The taxing questions over your crypto assets

by Stephen Hignett and Andre Anthony of CMS Law

HM Revenue & Customs (HMRC) continues to update its guidance on the taxation of crypto assets. The analysis below reflects the latest position.

What amounts to a disposal for capital gains tax purposes?

When considering transactions involving crypto assets, what constitutes a disposal for capital gains tax purposes is highly fact dependent. Crypto assets would typically be treated as disposed of when an individual:

• sells tokens;
• exchanges tokens for a different type of token;
• uses tokens to pay for goods or services; and
• makes gifts of tokens.

HMRC recognises that no disposal would take place if an individual retains beneficial ownership of the crypto assets throughout the transaction – for example by moving tokens between wallets.

HMRC has confirmed that it would not regard using a mixer, tumbler, or similar service as a disposal when an individual puts token A into the transaction and receives the same token A in return. However, using a mixer, tumbler or similar service would result in a disposal taking place if an individual puts token A into the transaction and receives token B in return.

HMRC does not express a view on whether transactions which involve transferring tokens between distributed ledgers would result in a disposal for capital gains tax purposes. The answer would depend on the specific facts.

It should be noted that the usual capital gain tax reliefs and exemptions would, where relevant, apply equally to gains arising from disposals involving crypto assets.

What constitutes “trading” for tax purposes?

It is unlikely that an individual would be treated as “trading” for tax purposes where tokens are only occasionally bought and sold.

HMRC acknowledges in its guidance that it would treat individuals who buy and sell crypto assets as “trading” only in “exceptional circumstances”. What amounts to “trading” activity is ultimately a question of fact and is dependent on several factors.

HMRC has not formulated a specific “trading” test in the context of crypto assets. Instead, in respect of exchange tokens specifically, HMRC has confirmed in its guidance that it would regard a trade in exchange tokens to be similar in nature to a trade in shares, securities, and other financial products. It follows that guidance on what constitutes “trading” can be drawn from the existing law on trading in shares and securities.

The factors which the courts have previously taken into account when considering the question of what constitutes a “trade” for tax purposes include:

(a) the time spent by an individual on the activity;

(b) whether an individual entirely relies on their own expertise or uses the advice of brokers; and

(c) whether the activities undertaken are characteristic of established share dealers or not, for example, if the individual has no customers and is dependent on market movements alone to make a profit.

Broadly, UK tax resident individuals disposing of crypto assets which are held as personal investments would be subject to capital gains tax on any gains arising.

In circumstances where individuals are treated as “trading” in crypto assets, any gains arising on the disposal of crypto assets would be subject to income tax (instead of capital gains tax which typically attracts a lower rate of tax). It should be noted that “trading” has a specific meaning for tax purposes.

Inheritance tax and pensions tax relief

Inheritance tax typically arises on the deemed transfer of value that takes place on the death of an individual. 

In its guidance, HMRC has confirmed that it considers crypto assets to be property for the purposes of inheritance tax.

Individuals who are UK domiciled or deemed domiciled for tax purposes are subject to UK inheritance tax on their worldwide estates. Non-UK domiciled individuals are, subject to certain exceptions, only subject to UK inheritance tax in respect of any assets they hold which are situated in the UK (UK situs assets, for example).

There are no statutory rules to determine the situs or location of assets for inheritance tax purposes. Instead, the situs or location of assets is determined using general common law principles.

In respect of exchange tokens specifically, where the crypto assets are distinct from any underlying asset, HMRC has expressed its view on how situs should be determined. HMRC confirms that the situs of an exchange token should be determined by reference to the tax residency status of its beneficial owner, for the following reasons:

• exchange tokens have an economic value as such assets can be “turned to account”, for example, by exchanging the crypto assets for goods, services, fiat currency or other tokens;
• exchange tokens are a new type of intangible asset (which are different to other types of intangible assets, such as shares or debentures); and
• the only identifiable party to consider is the beneficial owner of an exchange token.

This approach marks a departure from general common law principles and is unsupported by legal precedent or legislative authority. It follows that should the question of the situs or location of exchange tokens be put before the courts it may well be answered differently.

It is also unclear how the situs or location of other types of crypto assets will be determined.

Tax Relief on making pension contributions

Subject to certain limits, income tax relief is available to members in respect of member contributions paid to registered pension schemes.

On the basis that HMRC does not consider crypto assets to be currency or money, should crypto assets be paid into a registered pension scheme, such contributions would not attract any income tax relief.

If an individual nevertheless contributes crypto assets into a registered pension scheme, albeit without any income tax advantages, such crypto assets would become part of the scheme assets which are subject to the tax rules governing registered pension schemes.

Stephen Hignett is a Partner, and Andre Anthony a Senior Associate in CMS’ tax team