As further evidence of crypto becoming a rapidly growing focus area for HMRC investigations, HMRC’s latest ‘nudge letter’ campaign will reportedly target UK taxpayers who may have failed to properly pay tax on their cryptoassets. HMRC are now armed with data gathered from cryptoasset exchanges and other sources, meaning that investigations into the UK tax affairs of crypto investors are likely to be imminent. Any taxpayers who receive a nudge letter, or who may be generally concerned about their tax position in respect of cryptoassets, should take protective action as soon as possible.
Targeting crypto investors
According to various recent press reports, HMRC are preparing to issue nudge letters to UK taxpayers identified as having invested in cryptoassets, inviting them to review whether they have paid the correct amount of UK capital gains tax (or, in some cases, UK income tax) and disclose any errors accordingly.
HMRC’s latest nudge letter campaign for crypto investors follows others targeting UK resident (non-domiciled) individuals (non-doms) and multinational businesses on separate tax issues. As we recently pointed out in relation to those earlier campaigns, nudge letters are rarely sent at random (see here).
In this case, HMRC’s information on crypto investors could derive from a variety of sources, including through exchange of information with other tax authorities and directly from cryptoasset exchanges. In 2019, for example, several cryptoasset exchanges publicly acknowledged that HMRC had made requests for specific data about their users and transactions. Although HMRC’s published guidance suggests that most cryptoasset exchanges are ‘receptive’ to law enforcement agency requests, exchanges will invariably require HMRC to issue statutory information notices to oblige them to disclose user data. In response to freedom of information requests made earlier this year, HMRC confirmed that they are using their statutory information powers to gather user data from cryptoasset exchanges, including personal details (i.e., names and addresses), the frequency of transactions, and the value of any cryptoassets held.
Therefore, whilst the latest nudge letters will not make any specific accusations or be threatening in tone, recipients should assume that they are being targeted on the basis of actual data held by HMRC. Failure to take action or to respond is therefore likely to result in HMRC starting an investigation (either under civil procedures or, in cases of suspected fraud/evasion, using their criminal powers).
Taxation of cryptoassets
There are no UK tax rules dealing specifically with the taxation of cryptoassets. In light of the rapid growth of cryptoassets and their increasingly mainstream status over recent years, HMRC published its ‘Cryptoassets Manual’ in March 2021 to set out how existing UK tax legislation should apply to cryptoassets on general principles. Although written for HMRC employees, the new manual was also intended to help taxpayers and their advisers to understand HMRC’s interpretation of the relevant rules (and largely derives from earlier published guidance for individuals and businesses).
HMRC’s manual defines cryptoassets as ‘cryptographically secured digital representations of value or contractual rights that can be transferred, stored or traded electronically’. The term ‘cryptoassets’ (also referred to as ‘tokens’) covers a number of different types of digital assets, including:
exchange tokens (which are intended to be used as a means of payment and include cryptocurrencies such as bitcoin);
utility tokens (which provide the holder with access to particular goods or services on a platform);
security tokens (which provide the holder with particular rights or interests in a business, such as ownership, repayment of a specific sum of money, or entitlement to a share in future profits); and
stablecoins (which may be pegged to other assets considered to have a stable value such as fiat currency, such as US dollars or pounds sterling, or precious metals such as gold).
HMRC assume that the vast majority of individuals will hold cryptoassets as a personal investment (i.e., receiving and disposing of tokens on an infrequent basis in order to realise any appreciation in value). This means that any profits realised on disposals of cryptoassets will be subject to UK capital gains tax in the normal way.
However, if an individual is exchanged in frequent trading, any profits may instead be subject to UK income tax (which is generally taxed at a higher rate than UK capital gains tax). In addition, individuals may be subject to UK income tax and national insurance contributions on any cryptoassets received through their employment.
Location of exchange tokens and non-doms
As cryptoassets are digital in nature and therefore do not have a physical location, it is usually necessary to determine their location for tax purposes.
HMRC’s view is that exchange tokens are located for tax purposes where the beneficial owner is resident. For these purposes, HMRC consider an individual to be UK resident if they are tax resident under the UK’s statutory residence test. This is of particular relevance to non-doms who, unlike other UK resident taxpayers (who are generally liable to UK tax on their worldwide income and gains), are taxed on the remittance basis – meaning they are only liable to UK tax on any overseas income or gains to the extent remitted to the UK. The location of exchange tokens for tax purposes is therefore important for determining whether gains are treated as arising outside the UK (and therefore capable of benefitting from the remittance basis).
