Where on earth is my Bitcoin? Taxation of cryptocurrency – a warning for non-UK domiciliaries
23 December 2021
New Quadrant partner Paul Davidoff explores the complex tax treatment of digital assets such as cryptocurrency.
Where is your Bitcoin? Where is your Ethereum? Where are your other digital assets?
For some digital assets, “where” they are may be obvious: for example, they may be saved on the hard disk of your home computer or on an external memory stick. But what about crypto-assets such as Bitcoin, Ethereum and the many other derivative coins that one can buy these days and which only exist digitally, not on a specific computer or server whose physical location can be known?
And does it matter?
Simply put, there are no clear rules in this country which tell us what the location (or “situs”) of a cryptocurrency holding (Bitcoin, Ethereum, etc) is. There is a wide variety of digital assets and in this brief article I am not going to look at what they all are or how they work, but will touch on what one might ordinarily call “cryptocurrency” – which is not linked to another asset (from which it derives its value).
Cryptocurrency is not cash. It is not “held” in a bank account. “A Bitcoin”, for example, is not a “share” – something which confers ownership of a portion of some entity. Rather it is a type of currency which only exists digitally: it is not found in any single place, but, in very broad terms, it is based on a network which is distributed across a large number of computers. That said, the focus of this note is not the technological side of how cryptocurrency works, but some of the legal and tax issues involved with holding it.
For many aspects of law, the situs of an asset affects things such as how the asset is taxed (for example, for inheritance tax and capital gains tax), proprietary rights and succession rights. In the UK, there are no statutory rules which dictate how one determines the situs of cryptocurrency. This means that, for now, it is up to the courts to decide what the rules should be. We do not yet have any conclusive decisions on the point, but HMRC has expressed its view as follows: where there is no other way to link a particular cryptocurrency holding to a particular jurisdiction, the situs of that cryptocurrency holding is the place of that person’s “tax residence”. That is only HMRC’s view and it is subject to (a) a court concluding otherwise and (b) statutory rules on the matter being introduced (and we are not aware of any such rules in the pipeline).
Not everyone agrees that “residence” should be the determining factor. Some digital assets can be linked to a particular “exchange”, whereby the “owner” may not actually own the cryptocurrency direct, but may hold some form of account with the exchange (and it may be possible to determine where that “exchange” is located). Or digital assets may be pooled and not controlled by any one of the individuals involved. Where a person is dual resident, one might consider that the relevant place of “residence” is the place with which the person has the closest connection, but again the position is not yet clear. In addition, one non-UK court has considered that a person’s “domicile” (broadly, the jurisdiction which one considers to be one’s permanent home) should be the determining factor.
Jointly-held digital assets are another difficult area. If two co-owners are resident in different countries, one possible outcome will be that each co-owner’s share will be treated differently.
A further point to consider is whose place of residence is relevant. If the cryptocurrency is held in a digital “wallet” by a nominee and the beneficial owner (the underlying owner of the asset) does not have access to that key, is it the nominee’s (or trustee’s) residence which should be considered, or the beneficial owner’s? This point needs careful consideration, as it may be that both the nominee and the beneficial owner are able to access the wallet, even though the beneficial owner has asked the nominee to handle it for the time being.
For someone who is both resident and domiciled in the UK, where their cryptocurrency is located, or whether it could reasonably be said not to be located anywhere, may well make no material difference. For someone who is non-UK domiciled, it could have substantial tax consequences and, unfortunately, the position is far from settled, despite what HMRC have said to date.
What are the tax problems for non-doms in the UK?
- Inheritance tax – A “non-dom” (someone who is not domiciled in the UK) who is also not deemed UK domiciled (on account of having spent a long time in the UK) is subject to inheritance tax only on their UK assets. Suppose a UK resident non-dom (“RND”) owns £1m of Bitcoin, which is “held” in an offline digital wallet which only that RND is able to access and which is physically located outside the UK: HMRC says that it will consider the Bitcoin to be situated in the UK for tax purposes, because the individual with control and access to the cryptocurrency is resident in the UK. Therefore, all that cryptocurrency is within the scope of inheritance tax in relation to lifetime gifts, gifts into trust and on that individual’s death. If “domicile” were the determining factor for deciding the location of cryptocurrency, then that RND’s Bitcoin would be outside the scope of inheritance tax.
- Capital gains tax (and, in some cases, income tax) – If held by a RND, any capital gains will be treated as “UK-source” and taxed on the arising basis, as the individual is resident in the UK. The remittance basis of taxation cannot apply to gains on assets which are located in the UK nor income arising from assets located in the UK. If you are a RND who claims the remittance basis of taxation and you are in the habit of investing/trading in cryptocurrency, you may be surprised to learn that all of the gains and income that you make from your cryptocurrency is taxable in the UK and the remittance basis will not apply to it.
Of course, one does not have to accept HMRC’s view that the situs of cryptocurrency should be determined by residence. However, if you are going to take an approach which differs from HMRC’s stated view (for example, to take “domicile” as the determining factor), then it may be advisable to explain that on your tax return or inheritance tax account, so that you cannot be accused of deliberately failing to report the gains/income/assets to HMRC. You will also need to accept the risk that (a) HMRC will most likely disagree with you and (b) you may have a protracted (and costly) debate with HMRC, which could involve taking the matter to the Tax Tribunal.
More generally, situs of cryptocurrency may also be relevant from the point of view of succession rights. In England, we would consider that the law surrounding the succession to cryptocurrency is determined by one’s domicile. For non-UK domiciliaries, this could have implications for how you can bequeath your cryptocurrency on your death and who might have a claim on it. There may also be other countries’ laws to consider as well. Of particular importance, though, is the question of (a) how your executors will know what cryptocurrency you have and (b) how they will be able to access it. How will you ensure that it can be located, transferred or sold after you have died?
This is a continually evolving area, as more and more people are investing in cryptocurrency and, in recent years, because its value has soared. Whether that will continue is hotly debated, but, at least for now, it is something which many will have to consider carefully in connection with their estate planning and their tax compliance.
If you feel that you need advice about your own estate planning or tax position in the context of your cryptocurrency holdings (or other digital assets), please contact Paul Davidoff to discuss the matter further.
Also, if you would like to read more about “domicile” generally, please click here for a summary of what it is all about.
This note is intended to be a general summary of some of the issues surrounding crypto-assets: it does not cover all circumstances and does not constitute legal advice.