Cryptocurrency is a new asset class and, to that extent, its regulation has not been fully determined. At the same time, its popularity has soared and increasingly, people (particularly young philanthropists) are keen to gift cryptocurrency and crypto-assets to charities. A number of UK charities (including the RNLI and Save the Children) are accepting gifts of cryptocurrency.
What Is Cryptocurrency And How Does It Work?
Created by Satoshi Nakomoto (a pseudonym) in October 2008, cryptocurrency is a digital representation of value. It is secured by a mechanism known as cryptography which converts legible information into code. It can be converted into legal tender and vice versa and is a medium of exchange which is independent of a central authority such as a central bank. It is stored on publicly visible electronic ledgers called Blockchain and transactions are verified via agreement between users using a process called Distributed Ledger Technology.
The creation of a new unit of Blockchain involves a process known as ‘mining’, which is essentially the solving of an algorithm by computers. Mining uses large amounts of electricity. The technology itself presents opportunities outside the cryptocurrency arena to the extent that the consensus required for a Blockchain transaction is capable of adoption in a range of different areas; for example, information held on a public register, healthcare records, or for payment processing purposes.
A holder of cryptocurrency possesses a public address and a private key, both of which are effectively lines of code. The public address is akin to a bank account number. The private key is akin to a password but cannot be changed by the owner. For the owner of currency to transfer it, the public address and the private key are needed. The private and public keys can be stored in paper form or in various forms of online ‘wallet’. The wallet stores the public address and the private key but not the currency itself.
While cryptocurrency is a crypto-asset, consideration of the wider category of crypto-assets (which, for example, would allow the holder to access certain goods or services rather than just being capable of conversion into cash) is beyond the scope of this article.
Acceptance Of Cryptocurrency
Before agreeing to accept cryptocurrency, a charity will need to consider certain governance steps to ensure that, in broad terms, the acceptance of cryptocurrency is in the charity’s best interests and to ensure the prudent management of gifts of cryptocurrency. This analysis will involve considering the following issues:
The results of an analysis of this nature will allow the charity to decide whether to accept cryptocurrency and to establish a corresponding policy regarding its acceptance or otherwise. This article considers a number of the above issues.
Size of Gifts
Where the number of anticipated gifts of cryptocurrency is small, the charity may not consider their acceptance worthwhile from a cost/benefit perspective. In these circumstances, the charity might consider whether cryptocurrency could be accepted by an alternative route. For example, the donor could make a gift of cryptocurrency to a donor advised fund or other umbrella charity. Such a fund or charity then could take responsibility for the required due diligence steps, liquidate the cryptocurrency, and make an onward grant of cash to the original charity.
Know Your Donor
In general, charities are not subject to money laundering regulations. As such, the receipt of cryptocurrency would not give rise to a need to consider money laundering legislation. However, charities are subject to the Proceeds of Crime Act 2002 where, broadly, they can be liable if they receive property constituting the proceeds of crime and know or suspect this to be the case. Charity Commission guidance requires charities to ensure that they know their donors. The Commission guidance advocates a risk-based approach and, accordingly, does not prescribe the information which charities are required to obtain in connection with donations. Nor does it set a minimum figure below which scrutiny is not required. However, given that the Proceeds of Crime Act does not set any de minimis figure, charities should err on the side of caution, particularly where gifts are large, either in themselves or relative to the charity’s overall assets and/or income.
In the case of a gift of cryptocurrency, it is not possible to verify that the donor is the lawful owner of the currency. Unlike other assets (for example, registered land), the information on the public and private keys does not prove ownership. In the case of gifts of cryptocurrency, the charity should carry out adequate checks on the donor of the cryptocurrency so as to ascertain the donor’s identity and residence. In addition, it may be the case that previous owners of the cryptocurrency obtained it as a result of criminal activities. A number of businesses offer a service to check previous holders of cryptocurrency on the Blockchain, which can show whether the unit on the chain representing the proposed gift has previously been used for criminal purposes.
Practicalities of Acceptance
From a legal perspective, it is significantly less complex for a charity to refuse to accept a donation than to seek to return a donation once it has been received. This is because, once received, a donation is charitable property and in certain circumstances, Charity Commission consent may be required in order to return it.
Before accepting cryptocurrency, a charity will need to open a wallet with a wallet provider. As a matter of prudence, the charity should not make the wallet details publicly available as this would, in some cases, allow donors to gift cryptocurrency to the charity without its knowledge and prior to it carrying out of necessary checks.
Charities are generally required to maximise their assets. That said, it is open to charities to refuse to accept certain donations if to do so would hinder the furtherance of their purposes or discourage donors from making donations. The process of mining cryptocurrency requires a huge amount of electricity. As such, charities working in certain sectors (for example, the protection of the environment) might legitimately conclude that the acceptance of cryptocurrency conflicts with their objects and can be refused on a blanket basis.
Taxation Of Cryptocurrency
Legal Categorisation of Cryptocurrency
Much of the discussion around the tax treatment of cryptocurrency, from the perspective of the person gifting it and the charity using it, has hinged on its legal categorisation. The courts have considered whether certain types of cryptocurrency constitute property, an asset and/or a security. The categorisation is relevant as the wording of the various tax reliefs needs to be considered on a case by case basis.
At the end of 2019, a Legal Statement on the Status of Crypto-assets and Smart Contracts was published by the UK Jurisdiction Taskforce. It aims to provide a view of the legal foundation around cryptocurrency and crypto-assets. The Statement concluded that, in general terms, crypto-assets have all the legal indicia of property. The fact that they have novel or distinctive features, for example, intangibility, decentralisation and cryptographic authentication, does not disqualify them from being property.
