As the most prominent cryptocurrency, bitcoin is regularly in the news.
But if you have clients investing in it, what do you need to know? What are the tax implications, and is it a bubble that’s about to burst?
“The prudent watchword is caution,” says David Lyford-Smith, Technical Manager for the IT Faculty at ICAEW. “There’s a lot of interest in cryptocurrencies in general, and there are several interesting ones. But it’s important to know that they fall outside the Financial Services Compensation Scheme – and a lot of other regulatory schemes too.” So, if your cryptocurrency of choice should crash, or be shown to be a fraud – as has happened with some of the smaller ones – “there is no recourse, and no one will come to your rescue.”
As well as this, Lyford-Smith adds, “the other current advice is to say that cryptocurrencies are not considered cash equivalents – they don’t have enough of the qualities and liquidity to meet that definition.” If a client were to be heavily involved in a company that acquired and sold cryptocurrencies at fair value through profit and loss, “we would see that as a commodity. Similarly, we have been advising that if companies have significant balances and transactions in cryptocurrencies, have a note to say why you are pursuing that and what your protections are against difficulties with those cryptocurrencies.”
Innovation or complication?
“Cryptocurrencies are very difficult to provide accounts for,” says Damian Evans, Partner at Chartered Management Accountants firm EvansEntwistle. “The reason is, it’s not like a normal bank account – you have an electronic wallet, and trying to find those transactions in the wallet can be difficult as there’s no separate record of them.” For Evans, the accountant’s obligations in terms of due diligence and staying in line with money laundering regulations means you have to tread carefully. “Where have the funds come from, where are they going, and what are they for? Because cryptocurrencies are outside the normal financial system, it’s hard to be comprehensively aware.
Cryptocurrencies are very difficult to provide accounts for
“So your first problem,” Evans says, “is in simply identifying the transaction – but there’s a second problem too, which is how you record them in your accounts and know what the value really is.” When you report to HMRC, Evans points out, you report in sterling. But because the valuation of cryptocurrencies is so volatile, how do you calculate your profits to know how much tax to pay? “If it leaps from £1 to £13,500 in a year, does that mean you’ve made £13,499 in profit and so have to pay the appropriate taxes on that?”
Like Lyford-Smith, Evans argues that cryptocurrencies are really a commodity, not a currency at all. “There’s nothing underpinning bitcoins, other than the fact that people want them.” For Evans, this has the makings of a bubble. “What are they ‘for’? It’s like tulips in 17th century Amsterdam. People were exchanging apartments for a tulip. But when you reach ‘peak tulip’, everyone wants to sell – and then it crashes.”
The Bank of England made its feelings very clear recently on cryptocurrencies. Governor Mark Carney described bitcoin as a “global speculative mania” which would face a “pretty brutal reckoning,” saying that its see-sawing valuations are “reliant in part on finding the greater fool.”
But could it be argued that Carney is playing reactionary traditionalist, fearful that bitcoin is stealing a march on the conventional financial institutions? “I suspect Carney is right,’” says Evans. “There’s no real value to what you’re buying apart from convenience – the ability to transfer value outside the normal banking system. If all people are buying them for is to speculate on the rise in value, then this is your evidence that it’s a commodity not a currency.”
Positives of bitcoin
Away from the downsides, what are the advantages? “One of the strong factors,” says Lyford-Smith, “is it’s really easy to prove ownership and history of sale – it’s a public ledger and anyone can see that. So if a firm looks at acquiring a company and wants to audit it, they have an advantage – it’s easy to look at the record because cryptocurrencies are so public.”
Cryptocurrencies are also extremely secure in terms of technological protection – “no one has ever successfully attacked the blockchain system that underlies them.” However, “the less secure area is the fact you don’t have those safety nets and you’re at risk if you’re duped.” If your client is successfully scammed – by surrendering their password to the bitcoin wallet, for instance – “that person can spend the money and there’s nothing they can do. It’s gone.”
These risks are not, of course, exclusive to bitcoin but the lack of protection makes it a concern. “There’s always an opportunity for fraudsters to prey on people not just because they’re insufficiently technically proficient but also because they are simply in a rush.” Many frauds rely on people being in too much of a hurry to pay enough attention, Lyford-Smith says. “Your judgement can be impaired when a sense of urgency is pushed on you. Take your time, and know what you’re dealing with.”
Evans believes more advice from HMRC is needed. ‘These are early days and we’re talking about early adopters. But the tax authorities haven’t given any real advice on how to treat it. Can you pay your taxes in bitcoin? Probably not.” Knowing whether bitcoin is a currency or commodity is vital. “If you trade in them, they are liable to income tax or corporation tax. But if it’s an asset, it’s subject to CGT when you dispose of them.”
And for the future? “I think the most likely outcome is we’ll start to see consolidation once the excitement starts to die down,” Lyford-Smith says. “Some of the smaller cryptocurrencies have lost momentum or, worse, been exposed as scams – so I think the market will crystallise and we’ll see which cryptocurrencies are most appropriate for which case, and then it will become a more mature market.”
So on balance, is this a bubble about to burst, or are cryptocurrencies here to stay? “I do think they’re here to stay,” acknowledges Evans, “but as to whether they are overvalued or not… I can’t say.” Bitcoin’s value “has already come down somewhat from its high,” Lyford-Smith says. “There was more hype in the last few months of 2017 than was healthy.” There’s been a fear of missing out, he reckons, that has led to too much speculation. For the future though, “it’s hard to tell what will happen. Bitcoin is the first of its type and it’s completely different to what people are used to.”
Mark Blayney Stuart is Business Journalist of the Year, Wales Media Awards 2017 and Former Head of Research at the Chartered Institute of Marketing.