Cryptocurrencies – which still seem so new and innovative – have now been with us for over a decade, albeit the explosive growth in investor activity and popular media has come much more recently.
For many investors around the world, part of the big attraction of “crypto” has been the decentralised and comparatively unregulated way in which cryptoassets have been traded over the internet on exchanges across the world and the seeming total secrecy with which investors could hold crypto wealth beyond the sight of the world’s governments. It was almost as if cryptocurrencies existed in a parallel universe of the innovators’ own creation where the normal rules of government interference didn’t exist and wouldn’t exist so long as the blockchain encryption technology upon which cryptocurrencies are based could not be hacked by state actors.
Now, the external world is crashing in. In a development in the UK, which mirrors what the US Internal Revenue Service (IRS) began just before COVID in 2019 and will be repeated across the world, the UK’s tax authority, HM Revenue & Customs (HMRC), has made it known that it has a hoard of data about UK-resident crypto investors. HMRC is now systematically contacting them by the thousand to “educate” them of their tax responsibilities and to “nudge” them into contacting HMRC to put right what in some cases will be many years of unpaid UK taxes on the net gains they have realised.
For all the imaginings about how hard it would be for government bodies to get information on crypto transactions, the reality, as now evident in the UK and US, has turned out to be fairly straightforward. HMRC and the IRS have simply used their information powers to serve information notices on UK and US crypto exchanges requiring them to surrender bulk data on their clients. Crypto exchanges have reportedly sought legal advice on the notices received and have attempted to rein in the scope of the notices in both jurisdictions but they have ultimately supplied the transaction details of many thousands of customers.
HMRC has also doubtless exchanged information on crypto transactions with the IRS and other sister tax authorities around the world. For all the talk about when cryptoassets would be incorporated into the OECD’s Common Reporting Standard (CRS) regime and the US’s Foreign Account Tax Compliance Act (FATCA) reporting, tax authorities never really needed to rely on CRS or FATCA to start making inroads on international crypto investing when bilateral information exchange agreements are now so comprehensive between most of the major jurisdictions. Of course, as CRS and FATCA reporting of crypto investments goes onstream, that will take regulatory visibility to a new level.
Cryptoassets And The Taxman
The taxation of cryptoassets is still in its relative infancy.
In the UK, HMRC has latterly published guidance on the UK taxation of cryptoassets and has produced a manual which is publicly accessible. HMRC’s view is that on first principles – in the absence of new dedicated legislation – most disposals of cryptocurrencies are to be treated in the UK as the sale of intangible investments. As such, they will give rise to capital gains – net of any allowable capital losses or allowances - assessable to UK Capital Gains Tax. In some more limited circumstances, systematic buying and selling might create net profits, instead assessable as trading income. In regurgitating existing taxation principles, HMRC even suggest that in some circumstances some more speculative ventures might, on the specific facts, be regarded as gambling and tax exempt – however, we can confidently expect limited and only exceptional success persuading HMRC of that in practice.
Perhaps the most contentious current situation in the UK applies for UK resident “non-doms”. HMRC’s current stated position – in the absence, arguably, of solid existing principles upon which to rely in this regard – is that cryptoassets are to be regarded as located for UK taxation purposes where the individual owner is personally resident for tax purposes. That will likely be hotly contested in the Courts, with consequences across other Common Law jurisdictions.
Around the world, many other “mainstream” jurisdictions such as the US, Australia and Canada are adopting a broadly similar stance to the UK in treating cryptocurrencies as assets subject to tax on investment gains. However, there are outliers such as Germany which are adopting different and sometimes more benign principles. Indeed, some countries are seeking a competitive “haven” status by making most cryptocurrency transactions tax exempt.
The UK Approach To Putting It Right
In the UK, HMRC has the power to go back many years to assess and collect previously omitted tax. How far HMRC can go back depends on the particular circumstances and the “behaviours” of the taxpayer involved. Even in the most benign circumstances, HMRC can go back a minimum of four years to collect back taxes if they make a “discovery” of loss of tax but it can be up to as many as 20 years – i.e., to before the very dawn of crypto if a “deliberate error” was made in a submitted return or in the absence of a “reasonable excuse” if no general return omitting it was filed at all.