The law has traditionally recognised two different types of property, respectively a thing in possession (a tangible object) and a chose in action (a right of property that is enforceable in law). The Legal Statement confirms that crypto-assets constitute intangible property even though they cannot be distinctly classed as either of these types. This analysis has been upheld by the English courts in a recent decision about the status of particular crypto-assets.
Gift Aid Relief
There is some debate about whether cryptocurrency is eligible for Gift Aid relief. Gift Aid applies to a payment of a sum of money, i.e. sterling or foreign currencies. As cryptocurrency does not constitute legal tender, it is not yet recognised as money. Accordingly, for a charity to receive Gift Aid on a gift of cryptocurrency, it would need first to be converted to cash and the cash gifted to the charity. If in future, the Bank of England issued (and regulated) its own cryptocurrency, it is likely that it would attract Gift Aid on the basis that it would be legal tender.
Capital Gains Tax and Inheritance Tax
HMRC has published a manual on the tax treatment of crypto-assets. The manual defines crypto-assets in broad terms and refers specifically to exchange tokens (e.g. Bitcoin), utility tokens, security tokens and stablecoins. The combination of a wide definition and a changing technological backdrop means that advice should be taken before seeking to rely on the existence of a particular relief, particularly to ensure that the characteristics of the crypto-asset in question are such that relief will be available.
Gifts of cryptocurrency to a charity would, generally speaking, be eligible for relief from capital gains tax, with the transfer taking place on a no-gain, no-loss basis.
Individuals can gift certain shares and securities to a charity and obtain relief from both income tax and capital gains tax. However, to avail of the relief, the shares and securities are restricted to those traded on a regulated exchange and to certain types of fund (for example, authorised unit trusts). These latter provisions are too narrow to be applicable to a gift of cryptocurrency itself but they could, in principle, be relevant to gifts of units in certain funds (for example, units in a cryptocurrency fund).
The Inheritance Tax Act 1984 provides that a transfer of value is exempt to the extent that the value transferred is attributable to property which is given to a charity or charities. It is reasonably clear, therefore, that a bequest of cryptocurrency will attract tax relief, assuming that it is property with a value. That said, advice should still be taken as bequests of cryptocurrency can give rise to the need to consider issues such as the situs of the asset and practical issues relating to the safe custody of the public and private keys.
Taxation Within the Charity
From a tax perspective, the charity will need to take care that its dealings with cryptocurrency do not amount to a taxable trade. Generally, charities can only carry out limited trading activity where the trading is not in furtherance of, or ancillary to, the charity’s purposes. Trading activity (by contrast with investment activity) is generally characterised by more frequent buying and selling with a view to a profit. If charities were to buy and sell cryptocurrency at frequency, they might be deemed to be trading in those assets, rather than investing in them.
Use Of Cryptocurrency By The Charity
Investment Powers and Other Considerations for Trustees
Following receipt of a donation of cryptocurrency, a charity will need to consider how to deal with it. This will first involve taking account of any particular wishes of, or requirements imposed by, the donor.
Absent any particular directions, the charity would then need to consider whether to convert the cryptocurrency into cash on receipt or whether to retain it as an investment. This decision will involve considering the charity’s short to medium-term need for funds to further its objects. Where the funds are deemed capable of being invested, the trustees would need to consider whether the cryptocurrency in question represents a suitable investment for the charity against the backdrop of the trustees’ investment duties, the provisions of the charity’s constitution, and any investment policy.
Charity trustees have a statutory power to make any kind of investment that they could make if they were absolutely entitled to the assets of the trust. This power may be restricted in a charity’s constitution and, to a certain extent, in an investment policy. From an investment perspective, an investment in cryptocurrency is only capable of capital growth and will not produce any income – the constitution should be reviewed to ensure that the investment power does not exclude a non-income generating investment. Assuming the trustees have power to invest in cryptocurrency, the standard investment criteria (broadly, the suitability and the need for diversification) would need to be considered in relation to the specific investment proposed.
Grants Using Cryptocurrency
Some charities may consider making grants in cryptocurrency, rather than in cash. Charities are required to ensure that grants made are used to further a charitable purpose. It may prove difficult to satisfy the use test when making a grant of cryptocurrency unless the recipient is required to convert the currency into cash within a particular time period. To that extent, careful consideration should be given to the conditions attached to any grant of cryptocurrency.
Cryptocurrency and crypto-assets represent an obvious opportunity, and a new income stream, for the charitable sector, particularly in light of the funding issues faced by many charities as a consequence of the COVID-19 pandemic. It is likely that, with time, there will be greater clarity around some of the more intricate aspects of their operation. For now, however, charities should ensure that they give sufficient thought to the issues raised in this article before accepting gifts of cryptocurrency.
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Neasa is a charity and philanthropy lawyer with extensive experience advising grant makers, operational charities, public sector bodies, social enterprises, commercial clients and philanthropists on governance, regulatory and commercial issues. She provides tailored advice on governance and regulation, including on directors’ duties and liabilities, board policies, board remuneration, investment-related matters, and engagement with both stakeholders and regulators. She advises regularly in connection with sustainable finance (including impact investment and venture philanthropy). She also advises on not-for-profit mergers and project structuring, including on matters with a real estate and tax backdrop. She assists corporates and corporate foundations on charity law and practice, with particular focus on fundraising and sponsorship matters. Neasa has a particular interest in developments in technology, including FinTech and cryptocurrency, as applicable to the not-for-profit sector. She is recognised by the main legal directories and regularly writes and presents on developments affecting charities and not-for-profit organisations.