Cryptocurrency: Tax issues for FIs and asset managers

Cryptocurrencies and cryptoassets are in the news every day and are becoming increasingly popular worldwide. But as they gain in popularity, they also attract attention from HMRC and other tax authorities around the world, keen to ensure that any related profits are subject to tax.

As financial institutions and asset managers engage in cryptocurrency activities, we highlight some of the main tax issues for them in relation to this rapidly evolving and complex asset class.

Financial institutions

• Are cryptocurrencies treated as a security or money for tax purposes? – HMRC’s approach to the taxation of cryptocurrency is not yet entirely consistent across the range of taxes – the current HMRC guidance on the taxation of cryptocurrencies considers a trade of cryptoassets to be similar in nature to a trade in shares, securities and other financial products for direct tax purposes, yet for VAT purposes this is not the case. Instead, HMRC (following the approach taken by the Court of Justice of the European Union in David Hedqvist) has indicated that the VAT exemption for the issue, transfer or receipt of, or any dealing with, money will apply to services facilitating the exchange of bitcoin for legal tender. Given this divergent approach between taxes, financial institutions should take care to consider each of the taxes applicable to a crypto-related product or service separately, rather than applying a ‘one size fits all’ approach.

• Trading v investing – As with many of the activities carried out by financial institutions, it will be necessary to ascertain whether the purchase and sale of cryptoassets amounts to a trade, or whether those cryptoassets are being held as an investment by the institution, in order to ascertain the correct tax treatment. Although it is likely that financial institutions will be buying and selling cryptoassets with sufficient frequency and organisation to be considered to be carrying out a trade (with related profits and losses forming part of the calculation of the institution’s trading profits), this should not be assumed and financial institutions should take care to frequently review their levels of cryptocurrency activity in order to ensure that the correct tax treatment is applied to any profits/gains going forward.

• Gaps in HMRC guidance – HMRC’s guidance on the taxation of cryptoassets is not yet comprehensive, meaning that the tax treatment of many cryptocurrency-related products or services being offered by financial institutions to their clients is not yet apparent from the guidance – for example, the treatment of custody services provided in relation to crypto assets, or the taxation of derivatives where cryptocurrency is the underlying asset. Rather than having crypto-specific guidance to follow, financial institutions may instead be required to look to and apply the more generic (non-crypto) rules governing the taxation of such services or products in order to try and ascertain the tax treatment applicable to its crypto-related offerings.

• Further changes on the horizon – HMRC’s guidance on the VAT treatment of cryptocurrencies, and cryptocurrency related services, is marked as provisional pending further developments, indicating that the current VAT treatment is likely to change. In particular, any future changes to the UK VAT treatment of crypto-related services and products is likely to be influenced by regulatory developments, and changes to the EU VAT position. Financial institutions’ tax teams should therefore be alive to changes in the regulation of crypto-products, as any significant changes from a regulatory perspective may soon be followed by amendments to the VAT treatment applicable to the implicated products or services. Should the applicable VAT treatment change (for example, certain crypto-related services no longer falling within an exemption), financial institutions will have to consider whether they or their clients will bear any VAT burden from a financial perspective, and consider adjusting their fees accordingly.

Asset managers

• Situs of cryptoassets – UK resident non-domiciled individuals electing to be taxed on the remittance basis are only subject to capital gains tax on gains from non-UK situs assets to the extent those gains are remitted to the UK. HMRC guidance sets out HMRC’s view that the situs of exchange tokens is the jurisdiction where the beneficial owner of those exchange tokens is resident. This would mean that, for UK resident non-domiciled individuals, exchange tokens would never be able to be taxed on the remittance basis. Some commentators have suggested an alternative view that the situs of exchange tokens could be determined by the jurisdiction where a single physical copy of the private key for the exchange tokens is located, but it is not clear HMRC would accept this position.

• Investment manager exemption – UK based investment managers often rely on the UK investment manager exemption to ensure that trading transactions they enter into on behalf of a non-UK resident fund are not brought within the charge to UK tax. Currently, trading in cryptoassets is not covered by the UK investment manager exemption though we understand HMRC are giving serious consideration to extending the exemption to cryptoassets.

• Exchanges of cryptoassets – An exchange of one type of exchange token for another type of exchange token (eg an exchange of Bitcoin for Ethereum) is a disposal for the purposes of UK tax on chargeable gains. It is not possible to roll a gain on one type of exchange token into another type of exchange token. Chargeable gains and losses must be calculated in sterling so holders of exchange tokens are also exposed to exchange gains and losses on their portfolio.

For further information about the tax treatment of cryptoassets, sign up for our next webinar, Keeping Up with Crypto, on 10 February, 4pm GMT, co-hosted with Holland & Knight where we’ll be discussing the latest direct and indirect tax, compliance and enforcement initiatives in the US, UK and EU. Register here.