In the event that UK crypto investors have neglected their tax affairs, the best way to mitigate their position and reduce the risk of an intrusive and broad ranging investigation is to pre-empt HMRC by making a voluntary disclosure. In doing so they stand to get a more open-minded hearing from HMRC and to suffer lower penalties than they would if they waited for HMRC to open an investigation. HMRC’s aforementioned “nudge letters” are designed to push them in this direction with the implicit threat of an investigation.
The first step in any back taxes situation – whether for a voluntary disclosure or an investigation - is to establish the facts. Those facts and the tax advisor’s conclusions thereon will form the basis of a disclosure report to HMRC, prepared on the taxpayer’s behalf, computing the tax and late payment interest still payable.
In the case of crypto investors, this places many “early adopters” who did not catalogue their crypto transactions and did not do their tax accounting as they went along in a difficult and somewhat confused position. However, they will need to do what they can. To the extent that information cannot be retrieved, the taxpayer and their advisors will need to form assumptions to compensate for that missing information.
HMRC cannot demand information that the taxpayer can no longer provide and will consider whatever assumptions are offered to them subject to their acceptance that they appear reasonable in the circumstances. It might be necessary, for instance, to assume that some transactions should be treated as “no gain / no loss” in the absence of details about purchase price.
To the extent that some matters might be open to different technical conclusions, HMRC may challenge the advisor’s conclusions. Similarly, HMRC may challenge the advisor’s characterisation of the relevant “behaviours” that led to the default since this has a bearing on the number of years still assessable and the level of potential penalties. It is then a question of the taxpayer’s and their advisor’s degree of confidence in their arguments and the extent to which any upside would justify the further professional costs involved in extended negotiations or entering the appeals process.
Past experience of other HMRC initiatives – such as offshore investment accounts – suggests that HMRC’s approach will evolve over time. Initially, advisors are likely to have broad flexibility in making reasonable assumptions for dealing with missing information or some areas of technical ambiguity, but some assumptions and treatments will likely become standardised and more prescriptive over time which, depending on their own facts, may suit some investors but not others.
The Way Forward
Now that the world’s tax authorities have crashed the party, what was for so many the age of wilful naivety – or so-called “Nelsonian blindness” – is over. In so many jurisdictions around the world, crypto assets must now be thought of just like any other form of investment and detailed records must be kept. Crypto exchanges will have an important role to play – not just in complying with data notices served on them by their local tax authorities and with future CRS and FATCA obligations but also in providing “user-friendly” information to their customers to make it easier for them to properly meet their tax responsibilities in the first place.
Given the present disparate tax treatments adopted throughout the world, calls for globally standardising the tax treatment of cryptocurrencies are fanciful – at least for the foreseeable future. However, countries like the UK must urgently revisit their double taxation treaties and agree revisions as needed to ensure they are fit for purpose, particularly where conceptualisations of crypto taxation are fundamentally different between the counterparts.
What seems inevitable in taxing jurisdictions like the UK where modest annual allowances and exemptions apply is that there will be a more pronounced two-tier mentality to using crypto currencies like conventional currency. Far greater attention will be paid by wealthier people to the risks of crystalising significant chargeable tax events upon using cryptocurrency for significant expenditure – and that, surely, will heavily drive down its use for the purchase of things like property. Meanwhile, for so many smaller crypto investors, who may typically realise no other potential capital gains of any other sort during the course of a year, they will be able to continue using crypto currency for sundry expenditure as before so long as, in the case of the UK, they do not exceed their overall annual capital gains exemption (currently £12,300).
As always, the very tax issues and uncertainties thrown up will create scope for commercial innovation and competition. For the high-net-worth market, in the event, for instance, of ongoing uncertainty over where cryptoassets are treated as held by resident “non-doms” in jurisdictions like the UK, there is surely scope for offshore jurisdictions to develop, legislate for and market “crypto trusts” or insurance wrappers for the very wealthy. On a more mundane level, many investors will seek certainty and greater simplicity by investing indirectly in cryptocurrencies through crypto investment funds.
In the UK and internationally, we are still near the beginning of a fascinating journey in coming to grips with cryptoassets, of which, tax is just one strand, albeit an important one which is surely the major driver of global transparency initiatives.
Andrew Park is a Partner at Price Bailey in the UK. He specialises in regularising back tax issues with the UK tax authorities for all types of clients and all taxes – including cryptocurrency investors now coming under investigation or receiving “nudge letter” invitations from HMRC to make voluntary disclosures. Andrew can be contacted at email: firstname.lastname@example.org / tel. +44 07717 892 537