Practical and Reflective Thoughts on the UK's Cryptocurrency Taxation System

Written by: TaxDAO, Wu Talks Blockchain

Introduction

The development of crypto assets has brought not only innovation and opportunities but also challenges and risks. In the field of taxation, the complexity and diversity of crypto assets have introduced new difficulties and requirements for tax management. As one of the global leaders in financial technology, the UK plays an important demonstrative role in the tax policies regarding crypto assets for other countries. At the same time, the reform of crypto asset taxation in the UK is also at the forefront of the world, which is worth the attention of investors. This article will analyze the foundation, current situation, and future of crypto asset taxation in the UK, exploring the development trends and challenges of crypto asset taxation in the UK.

Foundation: Overview of the UK Tax System

The UK's taxation is primarily collected and managed by HM Revenue and Customs (HMRC), with various types of taxes including income tax, property tax, capital gains tax, inheritance tax, and value-added tax, among others. Among these: income tax, capital gains tax, and inheritance tax are progressive taxes levied in brackets based on the taxpayer's income level, while property tax and value-added tax are proportional taxes levied at fixed rates.

Direct Taxes: Income Tax and Capital Gains Tax

Income tax is a direct tax levied on various incomes of taxpayers. Taxpayer income includes wages, interest, dividends, rent, pensions, benefits, etc., but not all income is subject to income tax. For example: interest from Individual Savings Accounts (ISAs) and National Savings Certificates (NSCs), lottery and premium bond winnings, and rental income (if below £7,500 per year) are exempt from income tax.

In the UK, there is a basic tax-free allowance for personal income tax, known as the Personal Allowance. This is the amount of income that each taxpayer can enjoy tax-free before paying income tax. For the 2022-23 tax year, the Personal Allowance is £12,570, and only the portion of personal income exceeding this amount is taxed at different rates. In England, Wales, and Northern Ireland, there are four income tax bands: Starter Rate, Basic Rate, Higher Rate, and Additional Rate, while Scotland has five income tax bands.

Capital Gains Tax (CGT) is a tax levied on the profits obtained by UK residents from the sale or transfer of assets. The rate of capital gains tax depends on the applicable income tax rate and the type of asset sold, and there is a certain exemption amount. If the applicable income tax rate is the higher rate or additional rate, the capital gains tax on residential property is 28%, while for other assets, it is 20%; if the applicable income tax rate is the basic rate, the capital gains tax on residential property is 18%, while for other assets, it is 10%. For the 2021/2022 tax year, the personal exemption for capital gains tax is £12,300.

UK Corporation Tax is a direct tax levied on the income and capital profits obtained by companies or other legal entities in their business activities, which includes the taxation of capital profits (Capital Gains) obtained by companies. This means that when a company sells or transfers assets within the scope of corporation tax, the profits are included in the taxable range of corporation tax. In terms of tax rates, there has traditionally been a single unified rate of 19%. However, starting from April 1, 2023, to increase tax revenue and encourage the development of small and micro enterprises, the UK government has established a new corporation tax plan: companies with profits exceeding £250,000 will pay 25% corporation tax; companies with profits below £50,000 will continue to pay 19% corporation tax; and companies with profits between £50,000 and £250,000 will pay corporation tax at a marginally increasing rate.

Indirect Taxes: Property Tax and Value-Added Tax

There is no tax specifically named "property tax" in the UK, but there are indirect taxes levied on houses and land, primarily in two forms: Council Tax and Business Rates. These are local fees levied on residential or commercial properties to pay for public services provided by local governments, such as education, health, waste disposal, road maintenance, and traffic management.

Value-Added Tax (VAT) is an indirect tax levied on the value added to goods and services during production and sales. In the UK, there are three different VAT rates: the standard rate (20%), the reduced rate (5%), and the zero rate (0%). Different types of goods and services are subject to different rates; for example, food, children's products, and newspapers are subject to the zero rate, while the vast majority of goods and services are subject to the standard rate.

Current Situation: Analysis of Crypto Asset Taxation in the UK

History of Crypto Taxation in the UK

The UK is one of the largest financial centers in Europe and a significant player in the global crypto asset market. However, the tax policy regarding crypto assets in the UK has not been clear and unified from the beginning, but has undergone multiple revisions in response to the rapid development and changes in the crypto asset field.

