HMRC opines on situs of crypto-assets

For those of us operating in the UK tax world, HMRC have a marvellous ability to confound expectations. In recent years they have delivered surprises on topics such as specialty debts, offshore income gains (as non-protected income), and remittance basis users using non-UK income and gains as loan collateral.

Their latest plot twist is in the genre (if you will) of crypto. HMRC updated their guidance, 'Crypto-assets: tax for individuals', on 20 December 2019 to include a section on the situs of crypto-assets, ie where crypto-assets 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'). We still do not know HMRC's view on situs for 'utility tokens' or 'security tokens'; that will be a debate for another time.

Situs of Exchange Tokens

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 crypto-assets will track the residence of the holder for the purposes of all taxes.

This is unhelpful to a person who is in the UK on a short-term basis. Such individuals, provided 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 (such as offshore bonds). The new guidance is effectively an attempt by HMRC to remove the right to claim the remittance basis on crypto-assets.

HMRC's Approach

This is a bold departure by HMRC from established principles. They state that 'exchange tokens are a new type of intangible asset'. When we last corresponded with HMRC on the subject, back in August 2017, they made a similar statement then, but advised that situs will 'be determined by a range of relevant factors'.

They were quite right to say this - crypto-assets 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 which is needed to access a crypto-asset) 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 275(1)(b) TCGA 1992. In contrast, where private keys are not held personally, but deposited with a centralised exchange (such as Coinbase), the arrangement mirrors more closely 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 UK resident who passes away holding crypto-assets will pay inheritance tax on them, even if only temporarily UK resident. Although inheritance tax situs rules are governed by common law (as opposed to statute in the case of CGT), there is plenty to commend adopting the same situs rules for inheritance tax based on how private keys are held.

Time to Review

HMRC say the residence rule 'gives a clear, logical, predictable and objective rule which can be easily applied', but omit to explain why crypto-assets should be treated in this exceptional way. A more cohesive approach would be for the situs of directly held crypto-assets to be determined by the physical location of the private keys, and for those held on a centralised exchange the situs should be determined by the location of the exchange.

It is important for investors to note that HMRC's guidance represents their interpretation of the law, rather than the law itself. Perhaps HMRC will perform a U-turn (as they 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 the guidance as the January reporting deadline approaches, and they should review previous year returns.

One final thought – if the UK government are serious about promoting the UK as a fintech hub, they might consider giving normal (or even special) treatment to crypto-assets, rather than singling them out for punitive treatment.

James Brockhurst is a senior associate in our Private Client team.