🔮Cryptoasset derivatives (CFDs, Futures and Margin Trading)
What are derivatives?
The tax position regarding individuals trading and investing in derivatives over cryptoassets (ie Contract for Difference (CFD’s), Futures and Margin trading is different to the tax position of an investor buying and selling cryptoassets.
HMRC state at CRYPTO010150 that:
“A derivative is a financial instrument where the performance is based on the movement of the price of the underlying asset. Under a derivative the holder does not hold the underlying asset. Some businesses offer the ability for individuals and companies to gain exposure to the movements in the cryptoasset market by using a derivative. The nature of a derivative is typically very different to directly holding a cryptoasset. In particular, a derivative will give rise to contractual rights and obligations between the two parties. As a result, where a cryptoasset derivative has been entered into the guidance in this manual will not generally apply.”
HMRC refer individuals using derivatives to their guidance at CFM50070 for the tax position on cryptoasset derivatives, however this is non cryptoasset specific guidance.
How are derivatives taxed?
Trading profits?
An individual trader may use derivatives to hedge interest rates or other risks. Provided that the derivative is held for trade purposes, the profits will be trading profits. An individual may claim that their dealings in derivative contracts constitute a trade in itself. BIM56880 confirms HMRC’s position.
An individual may contend that derivative contracts are more sophisticated than dealing in shares; that such assets (not being income-producing) are usually dealt with by way of trade. HMRC disagree and their view is that you approach the question of whether a trade is being carried on in the same way as you would with somebody claiming to carry on a trade of buying and selling shares; by finding the facts and coming to a decision taking an overall view of all the circumstances. Refer to our detailed guidance on this.
pageInvestor or Trader?Capital gains or miscellaneous income?
Where the individual is not treated as a financial trader, two possibilities for taxation remain. Depending on circumstances, the profits may constitute miscellaneous income, or they may be taxable as capital gains.
Normally, taxation as miscellaneous income would take priority over any capital gains charge. However, tax legislation at ITTOIA05/S779 provides that gains arising to individuals in the course of dealing in certain commodity or financial futures, traded options or financial options are not taxable as miscellaneous income (and not subject to income tax); but are instead charged as capital gains.
There is full guidance at CG55400 onwards. Options other than traded or financial options will nevertheless fall within capital gains rules on first principles - see CG12300 onwards.
“commodity or financial futures” means commodity futures or financial futures that are for the time being dealt in on a recognised futures exchange.
“traded option” means an option which, at the time of the abandonment or other disposal, is listed on a recognised stock exchange or a recognised futures exchange.
“financial option” means an option which is not a traded option, but which:
relates to currency, shares, securities or an interest rate and is granted (as principal) by either a member of a recognised stock exchange or by an ‘authorised person’ (ie a person authorised under the Financial Services and Markets Act 2000 to carry on regulated activities); or
relates to shares or securities which are dealt in on a recognised stock exchange and is granted by a member of such an exchange (as agent); or granted to a member of such an exchange (whether that member acts as agent or as principal).
CG56004 confirms that the legislation at Section 143(1) TCGA 1992 was introduced to ensure most transactions (if not trading) are treated as capital gains rather than miscellaneous income. Capital gains tax treatment applies to:
over-the-counter futures, where one the parties is an authorised person (as defined in Section 143(3) TCGA 1992, see CG56027).
CG56100 confirms that if the transactions are taxed as capital gains ‘all debits and credits to the account, including commission and sums equivalent to interest and dividends, are brought within the computation of the net chargeable gain or allowable loss when the contract is closed out’. It is not clear if the same costs can be deducted if it is treated as miscellaneous income.
This guidance also goes on to state ‘Retail contracts for differences are financial futures, and, unless the profits are taxable as trading income, in almost every case Section 143 of TCGA92 charges the outcomes under the capital gains regime (CG56000+).
However, this guidance was written long before the prevalence of cryptoassets. It was probably expected that most futures would be traded via a recognised futures exchange on the HMRC approved list.
None of the cryptoasset exchanges are on the HMRC list of recognised futures exchanges.
Therefore, only ‘over the counter futures’, where one of the parties is an authorised person, would seem to be subject to the capital gains tax regime.
CG56027 states that ‘HMRC officers may accept that a reputable financial concern such as a High Street bank operating in the UK will meet these requirements’. This HMRC guidance used to state ‘You may accept than any reputable financial concern is an authorised person’; so HMRC appear to have narrowed their definition.
We have asked HMRC to issue guidance to clarify which of the current cryptoasset exchanges can be regarded as an authorised person, but no such guidance has been forthcoming to date.
It is therefore unclear whether or not gains and losses from futures cryptoasset derivatives should be treated as capital gains or miscellaneous income and the individual will need to make their own call on the matter in the absence of clear guidance from HMRC.
Swap contracts
If the derivative you are looking at is not a financial future (for example, a swap contract such as interest rate, currency swaps or certain kinds of credit derivative), HMRC is clear that profits and losses are likely to be taxable as miscellaneous income. HMRC’s views on this point were contained in Tax Bulletin article (TB66, September 2003), which is reproduced at CFM50080.
Futures and options can be used to generate a guaranteed return which is, in economic terms, equivalent to interest. Without special rules any profits on such transactions would however (except where it is trading income) be liable to Capital Gains Tax.
Where there is a disposal of a future or an option which is one of two or more related transactions which are designed to produce a guaranteed return (comprising the return from that disposal, or a number of disposals of the futures or options taken together); any profits on the futures or options are charged to income tax as miscellaneous income, rather than capital gains. Any losses are similarly deducted from miscellaneous income.
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