Expanding the IME to include cryptoassets

Update: For the government’s response to the consultation, see IME to expand to include cryptoassets.

HMRC has published a consultation on the expansion of the investment manager exemption (IME) to cryptoassets. The consultation, “Expanding the Investment Transactions List for the Investment Management Exemption and other fund tax regimes” indicates that HMRC is considering using the proposed OECD definition as a starting point, thus enabling the exemption to cover not just cryptocurrencies, but with modifications to target the definition at digital assets held by way of investments and ensure that the definition would not allow assets currently excluded from the IME (such as land) to be brought within scope.

At this stage, the consultation merely seeks feedback on a range of broad questions concerning the extent to which cryptoassets should be brought within the IME through inclusion in the investment transactions list. It also seeks to determine whether they should be included within that list for the purposes of other fund regimes that reference the list, such as approved investment funds. A response document, together with draft legislation, is promised for autumn 2022. Given the significant ongoing interest in the establishment of digital assets funds and management busineses, the consultation is a highly welcome step, following an extended dialogue between HMRC and interested parties, and presents a real opportunity for the UK to take the lead on a global level in establishing itself as a jurisdiction in which such managers can base their activities.

Background

The IME provides a safe harbour for non-UK funds using UK-based investment managers to conduct investment transactions on behalf of the fund without creating a risk of UK taxation for the foreign fund. The IME is an important factor in the UK fund management industry’s attraction for non-resident funds.

For corporation tax, UK based investment managers transacting on behalf of foreign funds, where the activities conducted in the UK amount to trading, will create a taxable presence in the UK unless the investment manager is considered to be acting on behalf of the fund as an agent of independent status in the ordinary course of its business. The IME provides greater clarity on the circumstances in which a UK investment manager will be classified as such an independent agent, thereby not creating a UK taxable presence for foreign funds. In effect, the IME operates as a safe harbour provided the relevant conditions are met on an ongoing basis.

Where the conditions of the IME are met, therefore, the UK manager will not bring the fund within the scope of UK taxation. These conditions include limits as to the types of transaction that can qualify for the IME and a list of qualifying transactions is set out in the investment transactions list (ITL). The IME only covers transactions in assets that are included within the ITL. Cryptoasset investments are not specifically included in the list and HMRC has suggested previously that they would not generally fall within any of its current categories. Whilst it is still possible for the general independent agent exclusion to operate where transactions fall outside the ITL, this will depend upon the relevant facts and circumstances and may not assist certain managers, e.g. boutique digital asset startups.

On 4 April 2022, as part of the government’s FinTech Sector Strategy, the government announced that it would see to establish clear UK tax and regulatory treatment of cryptoassets to place the UK at the forefront of innovation in cryptoasset and blockchain technologies. For more information, see UK review of cryptoasset regulation: tax aspects. In particular, the government announced that one measure would be to expand the ITL used for the purposes of the IME to include cryptoassets, to provide certainty of tax treatment to UK investment managers and their non-UK resident investors who are seeking to include cryptoassets within their portfolios.

The consultation published by HMRC seeks views on the scope of the planned extension

Consultation

The purpose of the consultation is to help HMRC understand:

• the types of cryptoassets which should be included within the IME, and
• whether there is a case for extending this change to other tax regimes which also use the ITL.

Defining cryptoassets

The consultation recognises that the term ‘cryptoassets’ is an umbrella term which encompasses different types of crypto technologies, including but not limited to exchange tokens, utility tokens, security tokens, stablecoins, smart contracts, and non-fungible tokens. It is an asset class that continues to evolve.

There are a number of definitions for cryptoassets that exist or are being proposed by a variety of organisations and authorities. Such definitions typically differentiate cryptoassets from other intangible assets by reference to cryptography that uses a form of distributed ledger technology.

The consultation seeks to identify the characteristics of cryptoassets that can be used as investment products to enable HMRC to create a definition of cryptoassets for the purposes of the ITL which is fit for purpose. The consultation indicates that the definition will need to meet the following conditions:

• it should only include assets which utilise cryptography and distributed ledger technology
• it should be clear and user friendly
• it should be ‘future-proof’ by being capable of encompassing newly emerging crypto technologies.

