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Crypto taxation – not all unknown

November 2018  |  SPECIAL REPORT: CORPORATE TAX

Financier Worldwide Magazine

November 2018 Issue


The taxation of cryptocurrency transactions and cryptographic token transactions has been a matter of debate within the taxation profession over recent months. The boom in cryptocurrency transactions has meant that what was once an arcane corner of the taxation world, which many would never be asked to consider, has now landed at the forefront of taxation thinking. The big ‘pitch’ of those who promote cryptographic tokens and cryptocurrencies is that they are not quite like anything which has come before and, as a new asset class, they disrupt the world view of such financial assets. They do not fit snuggly into any pre-existing asset class and that is what makes them so difficult to pin down from a tax perspective.

In reality, there are two questions. The first is what are the taxation implications for the issuer of a token which undertakes a sale of cryptographic tokens? Secondly, once you own cryptographic tokens, what is the tax position once you dispose of them?

Token sales

The central point to remember when analysing tax for token sales and issues is that ‘not all tokens are born equal’ – that is to say that the individual facts of each token issue and the contractual or other characteristics of each ‘bundle of rights’ which the token represents are more relevant than the technology supporting the storage and transfer of the token. Whether a cryptographic token sale and issue is a sale and issue of equity, debt, a method of prepayment or payment for goods and services, property of some other kind, stock, or a convertible virtual currency under the US Notice 2014-21, is a matter of fact, and as such the taxation profile of such a transaction cannot be established without a detailed analysis of each case on its own merits.

It is important to note that the legal and accounting treatment of the issue of cryptographic tokens is relevant to its tax treatment, and the legal and accounting treatment will vary between cryptographic tokens depending on their respective functionalities and the rights or benefits conferred on their respective holders.

In short, there is no simple one word answer to the question: are ICOs taxable on the issuer? Each token deserves proper analysis on a case by case basis, and a premise of that analysis is that the technology does not, in many cases, actually alter the tax status and accounting treatment of the underlying transaction.

Buying and selling tokens

The actual status of a cryptographic token once it has been issued, and the tax treatment of sale and purchase transactions using that token, is somewhat more certain. Let us think about a company which buys and sells tokens on its own account. Let us say it buys 1000 tokens for £1 each and it holds them for a year. Over the year they rise in value to £1000 each and the company sells. What is the treatment of such a sale? Under common law systems such as Gibraltar, that transaction would most likely be characterised as a capital gain rather than income.

The company has bought and held, the trade does not exhibit characteristics such as those contained in the familiar ‘badges of trade’ test laid out on the HMRC website, and therefore, the gain on the trade is of a capital nature and subject to capital gains tax (CGT). Similarly, an individual who trades like this will be subject to CGT, not income tax. Globally, rates of CGT and income or corporation tax (or its equivalent) can vary widely. In the UK, for example, an individual will pay income tax on a marginal rate of up to 45 percent, but CGT is chargeable at a maximum of 28 percent for a higher rate taxpayer. This is a substantial difference, and not to be ignored when considering planning opportunities.

Various jurisdictions across the globe (such as Gibraltar) do not charge tax on capital gains at all. Jurisdictions similar to Gibraltar with a taxation system based on the standard British overseas territory model of taxing only that income which is ‘accrued in and derived from’ the specific territory have introduced capital gains tax in an inconsistent manner. In the example set out above, were the company incorporated and registered in Gibraltar, it would not be charged any tax on the sale of its tokens as long as such a sale represented a capital gain and not income (i.e., the badges of trade test were not met).

However, this model of ‘buy and hold’ is not always the most practical in a highly volatile market such as the crypto space. For example, on 19 September 2018, the price of Bitcoin rose $350 in the space of 10 minutes. Such volatility means that the high volume trading model is much more likely to be the business model adopted than in the case of a more stable mature market such as quoted equities.

There has been long debate as to whether or not trading on one’s own account amounts to income or capital. The famous case of Salt v Chamberlain in the UK indicated for many years that a trade in equities amounted to a ‘wager’ and not a trade in itself. Therefore, the received wisdom has been that trading on one’s own account cannot amount to a ‘trade’ and is never income, regardless of the characteristics of the trading model. However, the more recent case of Ali Akhtar v HMRC has thrown this matter into doubt. In this later case trading losses were allowed to be offset against income from a trading business. The crux of the matter was that Mr Ali traded high volumes, according to a scheme and with regularity, thereby overturning the oft-criticised blanket characterisation of gains from trading on one’s own account as a capital gain.

The interesting point is to consider how this characterisation interacts with those taxation systems which are territorially-based. Many of the territories which form part of the community which developed its tax law from the British tradition as ex-colonies tend to have a territorial basis taxation. Income is taxed on the basis of where it accrues and derives, not on a residence basis. Thus, in Gibraltar, St Helena, Hong Kong and other jurisdictions, income derived outside the territory is not taxable. The longstanding test for the measure of this is to be found in its definitive form in the Hong Kong case of Commissioner of Inland Revenue v. Hang Seng Bank Ltd. In that case the judges found that trading of stocks and shares on an exchange occurs where the exchange is located, not where the person pressing the button to order the trade is located.

Therefore, a company with operatives located in Gibraltar doing high volume trades in crypto assets accordance with a scheme (as would satisfy the test in Ali) on a crypto exchange based in Cyprus (for example) would not accrue and derive its income in Gibraltar and would therefore not be taxable in Gibraltar. In a jurisdiction where tax is charged on a ‘worldwide’ basis (such as the UK) these considerations are irrelevant; a UK company would be taxed on its worldwide income.

Individuals and companies would of course need to take full advice in any relevant jurisdiction before committing to build structures which are subject to this regime, but it is interesting to note that there are jurisdictions in which a tax advantageous outcome is possible.

The demographics of the professional crypto trader would seem to be that of a highly mobile educated individual. The choice of jurisdiction in which they will locate their business is a commitment that they will not take lightly. Gibraltar believes itself to be one of the best placed jurisdictions in the world for such professional traders. It provides stability, a bespoke regulatory framework for distributed ledger technology (DLT) and cryptocurrencies, and a growing community of crypto professionals.

Gibraltar is a thriving hub for fresh, leading-edge start-ups and established crypto-businesses alike, and will likely remain so well into the future. It is vibrant in its approach to such matters. Gibraltar enjoys a favourable reputation on the global stage, a crypto-friendly government and banking system, a robust regulatory regime and a longstanding tax regime – all of which combine to create an environment in which traders can flourish. Its location in the main European time zone makes it uniquely placed for professionals to take advantage of trading in global markets.

 

Grahame Jackson, Aaron Payas and Vikram Nagrani are partners at Hassans International Law Firm. Mr Jackson can be contacted on +350 200 79000 or by email: grahame.jackson@hassans.gi. Mr Payas can be contacted on +350 200 79000 or by email: aaron.payas@hassans.gi. Mr Nagrani can be contacted on +350 200 79000 or by email: vikram.nagrani@hassans.gi.

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