At the end of October 2017, a reader wrote into the This Is Money website asking if he’d have to pay tax on his Bitcoin gains. He said he’d bought 1,000 bitcoins for £5,000 in 2012 and they were now worth £4m.
If he’d held onto them, that £4m would now be north of £10m (at time of writing).
What an outrageous stroke of luck. It almost seems churlish to ask if there’s any tax to pay on it but he does have a point.
Smart Team examines HMRC, taxes, and Bitcoins.
What is a Bitcoin?
Bitcoin is a virtual currency. Bitcoin is not run by a central bank nor an administrator. Transactions in Bitcoins are recorded on a ledger using cryptography with no intermediary.
Its value has soared in recent weeks passed the $17,000 dollar mark as hedge funds and other disruptive financial services companies have decided to invest their clients’ cash in it.
Many speculate that the soaring price is a bubble and they may well be correct. However, this is completely unchartered territory because cryptocurrencies like Bitcoin did not exist 10 years ago so there is no real track record against which the current pricing can be compared.
What about the £4m man and his tax?
There are two ways that you can obtain Bitcoins.
The first is to purchase them. The second is to “mine” them – there are a finite number of Bitcoins which are created when a particularly-complex mathematical puzzle is solved.
For any tax calculation, you have to work the profit you’ve made from a transaction.
Let’s say that our £4m was in the business of mining Bitcoins or is a Bitcoin dealer as a sole trader – this was his profession. In this case, he would be required to pay income tax and National Insurance.
When the £4m man comes to sell his Bitcoins, he needs to factor in the £5,000 he paid for them. This means that he has shown a profit of £3,995,000.
Assuming he’d earned no other money that year and he made his declaration on his Self Assessment form, he’d have to pay tax, Class 2, and Class 4 National Insurance on his gain.
This would result in £1,783,550 in income tax, £82,315.24 in Class 4 NI, and £148.20 in Class 2 NI, leaving him with £2,128,986.56 after tax.
What if he’d mined them though? Mining consumes huge amounts of electricity and, assuming he could prove that the electricity was used as part of his business mining Bitcoins, he could claim that cost back.
According to an answer by Brian Schuster, a blockchain advisor and entrepreneur, on website Quora, the cost of producing one Bitcoin in the USA is $5,041 – equivalent to £3,778.23 at time of writing. Had our £4m mined his 1,000 Bitcoins, the cost of production would be £3,778,230.
In this example, the £4m man’s expenses would mean that he showed at £221,770 profit on which he would pay £85,596.50 in tax, £6,850 in Class 4 NI, and £148.20 in Class 2 NI, leaving him with an after-tax sum of £129,174.66.
What if our £4m was not a Bitcoin dealer? Then the profits would be liable for capital gains tax.
After his tax-free capital gains tax allowance and assuming no other income during the year, he would pay £793,390 to HMRC.
Our £4m may have trouble persuading HMRC that he was not a Bitcoin miner by trade if he had spent nearly £3.8m on electricity bills so the likelihood of just paying capital gains tax on his gain would be very small.
What if the £4m man had actually been a company?
If the company’s core business was the mining of Bitcoin, the company would pay 19% corporation tax (assuming there were no losses from the previous year to carry forward).
Had the Bitcoins been purchased, the company would pay 19% of £3,995,000 – £759,050.
Had they been mined, the bill would be £42,136.30.
What about VAT?
If the person or the company is VAT registered, they will be able to claim the VAT back on the electricity bills they incurred during mining.
For the buying, selling, transfer, and conversion of Bitcoin to a standard currency, no VAT is payable.
Talk to Smart Team on 01202 577 500 or email us on firstname.lastname@example.org.