By Charles Amos, regional coordinator for the TaxPayers’ Alliance
With the economy still in turmoil and the prospect of impending inflation, some are looking to something called ‘Bitcoin’ to secure the value of their money. Whether you’re interested in investing in Bitcoin or not, at a market capitalisation of over £700 billion, it is making up a larger and larger part of the world’s financial system. But what is Bitcoin, how does it work - and what does it mean for taxation?
What is Bitcoin?
Bitcoin is a digital currency (also known as cryptocurrency), which is essentially a long line of unique code (letters and numbers). Unlike traditional money - such as the £ - it is not something you can hold in your hand, or administered by a central bank. Instead, Bitcoin uses computing technology called a blockchain to facilitate the buying and selling of goods by millions of users all over the world. There is no need for any third party to handle payments. It is so popular that the process of creating and validating Bitcoin, known as mining, has led to a huge shortage of microchips in recent months
Bitcoin has a number of advantages over traditional money and banking. Among them is greater privacy, lower transaction costs and better financial security. Also of note is Bitcoin’s totally finite supply - unlike the £, given (in theory) the Bank of England could print as much money as it desires. In the long run many believe Bitcoin’s value will continue to increase. As a result Bitcoin has the potential to be an incredibly secure store of wealth. Given the pound has lost 24 per cent of its value since 2010, it’s no wonder individuals are turning to this digital safe haven.
How is Bitcoin taxed?
HMRC recently published an internal manual outlining how it believes Bitcoin should be taxed. It considers Bitcoin as a “cryptoasset” rather than a currency, such as the £ or $. Individuals dealing with Bitcoin are subject to many taxes, including income tax, national insurance (NI) and capital gains tax (CGT).
If Bitcoin is received as an income from an employer, income tax and NI apply to the £ equivalent upon the time of receipt (taking this off gross pay). If the employee then wished to sell the Bitcoin at a later date they would be subject to CGT on the difference between the price it was received at (or bought at) and the price at which it was sold.
If an individual is engaging in financial trade, then profits would be subject to income tax, and not CGT. What constitutes financial trading is a complex area, but generally it must be frequent and sophisticated buying and selling. This is unlikely to apply to most individuals. Different advice applies to business dealings. Importantly, all of the above is merely HMRC’s advice regarding existing legislation, which makes minimal explicit comment to cryptocurrency.
The difficulties of collecting Bitcoin tax revenues
On paper Bitcoin seems easy to tax, but in practice it presents enormous potential for widespread tax evasion. Indeed this recently led HMRC to explicitly include cryptoassets on statement of assets forms for tax investigations. The core reason for this problem is the almost total anonymity that Bitcoin offers. Normally, when a tax investigation occurs HMRC can issue a third party notice which requires financial institutions, such as banks, to give up the details of their customers’ transactions. Since Bitcoin isn’t stored or transacted via any third party - it is potentially untraceable code sent from one to another - HMRC can’t easily acquire transactional information and decide what taxes are owed. In the United States evasion is already widespread; in 2020 only 0.04 per cent of taxpayers declared Bitcoin gains or losses to the Inland Revenue Service despite approximately 7 per cent of Americans owning digital currencies.
Bitcoin therefore can operate like undeclared cash, meaning HMRC clearly has a problem on its hands, which will no doubt one day require much wider consideration of the complexity and unwieldiness of the UK’s outdated tax system.
Bitcoin is a bold, exciting technology. It’s a product of the digital age, challenging assumptions about currency that we take for granted, and it’s here to stay for the foreseeable future. For HMRC, it presents a real problem when it comes to tax evasion - at least under the current tax code. If Bitcoin’s popularity and value continue upwards, the problem will only get bigger for the tax man. HMRC needs to overhaul the tax code and create something fit for the digital age. Simplification of taxes like CGT and NI among others - as we suggested in our landmark Single Income Tax - will be a key part of the solution.