In October 2020, Miami-based art collector Pablo Rodriguez-Fraile spent almost $67,000 on a digital token stating that he owns a 10-second video artwork that he could have watched online for free; he went on to sell that same digital token for $6.6 million.
Welcome to the weird world of cryptoassets. We’re going to take a look at cryptoassets, how they are taxed and what to do if you think you may have missed them off your tax return.
Bitcoin is probably the most well-known of cryptoassets, but as the example above demonstrates the crypto world has moved on significantly since then. Bitcoin is an example of a cryptocurrency, a store of value, but we now also have utility tokens, security tokens, platform tokens, and the list and their uses keep growing.
The term cryptoassets is used to encompass all these different types of currencies and tokens. Typically, what they will all have in common is that they are digital assets that use cryptography and a public, decentralised ledger to track ownership, secure and verify transactions. Interest in crypto assets has been steadily growing in the public consciousness since the arrival of Bitcoin back in 2009.
We’re seeing more and more clients who have cryptoassets as part of their portfolio, sometimes as a curio, a blind punt, or part of a strategy for a balanced portfolio of low and high volatility assets. It is important for investors to understand how this new asset class is taxed and to be aware of the complexities and risks.
The starting point for determining the tax treatment will be whether the individual concerned is trading or investing. HMRC’s view is that, in most cases, individuals will hold cryptoassets as a personal investment and so be subject to capital gains tax on disposal.
Calculating those gains may not always be so straightforward. Many cryptoassets are traded on exchanges that do not use pound sterling and it is also common in the crypto world to directly exchange one cryptoasset for another. Add into this the daily volatility in the crypto market, and actually valuing your cryptoassets on disposal can be tricky.
A key point to note here is that HMRC views different types of cryptoassets as separate assets for capital gains purposes. The swapping of your Bitcoin for, say Polkadot token, will trigger a disposal for capital gains tax purposes even if no actual currency has been received. In this case, the individual investor would realise either a taxable gain or loss as a result and may need to make further disposals of cryptoassets into actual currency to meet their tax obligations.
Some individuals may also be involved in mining and validating transactions, as well as staking and yield farming. In doing so, they will often be rewarded either through the receipt of fees and/or further cryptoassets. Typically, such rewards will be subject to income tax, but whether that is as trading income or not will depend on the particular facts and applying the case law principles of trading versus investment to those facts.
The very nature of cryptoassets is that they are decentralised and digital in nature and do not have a physical location or exist anywhere. However, determining the location or ‘situs’ of assets is important for tax purposes and particularly for UK residents, non-UK domiciles as it can change the tax consequences dramatically.
In their guidance, HMRC have stated their view on the situs of exchange tokens, which would include the likes of bitcoin. Their view is that an exchange token is located wherever the beneficial owner is resident (provided it is not a digital representation of another underlying asset). Therefore, if the bitcoin owner is resident in the UK, then the cryptoasset may be located in the UK also.
This situs of exchange tokens is only based on HMRC guidance and has not been specifically legislated for. It also brings to question whether other types of tokens other than exchange tokens are to be treated the same and whether the mechanism by which an individual accesses their crypto assets always amounts to beneficial ownership. The situation here is therefore far from clear.
Nonetheless, if a UK resident, non-UK domiciled individual personally purchases cryptoassets using their untaxed foreign income or gains, then they may have remitted those funds into the UK and triggered a tax liability at the point of purchase.
Further, if that individual goes on to dispose of those cryptoassets and realises a gain, that gain may be taxable in the UK too, without the benefit of the remittance basis of taxation. As individuals increasingly earn income on their cryptoassets, that income may be considered UK source and taxable on an arising basis as well.
Non-UK domicile, UK resident individuals should therefore think carefully about how they invest in cryptoassets and the tax consequences.
The first step is to work out if your historical investments in crypto are tax compliant or whether you do have a problem. If you do, HMRC offer a disclosure facility to help individuals correct historical tax errors. How to manage and prepare a disclosure in a complex area like this will include the need for a factual analysis of the position including a review of all available evidence and a tax technical analysis. HMRC will also want to understand what’s gone wrong and why as this has a bearing on what years are assessable and whether any penalties are due.
We have extensive experience advising clients making voluntary disclosures to HMRC. KPMG tax experts, Derek, Edward Renton, and Jonathan Peall support our clients to understand their UK tax position in respect of their crypto assets. If you have a query regarding the UK taxation of your crypto assets please contact them.
The artist who sold that digital artwork that was freely available to his Instagram followers is called Beeple. He has done even better, packaging his first 5,000 memes into another digital token that was sold for $69 million.