Even experienced tax advisers often assume that the summaries of fiscal law in HMRC’s Manuals have been arrived at through an objective consideration of the nature of the relevant law. In fact, the Manuals sometimes express views of the law the basis of which is flimsy or doubtful simply in order to advance the Department’s interests; views which are, occasionally, simply untenable. HMRC has recently published its ‘Cryptoassets Manual’. In it, amongst much else, it gives the Department’s view of the location, or situs, of what it calls ‘crypto-assets’ or ‘exchange tokens’ which are ‘distinct from any underlying asset’: that is of what is commonly called crypto-currency. It says:
‘Where the crypto-asset is an asset distinct from any underlying asset then HMRC’s view is that none of the statutory rules in the TCGA 1992 apply. Instead it is HMRC’s view that:
- exchange tokens have an economic value as they can be ‘turned to account’ – for example, exchanging them for goods, services, fiat currency or other tokens;
- exchange tokens are a new type of intangible asset (different to other types of intangible assets, such as shares or debentures); and
- the only identifiable party to consider is the beneficial owner of the exchange token,
such that the location of the crypto-asset will be determined by the residency
of the beneficial owner
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. This means that a person who holds exchanges tokens is liable to pay UK tax if they are a UK resident (as determined by the Statutory Residence Test, see RDRM11000) and carry out a transaction with their tokens which is subject to UK tax.’
The situs of an asset is of importance for many tax purposes most notably in determining the application of Inheritance Tax, Capital Gains Tax and the Remittance Basis in respect of the affairs of individuals who are not domiciled in a country of the United Kingdom. The Manuals rarely contain detailed citations of the authorities supporting the views expressed in them but they normally refer to the more important cases which are of relevance to the matters concerned. The discussion of the location of crypto-currency in the Cryptocurrency Manual, however, is unsupported by any reference to case law authority or the technical literature on the matter. It will have been seen that the view adopted is justified by HMRC only by reference to its administrative convenience.
The Society of Trust and Estate Practitioners (the ‘STEP’), clearly alarmed at HMRC’s cavalier attitude to determining the law on this important new class of assets, has produced a guidance note:
‘…noting that HMRC’s view does not appear to be based on any legal
The STEP’s Guidance states the essential difficulty that:
‘…, as cryptocurrency is property, it must be allocated a location, despite the fact that … cryptocurrency is specifically designed not to have a location … In the absence of any statutory rules, it is therefore necessary for the courts to develop the law to allocate an artificial location to cryptocurrency.’
The STEP’s analysis starts with the emerging consensus:
‘… in the common-law world that crypto-currency is a form of intangible property. For example, the legal statement on crypto-assets and smart contracts put together by the UK jurisdiction task force.’
That statement by the UK Jurisdiction Task Force considered a number of areas of legal uncertainty in respect to ‘crypto-assets’ and ‘smart contracts’. The statement said:
‘The great advantage of the English common law system is its inherent flexibility. Rather than depending on the often cumbersome, time-consuming and inflexible process of legislative intervention, judges are able to apply and adapt by analogy existing principles to new situations as they arise. In commerce, the law is there to support and fulfil reasonable expectations. It is “endlessly creative … a living law, built on what has gone before, but open to constant renewal”. Time and again over the years the common law has accommodated technological and business innovations, including many which, although now commonplace, were at the time no less novel and disruptive than those with which we are now concerned. In no circumstances therefore are there simply no legal rules which apply.’
Accordingly the STEP’s Guidance advises that:
‘In formulating principles to allocate a location to crypto-currency, we would expect a court’s starting point to be the principles that have been applied in allocating an artificial location to other types of intangible property. These include matters such as enforceability, recoverability, transferability, location of any physical assets to which the intangible is attached and the place where ownership is recorded or registered. It is notable that the residence of the beneficial owner is not a principle that has previously been applied in allocating a location to intangible property.
The problem, of course, is that many of the principles that have previously been applied are irrelevant to crypto-currency due to the nature of the asset. It exists only as a computerised entry on a digital database that has no single location. The token is represented by a public address or public key that is freely accessible. That public address or public key is linked to a private key that must be used to implement any transaction relating to the token.
Looking at the principles that have been applied in the past to allocate a location to intangible property, a case could be made for allocating the location of crypto-currency to the place where it can effectively be dealt with. This is, for example, the principle that has been applied to shares (and is normally where the share register is located).’
