IME to expand to include cryptoassets

Update: On 19 December, the government published regulations, the Investment Manager (Investment Transactions) (Cryptoassets) Regulations 2022, designed to give effect to these changes. The regulations come into force on 1 January 2023, and will apply: to accounting periods which were current on the date the regulations were made (19 December 2022) and subsequent accounting periods for corporation tax, and to the 2022/2023 tax year and subsequent years for income tax.

HMRC has published a summary of responses to its earlier consultation on expanding the investment transactions whitelist for the purposes of the UK investment manager exemption (IME). The response confirms that the expansion will take place, with regulations to be introduced before the end of 2022 but with an element of retrospection for transactions already undertaken.

The government has confirmed that it will adopt a broad, international based definition of cryptoassets based on the definition in the OECD’s Crypto-Asset Reporting Framework (CARF), though with a number of exclusions to protect the UK tax base.

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, particularly those adopted alternative strategies. It is also relevant to managed account arrangements.

For corporation tax, UK based investment managers transacting on behalf of foreign funds will create a taxable presence in the UK where the activities conducted in the UK amount to trading, 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, eg boutique digital asset start-ups.

On 4 April 2022, as part of the government’s FinTech Sector Strategy, the government announced that it would look 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, and a consultation on this aspect was published in May 2022, see Expanding the IME to include cryptoassets. Simmons & Simmons responded to the consultation and our response can be read here.

Summary of responses

The government has decided to push ahead with the expansion of the ITL to include cryptoassets.

Perhaps the most significant aspect of the consultation concerned the definition of cryptoassets. Responses to the consultation emphasised that it was desirable to have a single consistent and universal definition which is used across the UK tax system. In addition, there should be a broad definition of cryptoassets which can accommodate future evolutions in cryptoasset markets, on the basis that cryptoasset technologies are developing too rapidly for HMRC to attempt to provide and maintain a specific list of cryptoasset tokens which are within scope. There was broad agreement, therefore, on HMRC’s suggested approach using the CARF definition as a starting point:

‘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.’

Unsurprisingly, therefore, the government has confirmed this is the approach to be adopted, since the definition proposed by the OECD for CARF encompasses a wide breadth of cryptoassets but ensures that only cryptoassets which rely on distributed ledger technology or similar technologies will be included.

However, the government has also confirmed that there will be some exclusions to protect the UK tax base and prevent cryptoassets being used to circumvent rules preventing certain current asset classes from being within the IME. However, it appears that these exclusions will be more narrowly defined than suggested in the original consultation. For example, noting that the ITL framework allows derivatives to be included where they provide for the transfer of property that falls outside the IME, provided delivery of the property does not occur, the response recognises the benefits of this flexibility in the ITL and equivalent transactions in cryptoassets which provide rights in relation to other property will be in scope provided delivery does not occur. In addition, cryptoassets that are rights in relation to assets will be in scope provided transactions in those assets would be within the IME. Closed loop cryptoassets will not now be excluded, however there will be an exclusion for cryptoassets created or issued by the UK IM, non-resident fund or connected parties to prevent abuse.

The consultation also sought views on 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. Although the response notes that the government recognises that it is generally preferable to maintain a single ITL list for the purpose of the IME and for funds which use the ITL to ensure consistency of tax treatment and keep the UK tax system simple and user-friendly, the response document confirms that the change will focus on the IME investment transactions list only for now. The consultation responses did not indicate a case for extending other tax whitelists to cover cryptoassets at this stage, although HMRC will keep this under review.

Timing

The government has accepted that certainty is key, and so the changes will be legislated via HMRC regulations prior to the end of 2022 calendar year, with effect for transactions in the tax year 2022/23 for non-corporate entities and accounting periods current on 31 December 2022 for corporate entities (ie effectively retrospective to the start of the year).

Comment

Overall this seems a very positive outcome after a long period of dialogue with HMRC, especially as the government has recognised the need to introduce the changes without further delay – HMRC has also indicated that it will publish guidance on the interpretation of the regulations and is open to responding to questions on scope via email.