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16 January 2020
For those operating in the UK tax world, Her Majesty's Revenue and Customs (HMRC) has a marvellous ability to confound expectations. In recent years, it has delivered surprises on topics such as:
HMRC's latest plot twist concerns crypto. It updated its Cryptoassets: Tax for Individuals guidance on 20 December 2019 to include a section on the 'situs' of cryptoassets (ie, where cryptoassets are deemed to be located for UK tax purposes). The update relates only to 'exchange tokens' – namely, cryptographic tokens such as bitcoin which are distinguished from those which have some kind of utility ('utility tokens') and those which are underpinned by real-world assets ('security tokens'). HMRC's view on situs for utility and security tokens remains unknown.
The HMRC guidance states that "throughout the time an individual is UK resident the exchange tokens they hold as beneficial owner will be located in the UK". In other words, the situs of cryptoassets will track the residence of the holder for the purposes of all taxes.
This is unhelpful to a person who is in the United Kingdom on a short-term basis. Such individuals, provided that they are non-UK domiciled, can claim the remittance basis to shield their unremitted foreign income and gains from UK tax. The remittance basis applies to all types of asset, with minor and generally logical exceptions (eg, offshore bonds). The new guidance is effectively an attempt by HMRC to remove the right to claim the remittance basis on cryptoassets.
This is a bold departure by HMRC from established principles. It states that "exchange tokens are a new type of intangible asset". In August 2017 HMRC made a similar statement but advised that situs will "be determined by a range of relevant factors".
HMRC was right to say this because cryptoassets can be held in a variety of different ways, which logically should have some impact on their situs. For instance, some investors hold 'private keys' (ie, the passcode needed to access a cryptoasset) in their personal possession, perhaps on a hard drive or on a piece of paper in a safe (the latter being the preferred storage method of the Winklevoss twins of Facebook fame). In these cases, the logical approach would be to defer to the physical situs of the private keys (the device or paper on which they are stored) as per the tangible movable property rule under Section 275(1)(b) of the Taxation of Chargeable Gains Act 1992. In contrast, where private keys are not held personally but deposited with a centralised exchange (eg, Coinbase), the arrangement more closely mirrors a banking relationship and the consistent approach would be to determine situs with reference to the country in which the exchange operates or is incorporated.
The position is also unhelpful from an inheritance tax perspective as a non-domiciliary who becomes a UK resident and passes away holding cryptoassets will pay inheritance tax on them, even if only temporarily a UK resident. Although inheritance tax situs rules are governed by common law (as opposed to statute in the case of capital gains tax), there is plenty to commend adopting the same situs rules for inheritance tax based on how private keys are held.
HMRC has said that the residence rule "gives a clear, logical, predictable and objective rule which can be easily applied" but has omitted to explain why cryptoassets should be treated in this exceptional way. A more cohesive approach would be for the situs of directly held cryptoassets to be determined by the physical location of the private keys. For those held on a centralised exchange, the situs should be determined by the location of the exchange.
Investors should note that HMRC's guidance represents its interpretation of the law, rather than the law itself. Perhaps HMRC will perform a U-turn (as it did in 2015 on the use of non-UK income and gains as loan collateral) or perhaps a hearing in the Tax Tribunal will determine matters. That said, crypto holders should review their reporting position in UK tax returns in light of this guidance as the January 2020 reporting deadline approaches and review their previous year returns.
If the UK government is serious about promoting the United Kingdom as a fintech hub, it might consider giving normal (or even special) treatment to cryptoassets, rather than singling them out for punitive treatment.
For further information on this topic please contact James Brockhurst at Forsters LLP by telephone (+44 20 7863 8333) or email (firstname.lastname@example.org). The Forsters LLP website can be accessed at www.forsters.co.uk.
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