Some recent press reports have suggested that there is uncertainty regarding the correct UK tax treatment of cryptoassets and, in particular, that HMRC’s view regarding the location of exchange tokens is contested (usually citing guidance published by The Society of Trust and Estate Practitioners (STEP) on 3 September 2021). Whilst the STEP guidance puts forward alternative analysis for determining the location of exchange tokens for tax purposes, taxpayers need to be aware that this is largely an academic exercise and that there is no ambiguity whatsoever as to HMRC’s interpretation of the correct legal position. As the STEP guidance itself acknowledges, any taxpayers taking a different position to that set out in HMRC’s cryptoasset manual (i.e., that, contrary to HMRC’s view, exchange tokens beneficially owned by a UK resident are not in the UK) would need to make this clear in their tax returns and should expect HMRC to challenge that position.
Preparing for a crypto investigation
The latest nudge letter campaign is further evidence that HMRC are increasingly focused on UK taxpayers who they believe may have failed to properly declare tax on cryptoassets (either deliberately or as a result of ignorance regarding the correct tax position). At a time when HMRC are under unprecedented pressure to increase tax revenue to help the public finances, all crypto investors should therefore ensure that they are prepared for an imminent investigation by HMRC into their tax affairs.
As part of a standard investigation, HMRC will often ask the taxpayer to complete a ‘Statement of Assets and Liabilities’ form in order to gather information on all significant assets held by or on behalf of that person. That form now includes specific questions about cryptoassets and so it is critical that crypto investors prepare for an investigation by keeping sufficient records of their investments, including:
the types of cryptoassets held;
the date of any transactions;
whether assets were purchased or sold;
the number of units involved;
the value of the transactions in pounds sterling (as at the date of each transaction);
the cumulative total of the investment units held; and
any relevant bank statements and wallet addresses.
Investors should also be aware that HMRC can conduct criminal investigations where they suspect that crypto investors have engaged in tax evasion. Although HMRC acknowledge that holding cryptoassets does not ‘on its own’ imply tax evasion or any other illegal activity, the fact that the compliance section of HMRC’s cryptoassets manual (which deals with risk indicators and the conduct of investigations) has largely been redacted from public view indicates that cryptoassets are generally treated as a sensitive area by HMRC.
Any taxpayers who receive a nudge letter regarding their cryptoassets should check their tax position and seek professional advice as soon as possible.
HMRC can charge penalties to any taxpayer who carelessly or deliberately provides HMRC with an inaccurate document (e.g., a tax return). The amount of the penalties charged can be material – in some cases up to 100% of the additional tax due (or even 200% for certain offshore matters). However, the penalty system is designed to encourage transparency and cooperation, meaning that penalties can be heavily mitigated by taxpayer disclosure (and, in many cases, eliminated altogether). In some cases, the potential penalty reductions will far outweigh any professional fees involved in making a disclosure. A full and accurate disclosure should also prevent taxpayers from being publicly ‘named and shamed’ for any deliberate errors and, where applicable, reduce the risk of HMRC starting a criminal investigation.
Equally, even those crypto investors who receive a nudge letter but are confident of their tax position would be well-advised to take action. As noted above, if HMRC have sent a nudge letter, it is likely because they hold data (including from cryptoasset exchanges) to suggest that errors have been made. If, having checked the position with advisers, it is concluded that no errors have occurred with respect to cryptoassets, it would be better to correct HMRC’s misunderstanding through proactive engagement.
Finally, it is worth flagging that not all HMRC investigations will start with a nudge letter. Any taxpayers who think they may have made errors in the past with respect to cryptoassets, or are otherwise unsure of their tax position, should seek professional advice as soon as possible.
CMS Tax Disputes & Investigations
As part of the CMS global network with tax capability in over 70 offices, the CMS Tax Disputes & Investigations team is well-placed to advise on all forms of (direct and indirect) contentious tax matters. Our dedicated specialists have a wealth of experience guiding both individuals and corporates (across a wide range of sectors) through all aspects of tax dispute prevention, management and resolution.
Our team manages multi-jurisdictional internal investigations to identify tax errors for clients and, where applicable, make detailed disclosures in order to regularise the position (including under official disclosure facilities such as the Profit Diversion Disclosure Facility, Worldwide Disclosure Facility and Contractual Disclosure Facility).