Cryptocurrency – how to account for them and how to tax them
By Christopher Cork, haysmacintyre
Published: 12 October 2018
While it’s doubtful that cryptocurrency (CC) values will return to late 2017 levels for the foreseeable future, their continued volatility and proliferation of commercial applications mean they are set to remain a constant feature in the investment landscape.
Authorities in most major markets now acknowledge the place of CCs, and the need to accommodate them in legislative frameworks, but progress has been slow. To date, regulators in both the EU and US have issued guidance that applies CC related issues against pre-existing principles, and a similarly logical approach has been taken by accounting and tax practitioners.
Accounting for cryptocurrencies
Perhaps counterintuitively, CCs are not considered cash or equivalent because they are not legal tender and exhibit volatility and relative illiquidity that precludes them from being considered fiat currency – a view shared by the FCA in their April 2018 statement on crypto assets.
Nor are CCs financial instruments, as the purchaser of a CC has not entered into a contract to be settled in return for cash or other financial instruments (namely debt or equity). An exception here is short selling: the blockchain underpinning CCs does not allow for short positions and therefore, where investors have short-sold CCs, the position would be accounted for in the same way as any other. Classification as an intangible asset is considered the most appropriate treatment for those investing in CCs, with recognition at the cost of investment on the date of purchase. Rather than being amortised, CCs should subsequently be subject to periodic revaluation – this is permitted under mainstream accounting standards because active markets exist for these assets.
Any gains arising from an upward revaluation in a CC are not reflected in an entity’s profit and loss account, rather they are recorded in a separate reserve until the CC is disposed of, at which point a gain is transferred to the profit and loss account. It’s important to note that if a CC is considered impaired, then the loss is realised immediately in the profit and loss account.
If firms are regularly undertaking day to day transactions in CCs, they should be classified as inventory. Changes in value will only be accounted for when subsequent transactions take place, or if the exchange value falls below the initial cost of the CC on an expectedly permanent basis.
This logic-based approach is considered valid both under UK and international accounting standards.
Where an investing company is based in the UK, CC trading should be considered similar to equity and security investing, specifically that a tax liability will only arise on disposal of a CC. Similarly, tax relief will be given to companies who make chargeable losses from the disposal of CC.
A common pitfall arises on trading between CCs (say, selling Litecoin to purchase Bitcoin). Here, a disposal has still occurred, so a tax charge may still arise even though there has been no re-conversion to fiat currency.
For non-company UK entities where personal tax regimes apply (i.e. LLPs and LPs), CCs held as investments are subject to capital gains tax (CGT). The same principles will nonetheless apply in that gains and losses will only be considered taxable on disposal.
Our view is that other territories will likely adopt similar regimes but as always, local expertise should be sought.
It is also important to remember that if an entity is VAT registered, any transactions carried out in CC will be still be subject to VAT at the sterling value prevailing on the relevant date.
Initial Coin Offerings (ICOs)
ICOs are the issuing of a token offered by a new venture in return for fiat currency or other CCs. As one of the newest manifestations in the evolution of CCs, ICOs have had a significant impact on the fundraising landscape, with a cumulative $3.6bn raised in 2017 according to the Financial Times.
For investors, ICOs can offer very significant returns with equally high levels of volatility. EOS, a token that provides application services on the decentralised hosting platform EOS.IO, launched in June 2017 at parity with the US Dollar, and now trades around the $5 mark (having peaked at $22 in April).
There is clearly a long evolutionary road ahead for ICOs; underlying value exists when the business proposition underpinning them is feasible. However as with CCs generally, it will take time for regulators and investors to become comfortable with the process and put in place structures around them, which will ultimately enhance their popularity with, and value to, larger investors.
It is worth noting that ICOs do not necessarily give an investor equity in the entity offering the token, more likely the right to receive the goods and services offered by that entity. This is not an issue for many ICO investors who will subscribe with a view to holding CCs for trading. Where this is the case, investments that arise from ICO subscriptions follow the same accounting and tax principals as any other CC holding.
Since issuing a briefing note in 2014, HMRC has provided little in the way of further taxation guidance regarding CCs, while the International Accounting Standards Board discussed the CC issue in January 2018 but, to date, has only confirmed it is ‘actively monitory developments in this area’.
As CCs grow in size and scope, particularly given the increasing prevalence of Initial Coin Offerings, so too will the pressure for more detailed guidance. Until then, approaching accounting and tax logically within the existing frameworks remains the lowest risk approach for investors and practitioners alike.