First off, I am not an accountant, I am not a lawyer, I am not a financial advisor, this is not legal advice, this is not investment adivce and this is not tax advice. These are just my opinions on how to interpret British law in regards to the Bitcoin cash & carry trade. I will be using this opinion when I’ll be filling my self-assessment, given the lack of clarity on the subject.

Let’s start by defining what is the Bitcoin cash & carry trade or basis trade as I’ve seen it named in other places. At pixel time Bitcoin is currently valued at $60,262 per coin. On Binance, one of the biggest cryptocurrency exchanges, the BTCUSD futures contract that expires on 2021-03-26 is currently valued at $61,314. These contracts are settled in Bitcoin and not in dollars or other stablecoins.

The following trade will provide a profit:

  1. Buy 1 BTC for $60,262.
  2. Enter a short position on the Mar 26 futures contract at $61,314.
  3. Wait until the contract settles.

If we assume that the contract settles at $62,000 then you will have made a “profit” on the Bitcoin initial buy of 62,000 - 60,262 = 1,738 and a loss on shorting the futures contract of 62,000 - 61,314 = 686. The total “profit” of the trade would be 1,738 - 686 = 1,052. That is equivalent to a return of 1.74% or an annualized return of 61.24%.

There are several reasons why this is not guaranteed:

  • The fine print of the futures contract says that the settlement price is an average of the BTC price on multiple exchanges. That price might not represent the true price of BTC.
  • Counterparty risk! The cryptocurrency exchange could lose your BTC or the exchange engine could fail. Given that the FCA has banned cryptocurrency derivatives for retail clients, the only way you can trade the products is on offshore exchanges, which are unregulated and getting your money back will be very hard.

Those two are also probably the main reasons why the Bitcoin futures are trading in a contango. The third reason is probably people YOLO-ing their savings on levered futures, since you cannot leverage on the spot price. I am fine with those risks and I think this trade is a positive expected value bet for me.

The interesting question is how will I declare the gains from this trade. The first idea that came to my mind was the fact that I could apply the capital gains taxation rules. HMRC has provided a nice manual in regards to cryptocurrency taxation. However, it doesn’t specify anything related to cryptocurrency derivatives.

If we explore further and look at futures, it would appear as if they also go under the capital gains taxation guidelines. However, only future contracts that are traded on a recognized exchange or an FCA authorized person. Alas, Binance and Deribit don’t fit under this umbrella.

It may seem that we would need to apply different rules for the 2 legs of the trade: one would pay capital gains on BTC and income tax on the futures contract. Depending if you would make a profit on the long position or on the short position, the tax liabilities would be different.

It turns out that I’ve managed to find a specific piece of legislation that applies to my particular case – SAIM2700 - Disguised interest. To quote from the manual:

Disguised interest is the return that is produced from arrangements that give rise to an amount that is ‘economically equivalent to interest’ without constituting interest in legal form.

This is exactly what I am doing. The manual goes on to explain that income tax is applied to this type of arrangement. It doesn’t specify futures, but I am fairly sure that given how broad this legislation is, I do think it is intended to catch my situation.

One more question that I have is if capital gains tax still applies in this arrangement. It would be unfair to pay both income tax on the profit trade and then still be liable for the capital gains tax on the long leg position of the trade. Luckily, and I quote broadly:

Where a disguised interest return is taxable under other income tax provisions, those other provisions take priority over the disguised interest rules in ITTOIA05/PT4/CH2A (SAIM2710). Where the return is not taxable under other income tax rules, the return may be taxable both as disguised interest and under other tax rules, such as the rules on chargeable gains. ITTOIA05/S381D ensures that in such a case there is no double taxation.

The taxpayer may make a claim for relief from the other tax and HMRC must give effect to the claim by making any necessary adjustments on a just and reasonable basis. These adjustments may be made by making or amending an assessment, or amending a claim, or by any other means by which a person’s tax liability can be amended. Where the other tax is charged for a different tax year to the one for which the disguised interest rule applies, the adjustments can be for that other period.

