Crypto taxes: payment in pounds, dollars or eth sir?
1 November 2021
As HMRC nudge letters arrive at the homes of crypto asset owners, urging them to check they have paid the right tax, Citywealth’s April French Furnell spoke to tax advisors to find out everything UHNWs need to know to stay on the right side of HMRC.
A recent survey by Capgemini found that of 2,900 HNW individuals across 26 markets who were surveyed, 72 per cent, said they had invested in cryptocurrencies, and as the value of cryptocurrencies continues to rise, it’s no surprise that HMRC has begun to sharpen its focus on individuals who own crypto assets and wanting them to declare them for tax purposes.
The starting point for tax implications for crypto activities is understanding how HMRC views cryptocurrency. “Tax authorities around the world have cottoned on to the fact that crypto is a form of property and it should be treated as such, therefore there is tax to pay on a gain”, explained Dominic Lawrance, a partner at law firm Charles Russell Speechlys specialising in tax planning for international clients.
The ins and outs
For individuals, the main tax they need to be concerned with is whether they are liable to pay Capital Gains Tax when they dispose of their cryptoassets. That seems simple enough, but Zoe Wyatt, a partner at tax consultancy Andersen, highlighted that many don’t know when they are making a disposal and therefore misunderstand when they ought to declare a gain for tax purposes. “For those buying bitcoin and selling it at a gain back into fiat currency, they understand they’ll need to pay tax. But many do not appreciate that swapping one cryptocurrency for another or using tokens to pay for goods and services are also disposals”, she explained.
There are now funds marketing to UHNWs to make their investment in Bitcoin. Those UHNWs need to be aware that these transactions will also be considered disposals. Wyatt explained that using Bitcoin to buy shares in a company is a disposal regardless of whether the underlying asset is Bitcoin, other cryptoassets or traditional investments such as real estate.
In recent years, and following the publication of the 2021 Cryptoassets Manual, the situation surrounding disposals has become much clearer. “Pre-2018, individuals may have fallen into the category of being ‘careless’ (which attracts a 6-year enquiry window and potentially lower penalties), but with all the information now available, continued non-compliance is likely to be seen as ‘deliberate’ resulting in a 20-year enquiry window and maximum penalties which could be as much as 200% of the underpaid tax”, said Wyatt.
Chris Etherington, a partner at RSM UK said, “Given how volatile crypto is as a market, it’s perhaps unexpected that the individuals we see dealing in it are taking a cautious approach when it comes to the tax authorities. We are seeing clients get in touch to ask for help in calculating their gains, putting funds aside for future tax obligations and some have even asked if they could pay HMRC in advance”.
While HMRC have inevitably been playing catch up over the past few years, it’s not a surprise that they are looking more closely at the tax reporting of crypto asset owners. As David Britton, a tax partner at BDO confirmed: “HMRC now receives information direct from UK crypto exchanges and platforms. Last year Coinbase, the digital currency exchange, confirmed that it had shared with HMRC details of UK resident users who have used its platform with Crypto transactions of £5,000 or more in the 2019/20 tax year. HMRC has allocated resources to ensuring the tax due on cryptocurrencies transactions are declared through collaboration with their international partners.”
In the US, Biden’s administration has proposed changes to cryptocurrency reporting which would implement a new rule for businesses and crypto exchanges, requiring them to report any cryptocurrency transactions with a fair market value of $10,000 or more to the IRS. Similarly, the EU is focused on the exchange of information and updating its EU Directive on Administrative Cooperation (DAC). “Indeed, the EU is aware of the high risk of tax evasion embedded in the crypto-asset area and of the need for greater tax transparency. In March 2021, the EU launched a public consultation in this regard, which is part of the process that should lead to a proposal for a new update -- the eighth -- of the DAC”, said Marco Adda, a partner at BonelliErede. It’s expected that DAC8 will be implemented within the next 12 to 18 months leading to additional regulatory requirements for cryptoasset creators and distributors, and cryptoasset owners.
What should individuals do if an HMRC nudge letter finds its way to their home? Derek Scott, who leads tax investigations at KPMG advised, “Just because you receive a letter doesn’t mean you have a tax problem but it is important to address the matter proactively. HMRC has referred to this as an educational letter illustrating the tax on this area can be complex. It is quite possible that some individuals have missed they even have a tax issue to address. When filing a tax return this year, you do need to pay close attention to crypto investments and declare any crypto gains or income”.
Scott expects that there is a possibility we’ll see significant disclosures as a result, which might well have a knock-on effect for historical events also surfacing. “The nudge letter campaign is going to ensure people take stock of their tax position around crypto and if it emerges they have reported their historic crypto gains incorrectly (or not all) there is a need to now disclose that. A big part of any disclosure is explaining to HMRC why it happened. There will be a difference to the overall liability, including penalties, between those who have made a genuine mistake, someone not taking sufficient care and those who tried to evade paying any tax”. The level of penalties for non-compliance vary considerably including whether a disclosure is unprompted or in reaction to a HMRC challenge. Scott cautions: “If you don’t receive a letter from HMRC, don’t wait if you are in any way uncertain, speak to an advisor about your cryptoassets and get on the front foot”.
Look back in anger
Might we see a disclosure facility? In the past HMRC has offered an opportunity to disclose overseas income and gains, with the caveat that those who didn’t would face a 200 per cent tax penalty. “It would be extreme to take this position with crypto given the complexities involved in calculating gains, but it isn’t beyond the realm of possibility to offer an opportunity to disclose historic gains. HMRC have wide powers to be able to look backwards. It’s a long time to be looking over your shoulder”, said Etherington.
If the situation regarding applying legislation, guidance and case law wasn’t complicated enough, there are two areas where the situation is even less clear-cut.
Location, location, location
One of these is the situs of crypto which affects non-doms and their remittance basis. “HMRC has stated that the situs of crypto assets is determined by the residence of the person who is the beneficial owner. From HMRC’s perspective it doesn’t matter how it is stored, the wallet can be physically outside of the UK, but if you a resident of the UK then your crypto is situated in the UK”, explained Lawrance. James Brockhurst, a senior associate in the private client team at Forsters added: “The policy decision is discriminatory against crypto assets, as for any other asset situated outside of the UK you can claim remittance basis.”
The problem is that this is based on HMRC guidance, rather than law so it isn’t universally accepted. “I don’t envy HMRC trying to figure this out, and it is a logical view but there are some who say the situs should be determined by the domicile of the holder while others say it is where you keep the private key”, said Jonathan Peall, a director at KPMG. “It needs legislation or a senior court case to resolve this issue. Given the values involved it’s worth people’s while to litigate it”, said Lawrance. With enforcement on the rise, this could become a historical issue for non-doms who have inadvertently remitted large sums of money, as well as a potential issue going forward.
The second area is the emerging field of DeFi – decentralized finance – a term used to describe financial products and services that are accessible to anyone holding crypto who wants to sweat the asset. Products include lending and staking for rewards. This new development has not yet been addressed by HMRC and more information is expected soon.
Square peg round hole
In the meantime, clients delving into this area and entering smart contract arrangements are seeking advice but the answer isn’t always clear cut, explained Etherington. “It’s a matter of looking at case law, guidance and legislation, which can apply to different circumstances and trying to overlay it to their situation. It doesn’t fit particularly well, but it’s the best interpretation of the rules as they stand”, he said.
A final thought: if crypto has to pay its taxes in pounds or dollars, does the fiat conversion qualify as a disposal? Or do we see HMRC forcing themselves into a corner, then having to accept crypto as payment at forex day rates? If they did wouldn’t it ultimately validate the whole existence of crypto as a bonafide set of currencies?
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