Government Cuts to Capital Gains Allowance: What This Means for Crypto

The main draw for many investors interested in diversifying their portfolios through crypto trading remains the platform’s decentralised nature, providing asset holders with a sense of safety and security by insulating investments from mainstream economic instability and providing unmatched data reliability. 

Though this has always been the foundation holding up the cryptocurrency market, as more individuals adopt into the framework, more attention from regulatory bodies will follow. This is where the crypto sphere finds itself in 2023, with increasing levels of governmental legislation impacting how assets are to be monitored and managed. Arguably the most important of which for UK-based traders being the recently announced cuts to capital gains allowances, but what does this mean for crypto? 

Understanding crypto assets 

Before focusing on how recent legislation is likely to impact crypto trading, it’s important to define exactly what regulatory bodies mean when they begin to discuss crypto assets. Though the history of crypto currency dates all the way back to 2009, the technology and infrastructure guiding the industry has grown and developed to such an extent that some modern tokens and assets are essentially novel concepts. 

The most commonly discussed types of crypto asset amongst the public are payment currencies like Bitcoin (BTC) and Litecoin (LTC), but there are at least six other distinct digital asset types that function in a discernibly different manner, and as a result are often treated as unique technologies. 

• Payment currencies - As the name suggests, these digital assets are used as an alternative form of payment to traditional fiat currencies. Utilising blockchain technology, tokens are encrypted, regulated and able to verify the transfer of funds between parties 
• Blockchain economies - Blockchain economies add an additional layer of functionality to digital assets by not only acting as a usable currency, but also allowing for the creation of decentralised tokens and apps built directly from the relevant platform 
• Privacy coins - Privacy coins are developed and designed to keep all transactional data completely secret, this is achieved by utilising additional layers of encryption to completely mask the identify, wallet address and balance of users whilst also hiding the monetary value of funds sent and received to anyone other than the sender and recipient 
• Utility tokens - Utility tokens are notably distinct from most other forms of crypto asset as their main purpose is to improve certain aspects of the blockchain economy. Typically, these tokens are not utilised for investment, and can be defined as such using the Howey test 
• Stable coins - Stable coins were developed to bridge the gap between traditional regulated currency and decentralised crypto assets, their value is intrinsically linked to existing asset classes to avoid some of the volatility experienced in the crypto market 
• Security tokens - Security tokens are used to represent an investor’s stake in a blockchain project, and as such are treated in a similar fashion to traditional stocks. Investment here comes with a reasonable expectation of future profit 
• Non-fungible tokens (NFTs) - NFTs are a unique form of digital asset in that their value is determined mainly by their perceived rarity to the community. NFTs are not commonly used as currency and are instead minted and purchased using crypto or traditional monetary funds 

How crypto asset types affect taxes 

For holders of crypto assets, it’s important to understand exactly how each asset type functions as in some cases this can change the way that governmental body's handle expected taxes relating to investments. For example, payment currencies like Bitcoin (BTC) and Litecoin (LTC) have long been viewed by the UK government as similar to traditional shares, and so accrue similar expected taxes. 

Conversely, crypto assets not primarily utilised for investment such as utility tokens have seen a more complicated taxation history, as regulatory bodies attempt to determine exactly how to treat any taxable profits gained from the trading and purchasing of assets in line with existing investment vehicles. 

The most recent change in the legal recognition of crypto asset types has been the UK government’s announcement that stable coins will be treated as a recognised form-of-payment in the near future, primarily due to a reduced chance of volatility by way of their value being linked to existing currency. 

How capital gains tax affects crypto assets 

In the UK, there are two main ways that crypto assets are taxed, those being as part of the holder’s income tax rate and their capital gains tax rate. Income tax rates affect crypto profits viewed by the government as additional income, commonly as a result of mining assets and/or staking rewards. 

Capital tax rates, on the other hand, are determined by the amount of profit gained when selling, swapping, spending or gifting crypto to anybody other than the holder’s legally recognised spouse. Capital gains tax rates in 2022/23 have been set at either 10% for individuals with an annual income below £50,270, or 20% for those bringing in an annual income greater than the £50,270 threshold. 

This percentage tax rate is only applied to profits gained over a predetermined annual tax allowance, referred to as the annual exempt amount. In previous years, this allowance has been set at a fairly high value of £12,300 per person, though in 2022 it was announced that the figure would be reduced to £6,000 in April 2023 before being further stripped back to £3,000 during the following tax year. 