ITTOIA05/S381D will commonly apply where arrangements giving rise to disguised interest returns involve the disposal of chargeable assets for capital gains tax purposes. TCGA92/S37(2A) and TCGA92/S39(3A) make it clear that amounts taken into account in arriving at disguised interest returns are not excluded from the computation of chargeable gains on the disposal of such assets.

So, they have thought about this scenario and they’ve clarified that during the “disguised return trade” you are liable for the income tax, but outside of it you still remain liable for capital gains tax. Let’s walk through a comprehensive example:

  1. I buy 1 BTC for £60,000.
    1. I will add to my capital gains tracker a position of 1 BTC for the price of £60,000.
  2. I enter a short futures position of 1 BTC. The price of BTC at the time of entering is £60,500 and the price of the futures contract is £62,000. The contract settles for £62,000, which means that my 1 BTC is delivered for £62,000.
    1. I will declare that I realized an income of £62,000 - £60,500 = £1,500. One question that arises is on which tax year should I declare it. It seems reasonable to assume that this will be the tax year which contains the settlement date.
  3. I will declare that I realized a capital gain of £2,000, with an allowable cost of £1,500. This means that I will only be liable for £500 when I compute my total capital gains for this transaction.

The missing piece that goes unrecorded in the transaction is the BTC price at the time I enter the futures contract. I need to be careful when I log my trades to capture it.

The final nuance that I want to capture are BTC Perpetual Futures contracts. These are short-term future contracts that settle every 8 hours. The main difference is that at settlement, you either receive or give BTC based on the difference between long and short positions. Given that many people want to make leveraged bets on the BTC price, shorting the perpetual futures contract is another way to play the cash & carry trade.

Here’s another example:

  1. I buy 1 BTC for £60,000.
  2. I immediately enter a short futures position of 1 BTC. The price of 1 BTC is still £60,000 but the price of the contract is £60,100, since it usually trades at a premium.
    1. I receive 0.1% (£60 in BTC) as a funding fee rate after 8 hours. I declare that as income.
    2. I receive 0.1% (£60 in BTC) as a funding fee rate after 8 hours. I declare that as income.
    3. I receive 0.2% (£120 in BTC) as a funding fee rate after 8 hours. I declare that as income.
  3. I exit the futures contract at £62,000.
  4. I sell my BTC at £61,950.

One can see what is problematic – if we consider that BTC falls under the capital gains tax rule, but the BTC Futures contract falls under the income tax rule, we are again in a scenario where we will pay less tax if Bitcoin goes up and more tax if Bitcoin goes down.

To simplify the calculations, when I will be entering the short futures contract I will be also logging an asset disposal on my capital gains tracker. This makes sense when you consider the fact that I have a neutral Bitcoin position: I hold 1 BTC and hold 1 BTC short contract at the same time. The reason I’m willing to do this is so that people “pay me” to use my capital to go long using leverage.

Whenever I’ll exit a short contract I’ll be logging that I’ve acquired 1 BTC at the current market price. Now, one could argue that I can make an unrecorded profit when I trade the futures contract, since sometimes the future contract is far above the price of BTC and sometimes it is just equal. I agree that this is problematic, and I’m also unhappy with the current inelegant solution. It still “feels” like this type of trade should fall under the disguised interest rule. The only difference is the time interval (8 hours vs 3 months) and the fact that at settlement I automatically enter a new transaction.

As a compromise I will be using the futures contract enter and exit price to denote the Bitcoin exit and enter prices. If you think about it, it makes sense – the price at which I enter the short futures perpetual contract is the price I am exiting my position of 1 BTC and I’m becoming neutral. The price for which I am selling the futures contract is the price at which I’m again long 1 BTC. The only uncharitable argument against this is that I can somehow enter the futures contract and still be able to manipulate the collateral.