Cryptoassets are coming out of the shadows. Slowly but surely. Over the past decade or so, perhaps principally driven by huge gains (and losses) in the value of Bitcoin, there has been a palpable dawning recognition that cryptoassets, and the distributed ledger technologies (DLT) that underpin and encrypt them (such as Blockchain), are here to stay. Mainstream financial services are testing (and increasingly grappling to control) the investment market. At the same time, the rapid digitalisation of the global economy is suggesting new and potentially exciting applications for DLT across multiple sectors (including, for random example, in tax administration, collection and compliance).

As interest, and adoption, has grown, regulators have (necessarily) started to take a closer interest. They have been concerned most by the risks cryptoassets pose to consumers, and the integrity of the financial markets, that arise from the very characteristic that has made them so attractive: the decentralised, encrypted, nature of DLT. Determined to maintain its position as one of the world’s leading financial centres, the UK has dramatically stepped up its efforts over the past year. In March 2018, the Chancellor of the Exchequer established a ‘Cryptoassets Taskforce’, comprising the three cornerstone organisations of UK fiscal and monetary policy (HM Treasury, the Financial Conduct Authority (FCA) and the Bank of England) to formulate the UK’s policy and regulatory for cryptoassets and DLT.

The Nature Of Value

Broadly speaking, cryptoassets are easiest understood as being digital representations of value. And where value is found, taxation is unlikely to be too far away. The risks associated with cryptoassets, and the widespread perception of use in illicit financial crime, are exacerbated by the opportunities created for egregious tax avoidance and tax evasion. It is, then, no surprise that tax authorities are getting serious about how best to tap the revenue opportunity by bringing cryptoassets into the tax net. Easier said than done of course. Perhaps uneasy about how, where and when the value is created, or what it actually represents, pronouncements on the taxation of cryptocurrency have generally been tentative and heavily caveated.

Cryptoassets are capable of being transferred, stored and traded electronically. While acknowledging the evolution of cryptoassets (sometime referred to as ‘tokens’) is rapid, it is generally accepted that there are three broad (albeit notmutually exclusive) types:

• Exchange tokens – commonly known as ‘cryptocurrencies’ (including the most widely known, Bitcoin) used as a means of exchange or for investment;
• Security tokens – being types of investment issued to raise capital and which provide owners with certain rights (such as ownership, repayment of money, or a future entitlement); and
• Utility tokens – also types of investment issued to raise capital but which can be redeemed for access to a specific product or service.

Importantly, while ‘cryptocurrencies’ can, and often are, used as a means of exchange, they are not considered to be currency or money on the basis that they are (currently at least) too volatile and not widely-accepted as means of exchange. Since cryptoassets (including Bitcoin, but also any one of the other 1,074 types) are generally traded on exchanges which do not use sterling, the value of any gain (or loss) will need to be converted into sterling for UK tax purposes.

 Cryptotaxation In The UK

The UK tentatively dipped its tax toe in to the dark cryptoassets lake back in March 2014 when HM Revenue and Customs (HMRC) published a Policy Paper (Revenue and Customs Brief 9 (2014): Bitcoin and other cryptocurrencies) its initial thinking on the tax treatment of “activities involving Bitcoin and other similar cryptocurrencies”. Other than officially ruling out treating the buying and selling of cryptoassets as a gambling activity, little of technical substance has changed during the intervening five years but in December 2018 HMRC published a new Policy Paper (Cryptoassets for individuals) dealing exclusively with how individuals owning cryptoassets will be taxed.

The UK tax consequences for UK tax paying individuals who hold cryptoassets will depend on what they do with the cryptoassets but, ultimately, will be dictated by existing principles that underpin the UK tax code.  There are no plans to create special cryptotaxation rules for cryptoassets and DLT.

In the majority of cases, ownership of cryptoassets will be treated as any other investment. Just as with other holding of investment assets (e.g. shares) by individuals, any appreciation in value will be taxed (and any loss, relieved) on a subsequent disposal as a capital gain (and so subject to capital gains tax (CGT)). This is slightly odd because, by their very nature, cryptoassets are digital and are therefore intangible assets. Nonetheless, HMRC consider that provided they are capable of being owned, and their value can be realised, they will be chargeable assets for CGT purposes.

The exceptions are where individuals hold cryptoassets pursuant to:

• Carrying on a trade – normal principles (including assessing the degree and frequency of activity, organisation, risk and commerciality) apply to decide. Individuals ‘trading’ in cryptoassets will be subject to income tax on their trading profits in the same way as any other financial trader buying and selling shares, securities or other financial products. HMRC say individuals will only be considered to be trading in exceptional circumstances;
• Payment of earnings from an employer – in a similar way to the regime applying to other employment-related-securities, income tax and national insurance contributions will be charged on the value of the sterling value (at the time of receipt) of the cryptoassets received. An employer with a UK tax presence will, in most cases, need to operate PAYE. CGT will be applied at the time of a subsequent disposal;
• Cryptoasset ‘mining’ (broadly, cryptoassets acquired for verifying additions to the DLT) –  again, assuming the individual is not carrying on a trade of cryptoasset mining, income tax will be charged on the value of the sterling value (at the time of receipt) of the cryptoassets received and CGT will apply at the time of disposal; and
• Cryptoasset ‘airdrops’ (broadly, cryptoassets acquired as part of a marketing or advertising campaign) – assuming the individual is not carrying on a trade, income tax will only be charged if the airdrops are received in return for a service provided. It will not apply if the individual receives them in a personal capacity without having to do anything in return. Once in the individual’s possession, however, CGT will be charged at the time of a future disposal.

Individual taxpayers will, in the majority of cases, need to self-assess their liability to UK taxation on their activities and investments involving cryptoassets. That, given the increasingly concentrated focus of HMRC on the area, will necessitate careful record keeping of asset types, dates, volumes, values and statement paper-trails sufficient to prove acquisitions and disposals.

Revised guidance on the business and corporate taxation treatment of cryptoassets in the UK is expected during the first half of 2019 but one might expect that a similar, first-principles based, approach will be reinforced there too.

Into The Global Light

The UK approach is only one of many possibilities. Different countries could conceivably take (indeed have taken) very different routes. Perhaps it is the rapidity with which the technology is shifting the scene, or the inherent confusion and disorganisation, but there has been a marked reluctance by tax authorities around the world to publish detailed guidance. The result is disparate approaches ranging from effectively banning the use of cryptoassets to a total reluctance to engage in regulation.

Ultimately, given the global nature of the digitalisation of the economy and the borderless growth in the evolution and adoption of cryptoassets and DLT, a global consensus-based approach would be preferable in the long-term. Given the OECD’s current efforts to develop a solution for the (income) taxation of the digitalisation of the global economy, it is disappointing (albeit entirely understandable) that cryptoassets only get a passing mention as deserving of further work (to analyse the risks of tax evasion and possible solutions, including more transparency, mandatory disclosure and information exchange) in its “Tax Challenges Arising from Digitalisation – Interim Report” (March 2018).

As the technology unpacks itself, the promise (largely unrealised to date) becomes more tangible, and authorities scramble to regulate and control developments and tax the revenue, cryptotaxation is certainly a trend to follow closely.