The STEP’s Guidance then goes on to apply this principle:
‘In the case of crypto-currency, it can only be dealt with by the use of the private key and, arguably, its location should therefore be linked to the location of the private key or of the person who has control of the private key (who may or may not be the beneficial owner).’
The STEP’s Guidance turns aside to consider a contribution by Professor Dickinson, Professor of Law at Oxford University to a recent Oxford University Press publication ‘Cryptocurrencies in Public and Private Law’. In this publication Professor Dickinson had suggested:
‘… that the law of the place of residence of the participant is the appropriate law to govern any proprietary questions relating to the crypto-currency.’
The Guidance explains the basis of Professor Dickinson’s view:
‘The important point to note from this analysis is that the governing law is based not on the residence of the beneficial owner but on the residence of the participant in the relevant crypto-currency system. The reason for this is that Professor Dickinson’s conclusion that the value of crypto-currency derives from a claim or legitimate expectation to be associated with and have the power to engage in transactions in relation to particular units of crypto-currency within the system. In practice, this means controlling the public address to which the crypto-currency has been allocated and holding the private key which is needed to authorise transactions in relation to that crypto-currency.
Although Professor Dickinson’s focus is on determining the law governing proprietary aspects relating to crypto-currency. It might be expected that a UK court would consider similar principles in relation to the location of crypto-currency. Indeed, that is what the court in [the case of] Ion Science appears to have done.
In our view, the approach taken by Professor Dickinson and adopted by the court in Ion Science seems a more likely approach for the courts to take in relation to the question of location than that suggested by HMRC as it builds on existing principles (control, ability to deal and, by extension, enforceability) rather than introducing a completely new principle which has no precedent in determining the artificial location of an intangible asset.’
The Guidance goes on to say that in some situations the crypto-currency will not be held directly, that is the private key will not be held, by the beneficial owner, but instead will be held on behalf of the beneficial owner by a third party such as a crypto-currency exchange, trading platform, nominee trustee or a custodian. In such cases under the STEP’s analysis of what is most likely to be the law, it will be the residence of the third party, being a participant in the crypto-currency system and the holder of the private key, that will determine the location of the crypto-currency.
The STEP considers that there can be no rule of thumb allowing one easily to determine the location of crypto-currency under all arrangements. Instead the particular arrangements under consideration must be analysed in detail:
‘In this context, where the beneficial owner has an account with the crypto-currency exchange, the nature of the relationship with the exchange must be carefully analysed. In some cases, the wallet that represents the public address and the associated private key will be held by the beneficial owner and the exchange merely facilitates transactions. However, in other cases, the wallet and the private key will be held by the exchange itself on a pooled basis for all of its clients with the rights of the beneficial owner being limited to the holding of an account with the exchange in which the holding of units of crypto-currency are recorded in the form of book entries made by the exchange itself.’
We have seen in its guidance on the matter that HMRC has said that crypto-currency will be located where the beneficial owner is resident. It goes on to say in its guidance that for this purpose residence is to be determined under the Statutory Residence Test. The STEP’s Guidance, however, points out that:
‘One important point to note is that, whether the location of the crypto-currency is based on the residence of the beneficial owner or on the residence of the participant in the crypto-currency system, residence must surely be tested by reference to relevant common-law principles and not by reference to the tax definition contained in the statutory residence test. The reason for this is that, as explained above, the location of an asset is a general common law concept and is relevant for purposes which go beyond taxation. If the statutory residence test is to be used in order to determine residence for this purpose, this would need to be provided for by statute.’
It is always uncomfortable for taxpayers to be in the position of having to decide, because HMRC has taken a doubtful or untenable view of the law, whether to apply the view of the law which is most likely to be correct or to apply HMRC’s view. The STEP provides the following useful guidance:
‘Until there is a clear decision from the courts, taxpayers and their agents will need to decide what approach to take. However, if they conclude that crypto-currency that is beneficially owned by a UK resident is not located in the UK, it will be incumbent upon them to refer to this in the white space on the individual’s tax return given the clear statement setting out HMRC’s view in its Cryptoassets Manual. It should of course be expected that HMRC may not accept an alternative analysis and that a referral or appeal to the Tax Tribunal may be required in order to resolve the point.’