The end of the last decade did not herald an end to investments in crypto-assets, writes James Brockhurst, senior associate, and Nicholas Owen, trainee solicitor at Forsters.
Instead, financial advisers should recognise that crypto-assets are growing in variety and sophistication, with entities ranging from Facebook to the Chinese Government developing their own crypto tokens, and with real estate tokenisation becoming more prevalent.
For instance, commercial property was purchased last month in Switzerland for value of CHF130,000 (£102,000, $133,000, €122,000), paid mostly in BrickMark, a security token.
No financial adviser ought to make the mistake of thinking that ‘Ripple’ is purely a chocolate bar made by Galaxy.
Red herrings
UK financial advisers should be aware of HM Revenue and Customs’ (HMRC) treatment of these assets, which is continuously evolving as the sector develops.
They should note that HMRC does not adopt a one-size-fits-all approach to crypto-assets, as demonstrated by the fact that exchange tokens, those which lack any kind of utility or underlying asset, are treated differently to security tokens, which are underpinned by tangible assets; including real estate.
Investors in crypto-assets often fall foul of “red herrings”, which are disseminated online about the tax treatment of crypto-assets.
There is the mistaken belief that buying and selling crypto-assets equates to gambling, so is tax-exempt, and the equally dangerous claim that exchanges in crypto-currency are not disposals for capital gains tax (CGT) purposes.
Preferential tax treatment for investors in crypto-assets
As it is not unusual for individuals to capitalise on the volatility of the crypto-assets markets by making frequent transactions, advisers should ensure their clients appreciate the tax disadvantages of being viewed by HMRC as a “trader” rather than an “investor” in crypto-assets.
A”trader” will pay income tax on their profits from dealing in crypto-assets at 45% if they are an additional rate taxpayer; while an “investor” will pay CGT on their chargeable gains at a rate of only 20%.
Whether an individual is an investor or a trader is ultimately question of fact.
HMRC will take into account the experience and sophistication of an individual, the frequency of transactions, and the individual’s profit-making strategy.
The volatility of crypto markets brings a greater temptation to trade higher volumes, which comes with a trading tax risk.
It is perfectly possible that HMRC could regard someone who plays the crypto-assets markets at weekends whilst holding down an ordinary nine-to-five job as a trader.
Crypto-assets and non-domicliaries
HMRC’s latest guidance ‘Crypto-assets: tax for individuals’, published in December 2019, provided some clarity, but not comfort, as to how HMRC will treat UK resident non-domiciliaries investing in exchange tokens like Bitcoin.
HMRC previously confirmed they will treat crypto-assets as “property” for tax purposes, but many questions over the situs of crypto-assets remained unanswered.
Non-domiciled investors had reached the logical conclusion that their foreign-held crypto-assets would escape the net of UK inheritance tax (IHT) and CGT.
But, if, for example, their private keys for accessing their crypto-assets were stored in a foreign jurisdiction, they will now need to be advised that HMRC will refute this.
HMRC confirmed in December that, where an exchange token is beneficially owned by a UK resident, it will have a UK situs irrespective of the physical location of the private key.
Even if a UK resident holds their private keys in custody in Switzerland, HMRC will deem the exchange tokens to be located in the UK.
It is worth recognising that HMRC’s guidance is not law and that their position on crypto-assets, which sees exchange tokens treated differently to almost all other asset classes, could be challenged in the courts.
Unaccommodating
HMRC’s new guidance is unaccommodating to non-UK domiciled individuals resident in the UK.
Non-domiciliaries benefit from the remittance basis, which ensures they pay UK tax in the normal way on all UK source income and gains but do not pay UK tax on foreign income and gains that are not “remitted” to the UK.
By inextricably linking the situs of crypto-assets to residence, HMRC is effectively seeking to abolish the remittance basis for crypto-assets and weakening the distinction between domiciled and non-domiciled individuals.
As crypto-assets grow in sophistication, tax is only the tip of the iceberg.
New challenges will emerge in the context of divorce, succession, insolvency and many other areas, and financial advisers ought to be ready to meet these challenges.
This article was written for International Adviser by James Brockhurst, senior associate, and Nicholas Owen, trainee solicitor, at Forsters.
