On 20 December 2019, HMRC revised its published guidance in relation to cryptoassets. The revised guidance includes interesting commentary on the situs of "exchange tokens", more commonly known as cryptocurrency - i.e. where such assets are situated geographically, as a matter of law.

Why does it matter?

In a UK tax context, the question of whether an asset is situated within or outside the UK has a number of ramifications:

(1) For an individual who is domiciled outside the UK and is using the remittance basis, a gain realised on the disposal of a UK situs asset is immediately chargeable to capital gains tax (CGT). By contrast, a gain realised on the disposal of a non-UK situs asset only gives rise to CGT if something derived from the gain is remitted to the UK.

(2) In HMRC's view, if a non-UK domiciled individual who is a remittance basis user funds the acquisition of a UK situs asset using money that is derived from the individual's non-UK income or gains, that is a remittance of the income/gains in question. But there are good arguments that the position is, in fact, more nuanced than this, and that the acquisition of a UK situs asset using such money isn't necessarily a remittance.

(3) For an individual who is domiciled outside the UK, and is not deemed domiciled in the UK for tax purposes, the general rule is that only UK situs assets are within the scope of inheritance tax (IHT), for example in the event of the individual's death. Non-UK situs assets are generally outside the scope of IHT, as "excluded property".

(4) For a trust settled by such an individual, there is essentially the same general rule: only UK situs assets are within the scope of IHT, for example on ten yearly anniversaries of the creation of the trust. Non-UK situs assets are generally outside the scope of IHT, as "excluded property".

What are HMRC saying?

The HMRC comments about situs are restricted in scope to "exchange tokens", and don't extend to other forms of cryptoasset, such as "utility tokens".

HMRC explain that "Exchange tokens are intended to be used as a method of payment and encompasses ‘cryptocurrencies’ like bitcoin. They utilise DLT [distributed ledger technology] and typically there is no person, group or asset underpinning these, instead the value exists based on its use as a means of exchange or investment."

Situs under general law

HMRC's view is that "exchange tokens" beneficially owned by an individual are situated as a matter of general law where that individual is resident.

In HMRC's view this principle determines whether such tokens owned by a foreign domiciled, non-deemed domiciled individual are within the scope of IHT (see point (3) above). It also determines whether the acquisition of such tokens using non-UK income/gains results in a remittance of those income/gains (see point (2) above).

HMRC do not say what they mean by "resident". If their view were upheld by a court, the court might well do so on the basis that residence is to be determined applying long-standing principles regarding residence for the purposes of jurisdiction, and not tax residence under the statutory residence test.

In their paper, HMRC refer to tokens beneficially owned by "an individual". However, if HMRC are right about tokens being situated in the place of residence of their beneficial owner, the same rule must logically apply to tokens beneficially owned by persons other than individuals. In particular, it would follow that tokens held by a non-resident trust are non-UK situs; and that, where such a trust has been created by a foreign domiciled, non-deemed domiciled individual, such tokens are outside the scope of IHT (see point (4) above).

Situs for CGT purposes

HMRC note that for CGT purposes there are statutory rules determining the situs of assets, which can produce a different result from the rules that apply under general law. The comments made about the situs of "exchange tokens" for CGT purposes are a little out of focus.

HMRC note that such tokens are a form of intangible asset, different from the likes of shares and debentures (which is obviously correct), and say that "the only identifiable party to consider is the beneficial owner of the exchange token". HMRC seem to be saying, therefore, that for CGT purposes they will adopt the same situs rule as the one that, in their view, applies under general law - namely that an "exchange token" is situated where its beneficial owner is resident.

If this analysis were upheld, it would mean that gains realised by remittance basis users on the disposal of cryptocurrency would not qualify for the remittance basis, and would be immediately taxable (see point (1) above).

Are HMRC right?

In terms of existing jurisprudence about the situs of assets, HMRC's views are in one sense quite radical. Under general law, there is no existing class of assets whose situs is determined by the residence of the beneficial owner.

Under existing general law, there are essentially three principles that can apply to determine the situs of an intangible asset, depending on the nature of the asset in question. With some intangible assets, situs is determined by the physical location of a document that represents or derives its value from the asset. With other intangibles, situs is determined by the physical location of a register. And the situs of some intangibles is determined by where the counterparty, who would be sued to enforce rights arising under the asset, is resident.

None of these existing principles can be applied to "exchange tokens". These are undocumented assets, there is no register in any accepted sense, and there is no readily identifiable counterparty. As HMRC say, "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". It is essential that any rule for determining the situs of cryptoassets meets these criteria, and it seems relatively likely that if a court is called upon to determine the situs of such assets, it will adopt the rule proposed by HMRC. However, it is worth stressing that until there is a judicial decision on this, or there is statutory intervention, there is no law on the point.

HMRC seem to be on much weaker ground where the situs of "exchange tokens" for CGT purposes is concerned. It is reasonably clear that the statutory situs rules that apply for the purposes of CGT do not yield the result that such tokens are UK situated. HMRC seem to think that in a situation such as this, where an intangible asset is not expressly dealt with under the statutory situs rules, it is necessary to fall back on the question of where the asset is situated under general law.

However, there is an argument that if the statutory situs rules don't produce the answer that a particular intangible asset is UK situated, then that is the end of the matter - i.e. the asset is non-UK situs for the purposes of CGT. If that argument was upheld, it would mean that gains realised by remittance basis users on the disposal of cryptocurrency would typically be tax-free unless and until remitted to the UK - contrary to the view expressed in the HMRC paper.

The case for reform

There is a strong argument that the law of situs and source is in need of careful statutory reform. There are significant discrepancies between the situs principles that apply under general law and for CGT purposes, which are hard to justify. Aspects of the CGT situs rules are irrational, and difficult apply to modern financial instruments. There are situations in which an asset can be UK situs, either under general law or under the CGT rules, but be capable of generating non-UK source income, or vice versa. The law on the source of interest is something of an embarrassment, with the latest case in this area (Ardmore Construction) upholding a "multi-factorial" test which verges on meaninglessness. The pace of innovation in relation to financial instruments and the increasing complexity of financial transactions means that the existing rules are, in some cases, no longer fit for purpose.

The uncertainties about the situs of cryptocurrencies must surely add to the argument in favour of a clear, well considered and cohesive statutory code.

HMRC considers that throughout the time an individual is UK resident the exchange tokens they hold as beneficial owner will be located in the UK.

HMRC has considered other possibilities, but at this stage in the development of these tokens has found that a residence basis most accurately fits the majority of transactions.

This means a person who holds exchanges tokens is liable to pay UK tax if they are a UK resident and carry out a transaction with their tokens which is subject to UK tax.