The consultation notes that HMRC is considering the adoption of a cryptoasset definition for the ITL which is similar to that proposed in the Crypto-Asset Reporting Framework published by the Organisation for Economic Co-operation and Development (OECD) in March 2022. That definition is currently subject to consultation but the proposed definition reads:

‘The term ‘Cryptoasset’ refers to a digital representation of value that relies on a cryptographically secured distributed ledger or a similar technology to validate and secure transactions.’

The OECD’s proposed definition is broad and HMRC would seek to refine such a definition to ensure that the inclusion of cryptoassets cannot be used to circumvent categories of assets currently excluded from the ITL. In particular, the consultation notes that HMRC would, for example, want to exclude:

• transactions in land, including transactions of any nature which result in the acquisition of land
• cryptoassets that provide for the transfer of tangible assets or intangible assets not already included in the ITL.

In addition, the consultation states that the definition of cryptoassets that qualify for inclusion should also exclude ‘closed-loop cryptoassets’. These are cryptoassets which are only intended for use within a closed permissioned network, for example for the purposes of purchasing goods or services.

The consultation therefore sets out a broad set of questions for views, welcoming responses from investment managers, investors and fund managers in particular. The questions include:

• What types of cryptoassets are investment managers seeking to include as part of their product offer?
• Whether there any particular definitions, in regulatory or other contexts, that investment managers find useful in defining cryptoassets?
• Whether there any existing UK activities involving cryptoassets which would need to be excluded from the ITL in order to prevent a reduction in tax receipts?
• An indication of the likely types of fund products that will start or continue to be managed from the UK as a result of including cryptoassets within the scope of the IME.

Expanding the ITL for other regimes?

The purpose of the ITL is to identify transactions which would generally be considered to form part of an investment business and would not generally be viewed as trading activities. The ITL currently applies for both the IME and certain UK tax regimes for funds. These include:

• diversely owned authorised investment funds
• exempt unauthorised unit trusts
• diversely owned reporting offshore funds
• approved investment trusts.

Through the consultation, HMRC intends to explore whether cryptoassets should be included within the ITL only for the purposes of the IME, or whether there is a case for extending the change to the other fund tax regimes which also use the ITL. The questions posed in this section of the consultation therefore include:

• Whether any funds within the scope of the rules currently hold cryptoassets and, if so, how are they currently treated.
• An indication of the types of UK fund products that are currently offered, or may be offered in future, which would benefit from the inclusion of cryptoassets in the ITL.
• Comments on any differences in the definition of cryptoassets that would be needed for UK funds compared to that required for the IME.

Comments

HMRC’s launch of the consultation is to be highly welcomed, in an environment where many tax authorities worldwide are struggling to accommodate funds and managers investing in digital assets and to provide clarity on how existing tax rules, such as the “trading safe harbors” in the US, apply to such activities. The proposed approach of a broad, principles based definition of relevant digital assets aligned with international standards is sensible, and should provide the necessary degree of clarity and futureproofing to accommodate developments in the digital assets ecosystem. The anticipated limitations on the definition align with the approach on more traditional assets, and are therefore expected.

As to the preferred approach, we favour making the changes to the ITL for IME purposes first, with any changes to the ITL for other tax purposes following later, if and to the extent required. It is possible to amend the ITL that applies for IME purposes only by way of HMRC regulations, rather than requiring primary or secondary legislation, and taking this phased approach will enable those clients who would most welcome the changes (i.e. UK based managers managing non-UK funds investing in digital assets) to benefit from the development at pace. In addition, there are broader considerations, in particular regulation, that affect the ability of UK domiciled funds to invest in digital assets, and therefore it may be more prudent to align developments to the tax regime for such UK funds with any changes to the regulatory framework.

The consultation runs from 23 May 2022 to 18 July 2022 and comments should be submitted to investmentmanagerexemption@hmrc.gov.uk. We will be contributing to the consultation and would be happy to share particular feedback with HMRC on behalf of clients and contacts.

In addition, HMRC will consider holding meetings with interested parties to discuss the proposals in this consultation. A summary of responses together with a draft of any legislation will be published in autumn 2022.