Introduction
The dynamic nature of blockchain technology means that cryptocurrency protocols frequently undergo forks, leading to the creation of new assets or modifications to existing ones. While forks can present new investment opportunities, they also bring tax considerations that crypto investors must be aware of.
In the UK, the tax treatment of soft forks and hard forks varies, and understanding these differences is essential for compliance with HMRC regulations. This guide explains how crypto forks are taxed and how they impact future tax liabilities.
What Are Crypto Forks?
A crypto fork occurs when a blockchain’s protocol is altered, either as a routine update or as a fundamental change that splits the chain. Forks typically arise due to:
- Software upgrades to enhance network efficiency.
- Community disagreements leading to protocol divergence.
- Security fixes to address vulnerabilities.
There are two main types of forks:
1. Soft Forks (No New Asset Created)
A soft fork is a backward-compatible update where all users adopt the new rules without splitting the blockchain. The network remains intact, and no new tokens are issued.
Tax Impact: Since no new tokens are created, a soft fork is not a taxable event. The asset retains its original cost basis, and capital gains tax (CGT) applies only when the crypto is later disposed of.
2. Hard Forks (New Asset Created)
A hard fork occurs when a blockchain splits into two, creating a new asset alongside the original one. Holders of the original cryptocurrency typically receive an equal amount of the newly created asset.
Tax Impact: A hard fork itself is not a taxable event, but it affects the cost basis for future disposals. The original asset and the new asset must be accounted for separately when calculating capital gains.
How Are Crypto Forks Taxed in the UK?
1. Tax Treatment of Soft Forks
Since a soft fork does not result in new assets, there is no immediate tax liability. The cost basis of the existing asset remains unchanged, and CGT applies only upon disposal.
2. Tax Treatment of Hard Forks
A hard fork changes how assets are accounted for in tax calculations:
- The newly received asset must be pooled separately from the original crypto.
- The cost basis of the original asset is split between both assets based on their market values the day after the fork.
- Any subsequent disposal of the original or new asset is subject to capital gains tax.
Example of Cost Basis Apportionment:
- You own 1 BTC before a hard fork.
- After the fork, you now hold 1 BTC (original) + 1 new BTC forked coin.
- If the market value the day after the fork is:
- 1 BTC = £20,000
- 1 BTC (forked coin) = £5,000
- The total value of holdings = £25,000, and the original BTC’s cost basis is split accordingly (80% for BTC and 20% for the forked coin).
This "just and reasonable" approach ensures that costs are fairly allocated between the two assets. HMRC may challenge inconsistent or unfair apportionments.
Reporting Forks for Tax Purposes
When a hard fork occurs, investors must:
- Record the date and market value of the forked asset.
- Apportion the original asset’s cost basis between the two assets.
- Report capital gains or losses upon disposal of either asset.
If the forked asset is not recognized by an exchange, it may be worthless, allowing a taxpayer to:
- Allocate all costs to the original asset, OR
- Make a negligible value claim to declare a capital loss.
How to Minimize Tax Liabilities from Forks
- Utilize Capital Gains Allowances – The first £6,000 of capital gains in 2023/24 is tax-free.
- Negligible Value Claims – If the forked asset has little or no value, it may be written off as a capital loss.
- Hold Assets for Long-Term Investment – Investors may benefit from lower CGT rates compared to income tax.
- Seek Professional Guidance – Tax implications of forks can be complex, and professional advice ensures compliance.
Conclusion
While crypto forks are not taxable events in the UK, they impact the cost basis and capital gains tax calculations upon disposal. Keeping accurate records and correctly apportioning asset costs is essential for compliance with HMRC regulations.
At Block3 Finance, we specialize in crypto tax compliance, helping investors navigate the complexities of crypto forks while ensuring compliance with HMRC regulations.
If you have any questions or require further assistance, our team at Block3 Finance can help you.
Please contact us by email at inquiry@block3finance.com or by phone at 1-877-804-1888 to schedule a FREE initial consultation appointment.
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