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Crypto assets – worth the tax risk?

Posted on 8 November 2021

NatWest Chair Sir Howard Davies recently expressed support for a ban on cryptocurrency trading, arguing it should come with the warning -"Abandon Hope All Ye Who Enter Here", the inscription on Hell's gates according to Dante.  He further added that in his view, cryptocurrency appeared to be a "frothy investment bubble" and "gambling…with a sort of libertarian veneer on top of it".

Whether such views are universally agreed upon or not, the meaning and implications of gambling and playing with fire are currently not fully understood in the context of the tax implications of crypto investments.

HMRC Activity

HMRC have recently announced that they will begin issuing "nudge" letters to cryptocurrency investors who they believe may have underpaid tax.  These letters are being issued following the ability of HMRC to gain information in relation to investors from UK-based cryptocurrency exchanges and other financial institutions, and will encourage investors to examine whether they have declared and paid the correct capital gains tax and income tax on their investments.  HMRC's belief is that there are large amounts of income and gains that have either been undeclared or under-declared for tax purposes.

How are Crypto assets taxed?

HM Revenue & Customs has issued a 'Cryptoassets Manual' (last updated 30 March 2021) which outlines its view of the appropriate tax treatment of virtual currencies. HMRC's view is non-binding, but gives taxpayers a clear appreciation of how it expects to tax cryptocurrency transactions.

In one of the more recent updates to its manual, HMRC included a section on the location ('situs') of cryptocurrencies. HMRC considers that the situs of cryptocurrencies tracks the residence of the beneficial owner for the purpose of all UK taxes. The manual states:

Using the residency of the beneficial owner of the exchange tokens to determine the location gives a clear, logical, predictable and objective rule which can be easily applied. This means that a person who holds exchanges tokens is liable to pay UK tax if they are a UK resident (as determined by the Statutory Residence Test […]) and carry out a transaction with their tokens which is subject to UK tax.

Why is situs important?

For those who are UK resident but domiciled outside of the UK, the situs of a cryptocurrency will affect whether HMRC has an entitlement to tax gains realised on the sale or other disposal of cryptocurrencies.

Most non-UK domiciliaries who are tax resident in the UK have the ability to elect to be taxed on the 'remittance basis' under which they will be liable to UK tax in the normal way in respect of UK source income and gains, but will only be liable to UK tax on their foreign income and gains to the extent that they 'remit' them to the UK. 'Remit to the UK' has a wide meaning, but essentially means brought to, or received in, or used in the UK by the UK resident or certain people and entities connected to them.

If a UK resident individual disposes of cryptocurrency and realises a gain, HMRC will expect to tax that gain. However, an alternative approach to determine the situs of cryptocurrencies is by reference to its 'private key' and the person who holds it.  For example, if the private key is held by a nominee, trustee or cryptocurrency exchange offshore, the cryptocurrency would be located in that offshore location rather than in the UK where the beneficial owner resides. On that basis, HMRC would not be able to tax the disposal proceeds unless they were remitted, in full or in part, to the UK. This approach affords the non-domiciliary the ability to shield the gains they realise in respect of their cryptocurrencies from UK tax.

The challenge for investors

If the challenge of planning investments in an ever-volatile market was not enough, investors have to increasingly understand their tax obligations and be aware that scrutiny from HMRC is never far away.  The nudge letters from the HMRC should remind investors of this, and anyone burying their head in the sand should consider what and how they need to report ahead of an intervention from HMRC.  It is far better to voluntarily disclose any issues to HMRC rather than wait to hear from them, particularly in the light of the penalties that can be charged.

Given that HMRC can look into someone's affairs for a minimum of 4 years and up to 20 years in cases where they have deliberately avoided disclosure, anyone not reporting their crypto assets may find themselves looking over their shoulder for quite some time.  From a tax perspective, at least, there is no need to "Abandon Hope All Ye Who Enter Here" - just a need to understand obligations and act accordingly.

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