This is where the changes to the UK’s capital gains allowance is set to have the biggest impact on crypto. With the volatile nature of the current market, investors holding onto assets in the hope that future corrections will offset their losses may be faced with much higher tax bills than they had planned for, potentially causing more measurable unrest as traders weigh up the value of selling their assets at a loss. 

As is true for traditional investments such as shares and stocks, crypto losses can typically be offset against gains in the same, or in some cases future tax years. To achieve this, asset holders must realise their losses by transferring (or disposing of) tokens to an unconnected party via a market exchange. 

The problem here is that in order to avoid the drastic cuts to capital gains allowances, asset holders may feel they’re required to perform these transfers before the January tax deadline of each affected year, increasing the potential for measurable market impacts as assets are bought and sold in large amounts. 

It will also bring more people within the scope of completing a UK self assessment, before 6 April 2023, you only had to declare your Crypto disposals profits were greater than £12,300 or sale proceeds from disposal where more than £49,200. From 6 April 2023 profits now need to be reported if greater than £6,000 or sales proceeds are more than £18,000.

Reducing the impact of capital gains allowance cuts 

On the face of things, these drastic cuts to the annual exempt amount for UK crypto asset holders have the potential to cause a great deal of worry, though traders are presented with ample time to prepare themselves and position their investments in such a way that the impact of coming cuts may be mitigated. 

Losses reported to HMRC at the end of the tax year can be used to reduce total taxable gains, with any remaining losses carried forwards toward the next tax year to be filed as allowable losses. 

Additionally, losses may be controlled by ‘bed and breakfasting’ tokens. Using this rule holders can exchange tokens for a more stable asset and, provided that they buy back the token within 30 days, use the basis of any logged trades within this time frame as the grounds for calculating their gains and losses. 

A further method for mitigating the impact of capital gains allowance cuts can be found by banking potential losses with select tax authorities in order to offset against future gains. In this procedure, crypto assets that would cost more to dispose of than they’re currently worth will be logged by HMRC as a ‘negligible value claim’ and as a result all associated losses are able to be carried forward indefinitely. 

This process has been devised by HMRC in an effort to stabilise the cryptocurrency market and reduce worries amongst investors, with the tax authority currently working alongside crypto exchanges to share customer information and use this data to remind investors of their legal responsibilities and liabilities. 

Will lost or stolen crypto assets be affected? 

Lost or stolen private keys are far from unheard of in the crypto sphere, but if HMRC is aware of the digital assets stored within active but inaccessible wallets, they may still consider the owner to be legally responsible for existing funds, and in turn the monetary value that remaining assets have accrued. 

This means that if the crypto assets stored within affected wallets are stolen or transferred, tax authorities will not be expected to treat associated transactions as legally defined disposals, and so the owner will be unable to file relevant losses against any of their future gains. 

If holders of inaccessible wallets wish to address this issue before upcoming capital gains allowances are reduced, they will be required to prove that the affected assets are eligible to be classed as a negligible value claim on the grounds that the funds they’re currently holding have become essentially worthless. 

To do this, wallet owners will need to demonstrate to HMRC that there is no realistic prospect of recovering affected crypto assets by filing a claim. If this is accepted by the tax authority, assets will be treated as though they’ve been disposed of and re-acquired for no value, allowing holders to claim tax relief for a capital loss. 

Summary 

Upcoming capital gains allowance cuts are by no means welcomed with open arms by much of the crypto currency community, though provided that asset holders are well educated regarding the particular type of crypto assets in their possession, there is time to reduce potential negative impacts. 

Filing potential losses with HMRC before the end of each affected tax year will allow crypto asset holders to log current values and carry them forward into upcoming tax years, and in some cases classify losses as negligible value claims to provide some degree of relief amongst a volatile market. 

Check if you need to complete a UK tax return, as with a reduced capital gain annual exception it will mean more people will need to complete one for the first time.

Additional methods of loss control such as ‘bed and breakfasting’ assets may prove helpful to investors holding crypto currencies and stable coins, whilst holders of inaccessible wallets may wish to file their investments as unrecoverable to utilise losses against expected gains, regardless of which method is chosen it’s wise to make plans sooner rather than later to minimise the impact of capital gains allowance cuts.