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There aren’t many things more exciting than scoring your first Forex trading profits. However, one thing can tone your celebrations down a bit. You’ve guessed it; we’re talking about the possibility of a hefty income tax bill. Nothing can wipe the smile off a happy investor’s face faster than having to pay tax. However, when it comes to trading Forex, things are slightly more complicated than in the case of your standard taxes.
That’s because UK Forex trading taxes land in a sort of a ‘grey area’ regarding how they operate. Indeed, many Forex traders, especially inexperienced ones, might find Forex taxation laws very confusing. In general, when it comes to Forex trading tax classification in the UK, there are several factors a trader should be aware of including what kind of trades they are making, what types of instruments they trade, and the motivation behind trading.
This comprehensive guide will explain how UK Forex trading tax laws work and explain when (and if) you need to pay.
Tax Classification in the UK
Before diving into how Forex trading tax works, we need to clarify how HMRC (Her Majesty’s Revenue and Customs) classifies taxes in the UK. As a Forex trader, you can be taxed through four regimes:
- Income tax. Tax paid by individuals on overall personal earnings during a tax year.
- Capital gains tax (CGT). Tax paid on profits from selling assets (such as shares).
- Corporation tax. Type of tax paid by a limited liability company on profits.
- Stamp Duty Reserve Tax. Tax paid for buying shares.
However, how HMRC classifies Forex traders is an entirely different story. For the purpose of this article, we’ll focus on Forex income tax and capital gains tax.
Forex Trading Tax Explained
The primary problem with Forex trading tax classification is that Forex traders (while performing a similar activity) can trade Forex differently. For example, some treat Forex trading as a side gig. Those people may be more likely to be able to avoid paying taxes. On the other hand, investors who treat Forex as their primary income source are usually obliged to pay a fairly significant tax fee. That’s why it’s so vital to assess your situation before the UK tax office knocks on your door.
As covered, there are several factors a Forex trader needs to keep in mind when the time comes to pay tax on their Forex profits. In essence, HMRC will classify you depending on three main aspects:
- What kind of trading activity you perform.
- What kind of Forex trader you are.
- The types of instruments you trade to generate profits.
Forex Trading Activity
First, you need to determine whether you’re a speculative Forex punter or a serious investor. Depending on which category HMRC classify you under, you’ll have different considerations to make for your tax bill.
For instance, when speculatively trading, HMRC can classify you as a punter who treats the Forex market like sports betting market. In other words, HMRC treats you like a gambler enjoying tax-free gains while also suffering the consequences of their losses.
However, if you fall under the category of a Forex trader or investor, you’ll be required to pay taxes on your profits. On the other hand, being a trader or investor also protects you from losses, as you’re able to offset your poor trades against the tax bill.
Forex Trader or Investor Status
The next question is whether you’re a trader or an investor? Yes, there’s a significant difference between these two terms. Being a trader means you hold shares as your stock, whereas being an investor indicates you hold shares for use as assets to generate income. Therefore, a Forex trader will pay income tax, while a Forex investor will pay capital gains tax.
Does it make a difference what tax you pay? It depends on how you look at it.
On the one hand, investors have a substantial tax advantage over traders thanks to a fixed 18% capital gains tax rate introduced in 2008. On the other, Forex traders have more flexibility when it comes to the treatment of their losses. As a trader, you can offset your loss against any other income for the tax year of the given loss.
Another question arises, though. How can HMRC determine whether you’re a trader or an investor? In general, there are certain criteria and factors the tax office will take into account. We can divide them into motivational and transactional criteria.
It might seem a bit odd for HMRC to try and guess the motivation behind your Forex trading. However, it’s a vital component in determining possible taxation fees. Of course, you can’t just say why you’re trading and expect the tax office to believe you. Instead, HMRC will look at the facts surrounding your transaction processes, such as:
- Was your trade a one-time thing, or has there been a number of similar trades?
- Is trading your main income source, or do you have any additional sources of personal income?
- What do you do with your Forex gains? Do you withdraw or reinvest them?
Besides motivation, HMRC will also consider the circumstances of your transaction when trying to determine your trading motives. These include:
- Information on how you acquired the shares, either through purchase or inheritance.
- How much time passed between buying and selling the shares.
- Whether you used finance to buy the instrument.
- What was the cause behind the transaction?
- Whether there’s any evidence of previous trading behaviour (in other words, do you often buy or sell the chosen instrument).
In general, while HMRC considers all the criteria given above when assessing your status, any instrument that generates income is categorised as investment assets.
Forex Trading Instruments
Once HMRC determines whether you’re obliged to pay Forex capital gains tax or personal income tax, the next thing they’ll look at is the instrument associated with each of your transactions. When it comes to the Forex market, there are several instruments you can trade. Most of the time, you’ll either be engaging in CFD trading or spread betting.
Spread betting is the simpler of the two, as it only requires you to bet on the direction of the price at a specific amount per point. For instance, bet that GBP/EUR will rise at £0.89 per pip. Now, since you’re spread BETTING, it means you’re speculating, and, as covered, speculating means you’re free of any capital gains taxes.
Trading CFDs, on the other hand, is more complicated than that. Essentially, CFD is a contract between an investor/trader and seller that indicates the buying party will have to pay the price difference between the asset’s current value and its value at the time of contract. What’s important here is that trading CFDs involves a longer timeframe than spread betting. Because of that, HMCR considers CFDs as ‘capital,’ meaning it’s subject to capital gains tax.
Now that we have explained the basics, let’s answer several of the most frequently asked questions regarding paying taxes and trading in the UK.
Is Forex trading tax-free in the UK?
You have to look a variety of factors when determining whether you’ll be required to pay tax on your Forex trading activity. Forex trading can be tax-free if you’re speculating. For instance, all your speculative spread betting profits will be tax-exempt under the UK tax rules. However, if you’re a more serious trader or investor, you’ll have to pay either income tax or capital gains tax.
How much tax do UK Forex traders pay?
Forex traders in the UK are taxed on the basis of their applicable capital gains tax or income tax rates. If you conduct your trading as a business, profits and interest payments are most likely to be subject to corporation tax, ranging from 20% to 45%. As for other taxable profits, these will most probably be taxed as your capital gain at 10% or 20%. The first tax rate applies if your total income and capital gains don’t exceed £50,270. Starting from £50,271, you’ll be subject to 20% CGT.
How to fill Forex tax returns?
To file your tax return, you’ll need to make a record of your Forex transactions. You can also ask your Forex broker for your P&L statement (profits and losses). Another thing to keep in mind is that you can ask for tax relief for the losses on your Forex trading activity.
Understanding how Forex taxes work in the UK is essential if you want to make the most out of your trading activities. Hopefully, after reading this article, you have a clearer understanding of how the tax rules work when trading in the UK. As you can see, while somewhat unclear, UK tax implications are very friendly when trading Forex.
Essentially, determining what tax you’ll be required to pay will depend on several key factors. First, there’s the type of your trading activity. You will be subject to tax if you’re a regular trader or investor, whereas speculating is entirely tax-free. Then, there’s your trading status. When trading Forex, you can be classified as a trader or investor. Traders are usually subject to income tax, while investors are subject to capital gains tax more often than not.
Finally, HMRC will also take a look at your trading instrument. In this case, spread betting is classified as speculation, meaning it’s tax-free in the UK. On the other hand, trading profits from CFDs will be subject to taxation.
Be sure to visit our page dedicated to trading Forex if you have any further questions or doubts regarding the Forex market. And if you need more information or advice on Forex taxes, the best idea is to get in touch with HMRC itself or contact one of the reputable Forex brokers.