Forex trading is a popular way to make passive income in the UK. Investors speculate on the price of foreign currencies and earn a profit based on the fluctuations in exchange rates. For some investors, this is a casual side hustle, and for others, it’s a full-time job.
Regardless of how investors approach it, they still need to pay taxes on the income made from it. Many investors make common mistakes when it comes to handling their tax obligations. It’s easy to avoid them, however, just by being aware of them.
Not Knowing Which Tax Applies
Not all profits are taxed the same, and in the UK, the tax applied depends on how the trade was made. Some profits are taxed as ordinary income, while others are subject to Capital Gains Tax. Experts from Cryptomaniaks have also written about the difference between changing foreign currencies and cryptocurrencies. Cryptocurrencies can be used as a form of money, but tax agencies don’t treat them as such.
Financial assets are treated as stocks based on their type, not how long they’ve been in the investor’s possession. HMRC has a set of rules determining who is considered an investor and who is considered a trader. There’s also a difference between those who have set up a business to trade and those who do it as individuals.
Not Using Capital Gains Allowance
Those who pay capital gains tax on their forex trading profits are entitled to a tax-free allowance. Some investors are unaware of this, while others believe the process for obtaining the allowance is more complicated than it appears, and in both cases, they miss out.
As of 2024/25, the allowance is set to be £3,000 per year. If your gains are lower than that amount, you don’t need to pay any taxes. The allowance could offset gains exceeding this amount. It’s equally important to track your losses, as you can carry them forward to offset future gains.
The amount the investor can use as an allowance changes when new laws are introduced to govern it. Investors should pay attention to those changes.
Keeping Records
Record-keeping is one of the most important duties of a taxpayer. It’s a legal requirement, and it could help the taxpayer out if there’s a dispute over payments. When it comes to forex trading, investors should keep track of the following data: dates, currency pairs, positions, profit and loss, and broker statements. Experts from Cryptomaniaks have written about how easier this process is for cryptos, as the records are kept on a blockchain.
There are also legal requirements regarding the retention period for tax records. At this point, HMRC requires it to be held for at least 5 years starting from the submission date of 31st January. Modern trading platforms and apps enable users to generate, save, and organize this data automatically. However, it doesn’t hurt to have a paper copy as well.
Missing the Deadline
Deadlines are essential for filing taxes, and those who miss them must pay the proper fines. The UK deadline is always 31st January. One way to ensure you don’t miss it is to use software that files automatically.
Small-time traders can also file on their own, and it’s simply a matter of preparing the documents and being mindful of the due date. It’s also imperative for the taxpayer to fill out the proper documents with care and to submit a complete tax report on time. Documents that are sent on time but not completed in accordance with the regulations don’t count.
Using the Wrong Currency Conversion Rate
The profits investors make are based on the conversion rate between different currencies. The tax is then paid on that difference, which constitutes a profit. The conversion rate changes daily and sometimes by the minute. Taxes, on the other hand, are paid annually.
When calculating how much they’ve earned and, therefore, how much they need to be taxed, forex traders should rely on the currency at the time when the trade was first made. Many make a mistake in this regard and end up reporting their taxes incorrectly.
To Sum Up
Forex trading is a way to make passive income easily. Those who do so are obligated to pay taxes. Since it’s a somewhat novel way to earn and very niche, many make mistakes on how those taxes are paid. It’s essential to stay up-to-date with the rules to avoid issues with HMRC and the penalties they may impose.
In many ways, the process of following these rules and reporting taxes is made easier by the use of software solutions that automate it. These solutions are available for both small-time and affluent traders.