Initial Exploration: 2014-2018

In 2014, HMRC published its first guidance on the taxation of crypto assets, covering three types of crypto assets: exchange tokens, utility tokens, and security tokens, leading the way among EU countries at that time. The guidance stated that crypto assets are not currency or currency equivalents but rather assets, and thus fall under the existing tax framework. It also outlined the basic principles and methods for levying income tax and capital gains tax on crypto assets.

• Mining income is exempt from VAT;
• Losses and gains from holding and selling virtual currencies will be treated as gains from other goods or currencies;
• Digital currencies purchased and stored for personal reasons, without speculation, will not be taxed;
• When selling cryptocurrencies as services and goods in the UK, VAT must be paid.

In 2018, the UK government established a dedicated task force for crypto assets to study and assess the impact and potential of crypto assets and proposed a series of action intentions.

Refining Rules: 2019-2021

During this phase, HMRC published the second, third, and fourth pieces of guidance on the taxation of crypto assets, continuing the classification of crypto assets from the task force report and providing more detailed and specific tax rules regarding utility tokens, security tokens, crypto asset businesses, mining, and staking. Among these, businesses engaged in crypto asset activities are required to record all relevant information and determine their value and profits according to the corresponding accounting standards.

Responding to DeFi: 2022 to Present

In this phase, HMRC published the fifth piece of guidance on the taxation of crypto assets, primarily focusing on decentralized finance (DeFi). The UK Treasury issued two consultation documents in 2022 and 2023, seeking opinions on changing the tax treatment of DeFi lending and staking, and proposed corresponding legislative plans aimed at standardizing and regulating DeFi.

Tax Collection Methods for Crypto in the UK

Due to the common law tradition and the flexibility of crypto assets, the UK government has not chosen to establish a complete set of crypto asset tax laws but has instead incorporated them into the existing tax framework based on their nature and use, primarily levying income tax and capital gains tax on them. The methods for levying these two taxes are the same as for other types of income and assets. Taxpayers need to calculate their income and profits from crypto assets for each fiscal year based on their circumstances and report them on the appropriate tax return. The UK also provides some tax-free allowances or relief measures, such as the Personal Allowance, ISA exemptions, and the Annual Exempt Amount.

In addition, the UK may also levy other types of taxes on crypto assets, such as VAT, Stamp Duty, Stamp Duty Reserve Tax, and Stamp Duty Land Tax. These taxes primarily depend on whether the crypto assets involve goods, services, securities, or land. If crypto assets are used as consideration for the purchase or transfer of land or buildings, then Stamp Duty Land Tax should be calculated according to the definition of "money or money's worth." However, the situation is different for the other three types of taxes, where the need to pay VAT, Stamp Duty, or Stamp Duty Reserve Tax for utility tokens and security tokens depends on their specific characteristics and uses, while exchange tokens are not considered goods, services, stocks, tradable securities, or taxable securities in the UK, thus not involving the above three taxes.

As the UK currency has decoupled from the EU, taxpayers need to convert crypto assets into pounds when calculating the taxable amount for crypto asset transactions. HMRC stipulates that the exchange rate used for conversion should be the fair market value at the time of the transaction or the closest time to the transaction. Taxpayers can use exchange rates provided by any reliable source, such as crypto asset trading platforms or brokers.

Future: Further Improvement of DeFi Taxation

Overview of the Second Consultation on DeFi

The current policy focus of the UK government is primarily on the taxation regulation of DeFi. In the second consultation document, the UK government defines DeFi as "decentralized platforms or protocols that provide financial services using crypto assets, smart contracts, and distributed ledger technology. DeFi includes a range of activities such as lending, staking, trading, and insurance, aimed at providing alternatives or supplements to traditional financial services. The characteristics of DeFi are that it does not rely on any intermediaries or trusted parties but achieves automation and security through algorithms and code."

