HMRC ‘cracking down’ on crypto: How does it affect IHT and CGT liabilities?

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Investors are advised that they need to check their tax liabilities when buying and selling crypto assets but how do these digital tokens impact their standing with HMRC? Dominic Lawrance, partner at Charles Russell Speechlys, explained exclusively to what crypto owners should know.

At the end of 2021, HMRC began sending nudge letters to crypto asset owners, urging them to ensure they had paid the correct amount of income and capital gains tax (CGT) on their crypto holdings. 

These sparked concern from beginner investors who had not previously had a brush with HMRC quite like this, and ignoring such nudge letters can result in civil or criminal penalties. 

The cryptocurrency environment is still relatively young, which means many investors are understandably unsure of where they stand in regards to tax liabilities.

As regulations become more clear around crypto assets, investors will likely find themselves under increased scrutiny and should ensure they understand any new instructions with regards to their tax bills. 

Mr Lawrance explained that nudge letters are not something to be overly worried about as they are usually sent to taxpayers who have a non-compliant aspect of their financial circumstances, of which cryptocurrency is classed under. 

He shared: “These letters should not come as a surprise, as HMRC is cracking down on wealth held in the form of cryptocurrencies and similar blockchain-based assets. 

“HMRC suspects that the amount of tax reported and paid by taxpayers in connection with cryptocurrencies does not reflect taxpayers’ actual liabilities.

“Assuming this is true, most of the unreported liabilities are likely to be liabilities to capital gains tax (CGT).  However, there may be some inheritance tax (IHT) under-reporting as well.”

Under-reporting one’s liabilities can cause some significant issues for the taxpayers, and Mr Lawrance highlighted that since cryptocurrencies were first classed as assets when they first emerged there was widespread assumption that they were tax-free. 

This was based on the idea that crypto investments were a form of gambling, “but that view was never seriously tenable”. 

However, despite disputing these assumptions, there is still widespread confusion about how their CGT liabilities work with regards to cryptocurrency specifically and what counts as a disposal. 

Mr Lawrance added: “There are cases of individuals ‘switching’ between cryptocurrencies without appreciating that any such ‘switch’ is a disposal.”

Depending on the market value of the coins investors are switching to and from, this action may result in a gain or loss. 

He noted that “a significant amount of record-keeping” is required for accurate CGT reporting but some investors have “no clue about these rules”.

Not keeping accurate records during these switches and any losses or gains made can result in a “tax mess” which the investor will be required to sort out in order to report their CGT and pay the correct amount of tax. 

However, CGT is not the only tax liability for crypto investors to be concerned about. 

Mr Lawrance highlighted: “Under-reporting of IHT with respect to cryptocurrencies is likely to be a much smaller issue.  

“One reason for this is that generally there is less complexity to the analysis – where an individual has died holding any cryptocurrency, the holding is a form of property, which needs to be taken into account when working out the IHT bill.  

“A second reason is that cryptocurrencies are generally less favoured by older people; mortality rates amongst cryptocurrency investors are likely to be low.”

Cryptocurrencies themselves are a relatively new topic in the investing environment, and the thought of leaving these investments in one’s estate certainly a 21st century dilemma that many have not even considered. 

Because of this, Mr Lawrance shared that mistakes in one’s IHT with regard to cryptocurrency holdings is “likely to be born of ignorance rather than design”. 

He concluded: “There is a good argument that HMRC should offer a cryptocurrency disclosure facility, including an element of amnesty, or at least allowing tax to be reported on a simplified basis.  

“A well-designed facility for cryptocurrency investors would allow such investors to bring themselves into the fold, and would probably bring a substantial amount of wealth into the tax system.”

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