While gains realised from the exchange of foreign currency in bank accounts are exempt from UK tax, it is commonly agreed that cryptocurrency is an intangible asset and that gains on its disposal are subject to Capital Gains Tax (CGT). The question of where cryptocurrency is located for CGT purposes has, however, not been addressed in the legislation nor in HMRC’s guidance – until now.
The importance of location and how it determines tax liability
The location of an asset is primarily important for UK resident but non-UK domiciled individuals who elect for the remittance basis. For such persons, gains on UK-situated assets are subject to CGT immediately but gains on non-UK-situated assets are only subject to CGT as and when the proceeds are brought (‘remitted’) to the UK. Additionally, the purchase of a UK-situated asset using unremitted foreign income or gains has the effect of bringing those amounts into the UK and so counts as a remittance.
It is also important to determine the location of an asset for Inheritance Tax (IHT) because non-UK domiciled individuals are only subject to IHT on UK-situated assets. Location of an asset for IHT depends on case law, whereas CGT is primarily determined by legislation.
HMRC’s guidance states (with cursory explanation) that the location of cryptocurrency for IHT purposes should follow the residence status of the owner and that, since the CGT legislation does not cover the point, residence should also determine the location for CGT.
HMRC’s main argument seems to be that: “using the residency of the beneficial owner of the exchange tokens to determine the location gives a clear, logical, predictable and objective rule which can be easily applied.” Determination of residence may well be more predictable and objective than it used to be. Whether a person’s residence is a logical pointer to the location of an asset is more debatable.
Response from the profession
This guidance is still very new (December 2019), but the initial reaction from the tax profession is critical of the guidance, on the grounds that HMRC have not sufficiently justified the criterion of residence. In other contexts, the location of an intangible asset depends on the commercial environment, such as the location of the relevant trading exchange or the place where a contractual claim can be enforced.
The absence of legislation on the question has opened up a policy vacuum, which HMRC has attempted to fill with a commercially arbitrary test, based to all appearances on little more than expediency.
Despite the continued uncertainty, we have already seen evidence of HMRC applying their new guidance to real cases. It has even applied it to previous tax years, which is even more questionable on the basis that it was not the published practice of HMRC in those years. It may well take a Tribunal or Court judgement to clarify the position, or, perhaps even better, a legislative change which addresses the issue.
Pending such clarification, there will be continuing uncertainty for taxpayers who have already reported gains realised on cryptocurrency in accordance with the remittance basis and who need to know how to report such gains in the future. It is always important to remember that HMRC guidance is not legislation and is open to challenge.
If you have any concerns or have made cryptocurrency gains when claiming the remittance basis, your position should be reviewed by a professional tax advisor.