In the current crypto tax system, the tax treatment of DeFi lending and staking activities is overly complex. Taxpayers need to record the details of each DeFi staking/lending transaction, including the type, quantity, value, time, source, and purpose of the crypto assets, and calculate and report according to different tax types and rules. Moreover, the tax treatment of DeFi lending and staking activities may lead to issues of double taxation due to their nature. Therefore, the UK government is attempting to simplify and unify the tax treatment of DeFi staking/lending activities through a reform plan, making it more aligned with its economic substance while reducing the administrative burden on taxpayers. Specifically, the reform plan includes the following contents:

1. Crypto assets used in DeFi transactions will no longer be regarded as generating tax disposals; instead, tax disposals will only occur when they are economically disposed of in non-DeFi transactions. This can avoid multiple taxation on the same crypto asset and simplify the record-keeping and reporting obligations for taxpayers.

2. All DeFi income will be treated as miscellaneous income and included in a new miscellaneous income expense for crypto asset transactions. This can unify the tax treatment of different types of tokens and eliminate the need to judge trade activities or non-trade activities.

3. The new miscellaneous income expense will apply to both individuals and businesses, levied at the corresponding rates of income tax or corporation tax. This can maintain fair competition between individuals and businesses and align with the existing tax framework.

4. The new miscellaneous income expense will allow taxpayers to deduct costs and losses related to DeFi transactions but will not allow deductions or transfers against other types of income or profits. This can reflect the actual situation of DeFi transactions and prevent potential abuse or evasion.

The UK government believes that the economic substance of DeFi lending and staking is similar to repurchase agreements, as users do not relinquish their economic interests in crypto assets during DeFi transactions but merely temporarily transfer ownership or control. Therefore, the UK government hopes to treat DeFi lending and staking as repurchase agreements, thereby excluding them from tax disposals, meaning that users will not incur gains or losses in DeFi transactions. Instead, gains or losses will only occur when users economically dispose of crypto assets in non-DeFi transactions (e.g., selling, exchanging, or gifting), calculated at market value.

Responses to the DeFi Reform Plan from Various Sectors

The representative organization of the UK cryptocurrency asset community, Bitcoin Policy UK (BPUK), stated in its response on June 22 that BPUK supports the government's goal of establishing a tax framework for DeFi, believing that this will help the UK become a leader in the global fintech market and provide more certainty for taxpayers. BPUK supports the government's opinion of treating staking/lending DeFi transactions as repurchase agreements and suggests allowing taxpayers to choose whether the new rules apply to their past DeFi transactions to avoid double taxation or unfair outcomes.

However, there are also differing opinions regarding the treatment of staking/lending DeFi transactions as repurchase agreements. The Institute of Chartered Accountants in England and Wales (ICAEW) stated in its response on June 23 that it supports the government's goal of establishing a tax framework for DeFi and hopes the government can further study the tax issues of the broader crypto asset market. ICAEW further believes that compared to treating DeFi transactions as repurchase agreements, the no gain/no loss (NG/NL) rule is easier to apply to most situations in the DeFi market, not only making it more convenient for taxpayers but also covering a broader scope of DeFi transactions. The DeFi Education Fund also expressed in its response on the same day that treating DeFi transactions as repurchase agreements would lead to tax unfairness and irrationality, as well as administrative complexity and difficulties. They suggested that HMRC should develop a simpler, clearer, consistent, and fair tax framework to accommodate the complexity and diversity of DeFi transactions.

Possible Improvements to DeFi Taxation

Overall, the UK government's regulatory attitude towards DeFi is positive yet cautious, recognizing both the innovation and potential of DeFi while also valuing its risks and challenges. The UK government will determine whether regulation is needed based on the specific circumstances of DeFi and take appropriate regulatory measures, adhering to principles such as protecting consumers and investors, promoting market competition, maintaining market stability, and preventing market abuse. The UK government will also continue to monitor new technologies and models in the DeFi field and make corresponding regulatory adjustments and updates.

Regarding whether to treat DeFi lending/staking transactions as repurchase agreements, after considering the opinions of various institutions, this article believes that the UK government may reconsider the proposal to treat staking and lending in DeFi as repurchase agreements and make adjustments and modifications based on market feedback and actual circumstances. The UK government may attempt to find a balance that provides more flexibility and space for DeFi while protecting consumers and investors, promoting market competition, maintaining market stability, and preventing market abuse. In this consideration, the UK government may consider the applicability of the NG/NL rule.

In summary, the development trend of crypto assets in the UK is: regulation, innovation, and cooperation. This presents both opportunities and challenges for participants in the crypto asset field, serving as both an incentive and a constraint.