Chapter 1

What Cryptoassets Are

Cryptoassets are another term for cryptocurrencies. These are coins or tokens available electronically and function as digital cash. There are numerous kinds of cryptoassets, but popular ones that have taken the world by storm include Bitcoin, Ethereum, Litecoin, Dash, and Ripple.

Cryptoassets work through a peer-to-peer system with no central authorities used to facilitate transactions. They can be traded, stored, or transferred to others electronically without mediators such as banks.

Digital Ledger Technology (DLT) is a system used by cryptoassets to record transactions and their details. DLT also enables multiple crypto transactions to be recorded from different places all at the same time. However, note that all cryptos may be using some form of DLT, but cryptoassets may not be involved in all applications of DLT.

Now, many people consider cryptos as a form of money. It could function as one, but it's generally not money-like as of now, and this is the reason why central finance authorities refer to cryptos as cryptoassets rather than cryptocurrencies.

The UK's HMRC doesn't see cryptos as a currency form, either. They instead classify cryptoassets into three – utility, exchange, and security tokens. We'll quickly explain each of them here.

Utility Tokens

Utility tokens are cryptos developed and used in exchange for particular goods or services. The tokens, therefore, act as payment for goods and services. Businesses or organisations carrying out transactions using utility tokens typically issue their tokens and commit to using them inside a particular business platform.

Many utility tokens started up through an organisation developing and issuing them first. Later on, the new utility token is used to purchase goods and services offered by the crypto developer or issuer. Transactions made through utility tokens are usually meant to raise funds for the organisation to expand further and introduce new developments to their new cryptos and platforms.

Exchange Tokens

Exchange tokens are meant to be used as a payment method. DLT is used to facilitate transactions using these tokens. Unlike utility tokens, exchange tokens aren't backed by an individual business entity and do not provide access or rights to any kind of goods and services. In essence, exchange tokens are valued simply through its use as an investment or exchange vehicle. Most popular cryptocurrencies fall under the exchange tokens category.

Security Tokens

Security tokens are cryptoassets that function as investment contracts. A security token holder may anticipate a future profit from any revenue share, dividend, or market appreciation derived from the tokens.

There are stringent guidelines attached to security tokens regarding who can purchase the coins and how they are transferred to others. For instance, you need to complete a Know Your Customer (KYC) protocol before being allowed to hold a security token for crowdfunding events. KYC ensures that each token investor has their real identity revealed, unlike the anonymity that dominated utility and exchange tokens.

Cryptoasset Characteristics

Now, utility, exchange, and security tokens are all highly unpredictable in terms of value. Several cryptos started with high values only to drop considerably low numbers. Others remain relatively stable, making them continuously lucrative to investors amidst the possible losses and risks.

Volatility is a crucial characteristic of cryptoassets. But other factors include the following:

  • Decentralized nature

  • Runs on a trustless ecosystem

  • Immutable – transactions cannot be undone

  • Fungible – individual tokens can be interchanged with other cryptoasset types

  • Generally anonymous; some cryptos like Bitcoin can be pseudonymous as owners are only identified through addresses or keys

  • Offers an exclusive cryptographic proof of ownership for the crypto holder

All these characteristics play important roles in the formulation of cryptoasset taxation policies in the United Kingdom and elsewhere in the world.

Which Taxes Apply

Most cryptoasset holders are individuals who use cryptos as a personal investment. They typically use the tokens to make certain purchases or gain capital appreciation, which increases the value or price of the cryptoassets. As such, the HMRC mandates that crypto holders are liable to pay Capital Gains Tax when they "dispose" or use their cryptos in the following ways:

  • Utilizing cryptos for payment of goods and services

  • Exchanging crypto assets for another crypto type

  • Selling cryptos to gain fiat money

  • Giving away crypto assets to other people

Computation for such taxes will be determined by the capital gains an individual gets from the crypto transaction.

Meanwhile, Income Tax and National Insurance Contributions shall be collected from individuals who receive cryptoassets from:

  • Mining

  • Airdrops

  • Lending / Staking

  • Hardforks (not subject to income tax)

  • Income

This is because these cryptoassets provide an individual with transactions comparable to those earned from wages or business incomes/profits. They can also be classified as miscellaneous income, on which income taxes will be imposed.

Now, employers may pay their employees using cryptoassets, and it'll be classified as a non-cash payment. In this case, the employee recipient becomes liable to pay Income Tax and National Insurance contributions.

Exchange Tokens Location and Taxation

HMRC introduced an update to its guidance concerning exchange tokens taxation in December 2019. This concerns the cryptoassets' situs, or location, being an essential factor in determining the tax liability on the tokens. Note that this only applies to exchange tokens and not to utility or security tokens. To date, HMRC doesn't have a clear position regarding the location of both utility and security tokens.

In the United Kingdom, a non-domiciled person is either a British national/passport holder or a foreigner who lives in the UK but considers another country as his domicile or permanent home. Non-domiciles play a significant role in the UK's income taxation. As such, non-domiciles income taxation is based on remittance, which means only gains and income remitted to the United Kingdom are taxed.

For cryptoassets, HMRC mandates that exchange tokens held by a non-domiciled individual will be located in the United Kingdom when the person is a UK resident. Therefore, the person becomes liable to pay taxes to the UK.

Now, cryptoassets are generally intangible assets, as seen by the UK courts. Considering the exchange tokens' location, using the beneficial owner's residency is the best way to determine its liability to pay taxes. Typically, the Taxation of Chargeable Gains Act 1992 sections 275 and 275A provide guidance on which assets are deemed located in the UK. However, these stipulations cannot be applied to exchange tokens in most circumstances. This is because:

  • Exchange tokens are seen as a new form of an intangible asset. As such, determining its location is entirely different from the rules that apply to other intangible assets like debentures or shares.

  • Exchange tokens can be "turned to account," which means that they can carry absolute economic values when used in transactions such as payment for goods and services, exchanging for another kind of token, or exchanging them for fiat money, a legal tender.

  • The exchange token's beneficial owner is the token's only identifiable party who will become liable for taxes.

Now, what happens if a particular cryptoasset is co-owned by two or more beneficial owners? How will the Capital Gains Tax be paid for the exchange token? For this, section 275C of the Taxation of Chargeable Gains Act 1992 applies. Under this legislation, the beneficial owners' interest in the co-owned tokens is determined by where that beneficial owner is a resident.

For instance, you're a UK resident who co-owns an asset with a non-UK resident. You'll be liable for Capital Gains Tax on the premise that your share of the co-owned asset's interests is located in the UK. However, this will not affect your co-owner's location since he is not a UK resident.

Meanwhile, the inheritance tax is another story. HMRC's position regarding cryptoassets and inheritance tax is rooted in section 158 of the Inheritance Tax Act 1984. Cryptoassets are viewed as "property" for purposes of inheritance tax. As such, the assets' location is not determined through Double Taxation Agreements.