As the cryptoasset market continues to grow in value and popularity, HMRC's guidance on the tax status of cryptoassets in the UK continues to evolve. HMRC now has an internal manual dedicated solely to the tax treatment of cryptoassets, which was last updated in April 2021. Here, we consider HMRC's current position, and the impact this may have for UK resident individuals currently investing in cryptoassets.
Note that this article is principally concerned with the most common form of cryptocurrency, sometimes known as the exchange token (of which the most popular type is Bitcoin). There are many other types of cryptoassets.
HMRC's treatment of cryptoassets
HMRC does not consider cryptoassets to be equivalent to currency or money, and therefore treats them as a traditional asset for tax purposes. In addition, HMRC considers that investing in cryptoassets is not analogous to gambling (such that any profits made on investments in cryptoassets would not be taxable). For investments in tokens (such as Bitcoin and Ethereum), any capital gains are therefore in principle within the scope of capital gains tax.
HMRC considers that individuals are liable to pay both income tax and national insurance contributions on receipts of cryptoassets provided in return for services (e.g. as employment income). In addition, HMRC considers that receipts of cryptoassets arising from activities such as mining and staking will be taxable income (whether the activity amounts to a trade or not).
One controversial aspect of HMRC's guidance on the taxation of cryptoassets concerns the location of cryptoassets for UK tax purposes. HMRC's internal guidance manual currently provides (and HMRC's published guidance since December 2019 has stated) that for UK tax purposes the location of cryptoassets is determined by the "residency of the beneficial owner". HMRC considers that this gives a "clear, logical, predictable and objective rule which can be easily applied".
If an exchange token is co-owned between two or more beneficial owners, HMRC considers that each beneficial owner's interest in the asset will be where that beneficial owner is resident. If one or more of the co-owners are UK resident, this will not affect the location of the cryptoasset for those co-owners who are not UK resident.
Separately, it is worth mentioning that some cryptoassets are linked to an underlying asset that has a known location. One example of this is the Paxos Gold token on the Ethereum blockchain, where each token is backed by real gold reserves. HMRC accepts that where a cryptoasset is a digital representation of another asset, the relevant rule for determining the location of the underlying asset would determine the location of the cryptoasset.
What are the issues with HMRC's approach?
According to a Binance 2021 survey, 60% of crypto owners store their assets on an exchange platform, like Coinbase, FTX or Binance. In practical terms, this means that 60% of cryptoasset owners globally do not hold their cryptoassets personally. In these circumstances, what the individual owns may instead be a right of enforcement against an exchange, governed by the terms and conditions of the exchange in question (with most exchanges being located outside the UK).
Given this, one difficulty with HMRC's approach is that the person they are seeking to tax (i.e. the individual holding the cryptoassets via the exchange) may not in fact own any cryptoassets. This will depend on whether the assets are held personally or via an exchange, and if via an exchange it will depend on the terms and conditions of the owner's relationship with the exchange. Especially as the cryptoasset industry continues to rapidly develop and evolve, it is important to carefully consider the arrangements, the nature of the individual's interests and the "asset" that they may hold, in order to determine the potential impact this may have in determining its location and tax treatment more generally.
HMRC has adopted what it considers to be a pragmatic approach in determining the location of cryptoassets for tax purposes but it is a view which has material downsides for UK resident, non-UK domiciled investors in cryptoassets. Determining the location of cryptoassets by reference to the residence of the beneficial owner means the remittance basis is not available in relation to any gains realised on a disposal and gives rise to an exposure to inheritance tax on any cryptoassets owned on death.
Given the above difficulties STEP, the industry body for private client practitioners, has put forward an alternative suggestion: Location of Cryptocurrencies – an alternative view. STEP's suggestion (with reference to recent related case law and commentary), is that the location of cryptoassets should be determined by identifying the jurisdiction with which the "participant" in the cryptocurrency system is most closely connected. In some cases, the beneficial owner will be the "participant", such as where the person holds the cryptoassets directly and controls the private key. In these circumstances, the cryptoassets would (in STEP's view) be located where the owner is resident.
However, as mentioned above, in many cases cryptoassets are not held directly by the beneficial owner, but instead are held on their behalf by a third party, such as a cryptocurrency exchange, trading platform or custodian. In these cases, the relationship between the third party and the owner would need to be considered. If the wallet representing the public address and associated private key are held by the beneficial owner, then STEP considers that they should still be considered the "participant" in the system. However, if the wallet and private key are held by an exchange on a pooled basis for all of its clients (and the owners' rights are simply contractual rights against the exchange), then the "participant" in the system would (in STEP's view) be the exchange rather than the owner.
Planning with cryptoassets
Until there is a statutory basis for determining the situs of cryptoassets (or at least a clear decision from the courts), taxpayers and their advisers will need to decide what approach to take. If taxpayers conclude that cryptocurrencies owned by UK residents are not located in the UK, consideration should be given to disclosing this in the "white space" of their tax returns.
Alternatively, taxpayers could plan on the basis of HMRC's guidance, and consider other steps to mitigate their UK tax exposure. Some examples of such steps are set out below.
- For UK resident remittance basis taxpayers, consideration could be given to investing in cryptocurrencies via non-UK funds that have exposure to cryptoassets, rather than the taxpayer making the investment directly themselves (or via an exchange).
- HMRC’s guidance does not appear to contemplate cryptoassets being owned by companies or trustees. However, if one applies the same test as for individuals, exchange tokens held by non-UK resident companies and non-UK resident trustees will presumably be treated by HMRC as located outside of the UK for tax purposes. Therefore, holding cryptoassets via a non-UK company would result in the assets being non-UK situs for UK tax purposes.
- Similarly, if cryptoassets are held by a non-UK trust such cryptoassets should be treated as non-UK situs in the trustee's hands under HMRC's guidance above. However, if cryptoassets are contributed to a non-UK trust by a UK resident taxpayer, the taxpayer could be subject to tax on the transfer of the cryptoassets into trust. As a result, where the taxpayer is already tax resident in the UK, consideration could be given to settling cash into the non-UK trust, and for the trustees (or an underlying company) to then acquire the cryptoassets.
What next?
HMRC is taking active steps to enforce the UK tax rules against UK resident owners of cryptoassets. On 2 October 2020, the crypto news outlet Decrypt reported that the exchange Coinbase has, at the request of HMRC, agreed to disclose the account details of all UK customers with holdings valued at over £5,000 in the 2019/2020 UK tax year to HMRC. HMRC is also reportedly sending "nudge" letters to owners of cryptoassets to encourage them to declare any taxes owed on their cryptoassets holdings. Interestingly, we understand that HMRC is not sending these letters to non-UK domiciled individuals, although some such taxpayers are currently subject to their own specific "nudge" letter campaign (see our "News in brief" article).
Nonetheless, all owners of cryptoassets should be aware that transactions in cryptoassets can give rise to tax charges in the UK, and that HMRC is taking an increasing interest in cryptoassets. We understand that HMRC is looking to expand its guidance on other aspects of the taxation of cryptoassets, and we will publish further articles on this in due course.
Finally, owners of cryptoassets should be aware that often their transactions (such as disposing of or transferring Bitcoin interests) will be accessible on a public blockchain. This means that transactions can be easily verified by HMRC if one of the addresses used in a transaction – such as the address of a person's exchange wallet – can be linked to them.
To discuss this article in more detail, please reach out to Joshua Boughton and Toby Ney. Additional support was also provided by Trainer Solicitor, Steve Moore.
