In November 2021 HMRC will begin sending ‘nudge letters' to UK domiciled individuals they have identified as holding crypto-assets to encourage them to ensure they have paid the correct amount of income tax and capital gains tax (CGT) on any income they have received from their crypto-asset holdings. At present, HMRC will not send nudges to resident non-domiciles however their gains will still be subject to CGT.
Nudge letters should not be ignored and early open communication and co-operation with HMRC is advised to avoid any potential civil or criminal penalties.
The nudge letters arrive amidst a rapidly changing crypto eco-system and there are many ways in which a crypto-asset investor may unknowingly make a taxable disposition. The onset of Decentralised Finance (DeFi) has further complicated an already complex sector.
A nudge letter need not necessarily be a cause for concern but it should be an opportunity to take expert advice on the potential tax liabilities affecting an investor's crypto-asset holdings.
I have been sent a nudge letter, am I required to act?
HMRC typically sends nudge letters when it has grounds to suspect that an individual's tax affairs are not presently in order. They are not always a mere ‘fishing expedition'.
HMRC may take further action against a nudged individual if they do not respond within a proscribed period, usually 60 days from receipt of the letter. Open, early communication and full co-operation is essential to minimise the risk of civil or criminal sanctions being imposed.
The current landscape for crypto-assets is far from user friendly at present and there are numerous ways in which an individual may be unknowingly triggering UK tax liabilities. For example, should a UK resident non-domiciled individual personally purchase crypto-assets using unremitted foreign income or gains they could be deemed to have remitted the funds to the UK and be taxed on the purchase accordingly.
DeFi presents further potential pitfalls for crypto-asset investors with a lack of certainty of how different applications will be taxed. Broadly, the wide range of potential DeFi profits are subject to income tax on staking and other DeFi activities. However, there is also concern that clients may trigger CGT disposals if staking and other activities involve crypto-to-crypto disposals (such as may occur when a token, or pair of tokens, is staked in exchange for Liquiity Pool tokens). Expert advice should be sought on these issues, which vary depending on the DeFi application being used. The vast majority of DeFi activities, such as yield farming, whereby investors lock up their crypto-assets in exchange for interest or other rewards, are not accounted for in HMRC's guidance and careful analysis is required on their tax treatment.
How can HMRC identify my crypto-asset holdings?
The nudge letters form part of a wider trend of increased data gathering by HMRC due to the suspected increase in hidden wealth generated through crypto-assets and left undeclared for tax purposes as investors mistakenly believe that they cannot be traced by HMRC.
HMRC is empowered by legislation and through international treaties to gather information from crypto-asset exchanges and data holders about their customers' transactions in and holdings of crypto-assets both in the UK and abroad. This includes personal data in the form of names and addresses, the value of crypto-asset holdings and trading frequency. This data can be collected from both one time and recurring customers. HMRC has requested and received bulk user data from exchanges from 2017 onwards.
Conclusion
It is clear that HMRC will continue to step up its data gathering activities and crypto-asset investors will come under increased regulatory scrutiny in the near future. The proposed incorporation of crypto-assets within existing automatic information exchange initiatives under DAC 8 will further progress this agenda. Investors must carefully manage their crypto-asset portfolios to ensure their holdings are not incurring unintended tax liabilities and should take expert advice to ensure they are structured as efficiently as possible.
The Forsters team were very early entrants into the crypto advisory market, and have been advising some private clients for over five years. Forsters is ideally placed to advise clients on the full scope of crypto issues, including the management and taxation of crypto-assets.
Originally Published 29 November 2021
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
