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HMRC guidance on UK tax treatment of bitcoin avoids currency questions, says expert

Out-Law News | 04 Mar 2014 | 4:15 pm | 3 min. read

The UK will exempt the creation and trading of bitcoin and other virtual currencies from VAT as a 'payment service', rather than a currency, HM Revenue and Customs (HMRC) has confirmed.

The announcement, which had been expected by the bitcoin industry following recent negotiations with HMRC, was set out in a briefing note on the wider tax treatment of so-called 'cryptocurrencies', including in relation to corporation tax and capital gains tax (CGT). HMRC's classification of bitcoin as a payment service comes as authorities consider the legal and regulatory status of the emerging asset.

VAT expert Darren Mellor-Clark of Pinsent Masons, the law firm behind Out-Law.com, said that HMRC had been faced with a dilemma over whether or not to treat bitcoin as a 'currency' for tax purposes.

"It's interesting that HMRC has looked for VAT exemption in the legislative provisions regarding payment services and bank accounts as opposed to those concerning currency," he said. "One assumes that this is because of bitcoin's status as a cryptocurrency without the backing of a sovereign state and central bank. It may be that HMRC was concerned about putting it in the same tax basket as traditional currencies for fear of causing confusion as to its regulatory position."

"The recent difficulties faced by the MtGox bitcoin exchange, which has recently filed for bankruptcy in Japan after losing an estimated 750,000 of its customers' bitcoins, show the potential risks still inherent for those trading in virtual currencies. It may also be that such issues have played on the mind of HMRC and led to thinking that VAT exemption may be useful as a control against VAT fraud: the problems of the carbon emissions trading market over the last few years has shown the susceptibility to organised VAT fraud within some new marketplaces and asset classes," he said.

In its briefing note, HMRC noted that the VAT treatment adopted in the UK had to be consistent with any measures that may eventually be implemented EU-wide. It said that its position was "provisional pending further developments", but that any changes introduced at EU level or by regulators would not be applied retrospectively.

Bitcoin is a digital asset with monetary value, but it is not currently recognised as an official currency anywhere in the world. Some retailers accept payment by bitcoin for goods and services but most traders, especially in the EU, have not yet put systems in place to accept them in transactions. Virtual currencies are not currently regulated anywhere in the EU; however, the European Banking Authority (EBA) plans to appoint a taskforce to advise it on whether they should be.

HMRC has taken the view that the creation, or 'mining', of bitcoin will generally be outside the scope of VAT as it "does not constitute an economic activity for VAT purposes". Income received by those mining the currency for related activities, such as the provision of services in connection with the verification of specific transactions for which specific charges are made will fall within the payment services exemption. VAT will not be due on the value of bitcoins exchanged for sterling or foreign currencies, and any transaction charges will be exempt from VAT, according to the note.

VAT will, however, be due in the normal way from suppliers of any goods or services sold in exchange for bitcoin or other cryptocurrencies. The value of the supply on which VAT is due will be the sterling value of the cryptocurrency at the point that the transaction takes place.

Although HMRC's policy avoided the "currency question", VAT expert Darren Melllor-Clark said that the payment services exemption relied on by HMRC could create its own set of problems.

"HMRC will need to be alert to claims, by traditional currency operators, of unfair or excessively favourable treatment being granted to this emerging alternative sector," he said. "In particular, recent case law developments have narrowed the scope of the VAT exemption for those offering transaction services in relation to established currencies. If bitcoin traders enjoy exemption where the established sector does not, there may well be cries of foul."

"Businesses would be well served to note that the HMRC brief is very clear that these arrangements are provisional and subject to changes as the bitcoin position evolves," he added.

In relation to corporation tax, income tax and capital gains tax, HMRC said that whether these taxes would apply to activities involving cryptocurrencies would depend on the activities and the parties involved. Although in many cases the normal rules would apply, HMRC said that in some cases a transaction "may be so highly speculative that it is not taxable or any losses relievable", under the same rules that apply to gambling wins and losses.

"Given the volatility of bitcoin, it is not surprising that HMRC sees these transactions as potentially so speculative that they are akin to gambling and so outside the tax net altogether," said corporate tax expert Heather Self of Pinsent Masons. "It is more likely that HMRC will run this argument where taxpayers are trying to get relief for large losses, rather than where they have made huge gains."

"For businesses which use bitcoins to make or receive payment for goods or services, the normal 'forex' rules will apply so that the value of the bitcoins will be translated into sterling on the date of the transaction. Any profits or losses on the underlying transactions will be taxed as normal. If bitcoins are held for a period, any movement in their value will be taxed either as a profit or a loss on a currency contract, or as a capital gain," she said.