There was one topic it seemed everyone was talking about on the run up to Christmas - Bitcoin.
A cryptocurrency that has rocketed in value in recent times, it led masses to invest directly into it, and subsequently into many of the other cryptocurrencies (of which there are reportedly well over 1,000) that have become available.
There's been a whole host of discussions taking place around Bitcoin and whether the activity as of late is representative of a 'bubble' or not (and if so, how soon it will pop). But as fascinating as this is, it's not the discussion I want to focus on here. It's the other main talking point around Bitcoin - whether you have to pay taxes on any profits you make (and how to minimise any relevant tax bill).
Do you pay taxes on Bitcoin profits?
In a nutshell, if you're profiting from Bitcoin - or any other cryptocurrency - you're going to be liable to pay some form of tax. By profiting, we're talking about gains made from an investment into a cryptocurrency that's achieved once the cryptocurrency has increased in value and is subsequently sold.
For the most part, for investors on an indivudal level, the tax that would be paid is capital gains tax, as the profits are classified as being capital gains.
As a real world example, if you had bought one Bitcoin on 2nd November 2017, it would have cost you £5,386. If you had sold it earlier this week on 2nd January 2018, it would have sold for £10,846.77. This would represent a capital gain of £5,460.77 (ignoring any related fees for the purpose of this example).
Now assuming you didn't make any other capital gains in this tax year, this profit would fall within your capital gains tax allowance of £11,300 (for 2017/18) and would therefore not require tax to be paid on it.
However, let's say you bought and sold 10 Bitcoins in the same period instead. You would have spent £53,860 buying them and have subsequently sold them for £108,467.70, returning a profit (or capital gain) of £54,607.70. This would require tax to be paid on it - and there are two steps to determining how much.
- Firstly, you need to take off whatever capital gains tax allowance you have remaining. For this example, we'll make an assumption you haven't had any capital gains and therefore have the full £11,300. This takes your taxable gain from £54,607.70 to £43,307.70.
- Secondly, you need to understand your capital gains tax rate, as this is dependent on your income tax band. If you're a Basic Rate Tax Payer, you'll pay 10% capital gains tax. If you're a Higher Rate Tax Payer, you'll pay 20%.
Using the £43,307.70 taxable gain above, this means you'd be liable to pay either £4,330.77 (10%) or £8,661.54 (20%) tax on your Bitcoin profits.
Importantly, if you're a Basic Rate Tax Payer, your capital gain must fall within the total income threshold of £45,000 alongside any other taxable income you have. If it doesn't, you'll be taxed 10% on any gain that falls within the threshold and 20% on any gain above it.
Whilst there's no getting away from the fact your Bitcoin profits can be liable for capital gains tax, it is completely feasible to reduce your Bitcoin tax bill.
And this can be achieved through tax efficient investing.
Using tax efficient investing to reduce your Bitcoin tax bill
Tax efficient investing generally relates to investments made that bring with them particularly attractive tax reliefs, and there are two primary schemes to take into account - the Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS).
Both offering a variety of tax reliefs, these include two of the most generous tax reliefs currently available to investors - 50% and 30% income tax relief with the SEIS and EIS respectively.
However, they both offer incentives for capital gains tax bills, too.
EIS: capital gains tax deferral relief
With EIS, you can completely defer your capital gains tax bill by investing your gain (or part thereof) into an EIS eligible investment opportunity.
Although only deferred, this deferral can effectively be indefinite. The tax bill isn't due for payment until the shares in the EIS company are sold - which if it never happens, means the tax bill never gets realised.
The fact you can defer part of your capital gain can be particularly interesting to Basic Rate Tax Payers who have part of their capital gain fall into the 20% bracket - you could invest part of your gain into an EIS opportunity to bring your total income under the £45,000 income tax threshold, therefore only paying 10% on the non-deferred capital gain.
SEIS: capital gains tax relief
Through the Seed Enterprise Investment Scheme, you're able to completely reduce your capital gains tax bill by 50%.
Achieved in a similar style to how deferral relief is through EIS, if you invest a capital gain into a SEIS eligible opportunity, you can reduce the amount of tax owed on that capital gain by half.
Using the original example above once more, if the £43,307.70 taxable gain was invested directly into a SEIS eligible opportunity, the amount of capital gains tax you'd be liable to pay would reduce from either £4,330.77 or £8,661.54 to just £2,165.39 or £4,330.77.
Remember: unlike EIS, this isn't deferred. It's a direct reduction - your capital gains tax bill will be reduced by 50%.
Legally and ethically reducing capital gains tax with tax efficient investing
Investing into EIS or SEIS opportunities and reducing any type of capital gain as a result isn't illegal or unethical. It's not tax avoidance or tax evasion. These are genuine schemes introduced by the UK government to encourage investment into early stage companies.
However, it is important to remember that because of the stage the investee companies are at, there is generally a higher level of risk involved in these investments. Therefore whilst the ability to defer or reduce your capital gains tax bill from Bitcoin profits is entirely possible, understanding that your investment may not return a profit is also crucial.
But as an investor aware of the risk and return profiles of such opportunities, to answer the initial question of this piece, it is completely possible to reduce the amount of tax owed on Bitcoin profits, and it can be all achieved through tax efficient investing.