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Cryptoassets: Fear of the unknown

Posted on 10 November 2021

Cryptoassets and cryptocurrencies are rarely out of the press and often cloaked in mystery. Scepticism is usually fuelled by a fear of the unknown and so this article looks to set the record straight. Whilst there is a risk of cryptoassets being used for the ‘bad and the ugly’, don’t forget that cryptoassets can boost technology (particularly in the finance sector) and be used for ‘the good’ too. Striking the balance between managing compliance risks responsibly and harnessing technology is always a challenge.

Background

The UK Cryptoassets Taskforce was put together in March 2018 as part of the UK government’s Fintech Sector Strategy to make it easier for fintech firms to follow complex regulations and manage risks. The taskforce is made up of HM Treasury (“HMT”), the Financial Conduct Authority (“FCA”) and the Bank of England (“BoE”).

The UK is committed to being “at the cutting edge of the digital revolution”, the UK market growth in cryptoassets is not as advanced as other jurisdictions. That being said, the FCA’s recent research shows that increasing numbers view cryptoassets as an alternative (or a complement) to mainstream investments; whilst 38% of crypto users regard them as a gamble. The UK (as do many jurisdictions) face the challenge of balancing international reputation as a safe place to do business with high regulatory standards and embracing innovation and change.

Tax

Currently cryptoassets are classified by HMRC as intangible assets and so unless there is evidence of trading, some gains are subject to capital gains tax. HMRC considers that evidence of trading for individuals will be rare as individuals are unlikely to be carrying out the sufficient level of transactions to be considered to be trading. HMRC will not accept that buying and selling cryptoassets is akin to gambling. It is also important to note that investors cannot offset crypto exchange trading fees against profits.

HMRC updated its guidance in relation to the tax treatment of cryptocurrencies on 30 March 2021. it is interesting to point out that certain content in the manuals has recently been redacted. For example, the sections 'cryptoassets in investigation' and 'risks' in relation to compliance. This leads us on to the stigma attached to cryptocurrencies and regulation risks.

Why is there a stigma attached to cryptocurrencies?

Cryptocurrencies differ from currencies as they are not legal money or currency, they are not managed by banks and the currency is held in a digital wallet. These features and the fact that you can buy cryptocurrencies on the dark web make regulation and compliance challenging and increase the risk of money laundering and fraudulent activities. Risks include market integrity risks, consumer risks due to lack of regulation and the risk of cryptoassets being used for illegal activities.

Directly related to money laundering risks, HM Revenue & Customs (“HMRC”) is also concerned about tax avoidance and tax evasions in relation to cryptoassets. Information is power and there is a conscious or unconscious bias towards cryptoassets due to its very nature. “Crypto” literally means concealed or secret.

A key issue taxpayers will face is the lack of recordkeeping in this area and in fact some trading platforms only retain information for a 6-month period. Due to the fast-paced nature of crypto exchanges and the fact that they can be multi-jurisdictional, it is likely that records will not be as meticulous as HMRC would like. As such, HMRC considers the responsibility for record-keeping and retaining records to lie on the taxpayer and not the bank or crypto exchange.

Nudge Nudge, Wink Wink

HMRC use nudge letters as a tool to seek out those who need to rectify any tax issues. The burden lies on the taxpayer to determine whether there is indeed a tax issue and what action to take. The nudge letters are warnings which should not be ignored as the next interaction with HMRC for those with tax issues will be more serious (for example, tax investigations and higher penalties).

Nudge letters for the most part are sent as a result of information held by HMRC – in this day and age, HMRC receives and has access to a wealth of personal information (including offshore financial information).

HMRC recently launched a ‘nudge letter’ campaign in relation to cryptoasset holdings. The purpose is to prompt taxpayers with cryptoassets to review their tax affairs and rectify any issues. We are working with a number of clients with cryptoassets to resolve these issues as well as those who wish to clarify their positions to HMRC to avoid any future issues.