem to confirm a transaction and adds it to the ledger, your reward for carrying out this task is to receive payment in a crypto currency amount. 
 
This all might sound very complex, that’s because it’s such a big leap from what we’re used to. However, if you had invested £700 in Bitcoin ten years ago, it would now be worth almost £15 million. 
 
Because only a limited number of each of these currencies exist, there is a perceived value, which is subject to the laws of sale and demand. Therefore, crypto assets can be traded on the exchange in a similar way that investors buy and sell shares on the stock market. 

What are the implications? 

Cryptocurrencies are available outside of the traditional confides of a traditional bank, opening up trade and finance to those who have been unable to get traditional financial backing. They may well be the future of all currency and some feel having access to this form of currencies could lift many people out of poverty. 
 
Due to so many people having easy access to a mobile phone, the need to visit a bank in person has diminished. New consumer behaviour and preference is to transact and transfer their money online, doing away with the need for physical money. 
 
The COVID-19 pandemic has contributed to the surge in digital transactions and boosted e-commerce across the globe. As a result, the interest in crypto assets are on the rise. 

HMRC’s guidance on cryptocurrency 

If you choose to join the digital revolution and invest in cryptocurrency, you should bear in mind that HMRC have now introduced a manual for individuals and businesses on how tax should be applied to cryptocurrency. 
 
In this manual HMRC have indicated that the tax treatment depends on the nature of the crypto asset and what it’s used for. These include: 
 
Location – if you are a UK resident, the crypto assets you hold are also within the legal jurisdiction of the UK. 
 
Individuals – any profits arising from the trading of crypto assets will potentially be subject to Capital Gains Tax, but unlikely to be subject to Income Tax. However, if you receive any crypto assets as a bonus from your employer, they will be taxed as employment income. 
 
Businesses – if a company invests in cryptocurrency, for tax purposes it will constitute a derivative contract, which means any profit or losses will most likely be subject to Capital Gains Tax. 
 
Record keeping – HMRC puts the onus on the individual to keep their own records of each transaction, in case they are required as part of an enquiry. The information you should keep includes the type of cryptocurrency, the value in Pounds Stirling, date of transaction, number of units bought or sold, cumulative value of the investment, bank statement and the digital wallet addresses. 
 
Pensions – because HMRC consider cryptocurrency to be a token and not currency or money, pension contributions made using crypto will usually not qualify for tax relief. 
 
Gambling – on the whole, the buying and selling of crypto assets is not considered to be gambling by HMRC. However, they will consider the particular facts of each cryptocurrency transaction to conclude if any particular transaction is of a gambling or betting nature. 
 
VAT – HMRC state that in most cases cryptocurrency transitions will be outside of the scope or exempt from VAT. The exception to this rule is where goods or services are provided in exchange for cryptocurrency. 
 
Please note that it is highly unlikely for any profits made via the buying and selling of cryptocurrency will receive a beneficial tax treatment by HMRC. 

Accounting treatment 

The Generally Accepted Accounting Principles (GAAP) must be used when calculating any business profits. 
 
HMRC will apply the Badges of Trade when a company buys, sells, exchanges or mines cryptocurrency, or if they provide goods of services in return for cryptocurrency. This is to determine if the profit made is of trading nature and should therefore be subjected to Income or Corporation Tax. 
 
The speed at which this form of digital currency is evolving is extraordinary, therefore it’s likely that the rules and tax liabilities will be subject to change with the evolution of cryptocurrency into a valued, mainstream currency. 
 
If you’re in the market for a new accountancy firm to help guide you through your tax and VAT contributions on conventional and cryptocurrency, please contact us to see how we can assist you. 
 
 
 
 
Written by: 
 
Nicola J Sorrell - 
Effective Accounting 
 
Founder | Xero Champion | IR35 Expert 
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